An international forensic perspective of the determinants of bank CDS spreads

Abstract

Against the backdrop of the Great Recession, investigating the differences in institutional frameworks became important to explain the heterogeneity in the market perception about the credit quality and default risk of banks in different countries. Using data for 118 banks of 30 countries over the period 2004–2011, we find that an improvement of the quality of economic and legal institutions can help in reducing banks' CDS spreads, as banks operating in countries where the regulatory quality is stronger tend to be less affected by spikes in financial stress of 2008–2009. Considering a series of indicators of the financial structure of the banking system, our results reveal that more concentration of the banking sector, a stronger presence of foreign banks, a deterioration of the banking sector health or the lack of alternative means of finance is associated with higher CDS spreads of banks. We also show that the dynamics of bank CDS spreads accrue to: (i) the quality of banks’ balance sheet; (ii) (il)liquidity of banks’ assets; (iii) how profitable banks’ operations are; and (iv) the banks’ leverage ratios. Finally, higher CDS spreads of banks tend to be associated with periods of high inflation and low GDP growth.