Risk Exposure, Liquidity and Bank Performance: New Evidence from the Recent Financial Crisis of 2007–2008

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In this paper, we examine the main determinants of stock return performance of 178 large and medium sized banks across the world, during the recent financial crisis of 2007–2008. We test the validity of various hypotheses advanced in the academic literature to address the question of why some banks performed so poorly during the crisis. Previous empirical analysis reports that the fragility of banks financed with short-term funds raised in capital markets, as well as the insufficient capital are among the factors that can explain the poor bank performance during the crisis. Our analysis brings new evidences in support of these arguments. We find that financial institutions with less deposits and loans, more liquid assets, lower return, lower ex-ante risk, and more funding fragility ahead of the crisis performed more poorly during the crisis. We investigate the impact of regulations on bank performance and find a strong correlation between restrictions on bank activities and bank stock return only in the sample of large banks. However, no systematic evidence exists that such restrictions made banks less risky before the crisis. Our main results hold up in a variety of robustness tests.