Bank Holding Research Articles

Executive Compensation, Bank-Owned Life Insurance, and Bank Holding Company Performance

Bank-owned life insurance (BOLI) is life insurance purchased by bank holding companies (BHCs) for key employees, whose proceeds can be shared by the company and employees' heirs. We investigate whether and how executive compensation affects BOLI and whether BOLI use affects BHC performance. Using a sample of 2,041 firm-year observations from 2004 through 2013, we find a statistically significant positive relation between CEO compensation and BOLI, supporting the notion that BOLI is a complement to other forms of compensation. Further, we provide evidence that increases in BOLI, both relative to total assets and relative to other BHCs, benefit shareholders. This suggests the incentive effect of BOLI on BHC executives outweighs the potential agency problem of BOLI. The results are robust across various measures of BOLI and model specifications. Our results imply that ex-ante incentives embedded in BOLI motivate BHC managers to enhance shareholder value.

The Earnings Smoothing Management Philosophy of BHCs in the SFAS -133 Framework

Purpose- The main purpose of this paper is to examine whether or not Bank Holding Companies (BHCs) took advantage of SFAS’s 133 differential treatment of the changes in the fair value of cash flow hedges to smooth earnings. Design/methodology/approach- The author used a causal-comparative research design featuring an investigation on the Income Smoothing effects of BHCs’ corporate use of derivatives designated as cash flow hedges and discretionary accruals one year after the 2008 amendment of SFAS 133. Findings- The results of this research showed that SFAS133-Accounting Hedgers had smoother earnings than SFAS133-Compliant Hedgers due to derivative use but did not take advantage of the differential treatment of cash flow hedges to manipulate earnings. This study suggests that hedge accounting rules under SFAS 133 fully determined the hedging behavior of SFAS-Accounting Hedgers . To ascertain the implementation of effective hedges SFAS-Accounting Hedgers captured the benefits of hedge accounting while compromised the economic benefits of hedging in an attempt to manage any associated accounting volatility and smooth earnings. Research limitations/implications- This study extends prior research on corporate risk management activities of BHCs and impacts social change by presenting new evidence on the effects of SFAS 133 cash-flow hedges on earnings smoothing. Practical implications- The evidence suggests that corporate governance mechanisms affect earnings management since BHCs withhold discretion with respect to the realization of gains and losses from derivative instruments designated as cash flow hedges. This is an indication that BHCs with an intent to achieve smoother earnings as a leading corporate risk management strategy, have a comparative advantage compared to non-financial institutions to apply hedge accounting since they regularly use derivatives and are more experienced with the implementation of SFAS 133. Originality/value- Although prior studies typically considered derivatives and accruals as substitute proxies in managing reported earnings, the paper’s results suggest that the most significant determinant of earnings smoothing is derivative use for SFAS-Accounting Hedgers and information asymmetry for SFAS133- Compliant Hedgers .

Heterogeneity in the Bank Risk-Taking Channel of Monetary Policy: Empirical Evidence of U.S. Bank Holding Companies

In this study, I analyze the heterogeneous dynamics of the bank risk-taking channel of monetary policy under different business models before the recent financial crisis in the U.S. I find that banks' asset-side risk-taking in a low interest rate environment exhibits heterogeneity across different bank business models. In addition, I find that the heterogeneity lies in the behavior of banks as yield-oriented investors by investing in the non-trading account securities in search for yield. Moreover, banks respond asymmetrically to expansionary and contractionary monetary policy. Although monetary policy is not neutral to the financial stability of the banking sector, the lean-against-the-wind type of monetary policy should be carefully applied due to the heterogeneity and asymmetry in the risk-taking channel.

Banks and sovereign risk: A granular view

We investigate the determinants of sovereign bond holdings of German banks and the implications of such holdings for bank risk. We use granular information on all German banks and all sovereign debt exposures in the years 2005–2013. As regards the determinants of sovereign bond holdings of banks, we find that these are larger for weakly capitalized banks, banks that are active on capital markets, and for large banks. Yet, only around two thirds of all German banks hold sovereign bonds. Macroeconomic fundamentals were significant drivers of sovereign bond holdings only after the collapse of Lehman Brothers. With the outbreak of the sovereign debt crisis, German banks reallocated their portfolios toward sovereigns with lower debt ratios and bonds with lower yields. With regard to the implications for bank risk, we find that low-risk government bonds decreased the risk of German banks, especially for savings and cooperative banks. Holdings of high-risk government bonds, in turn, increased the risk of commercial banks during the sovereign debt crisis.

Banking, Not Banking and the Valuation of Banks

Rethinking of bank business models, fueled by the recent crisis and tightened capital requirements, is under growing attention from financial research on banks. Effects of the income structure on banks’ performance and value creation are central items. Market valuations of banks are of particular interest since they reflect combined expectations for profitability and risk. To date, studies refer to aggregated components of earnings. Hence findings provide with limited insight on the value-contribution of specific activities and, further, they tend to conflict.The present paper proposes an original investigation of the value-contribution of different activities, based on a sample of 218 quoted US Bank Holding Companies throughout 2003-2009 (a full economic cycle). With regard to an historical debate and a major issue for banks’ stakeholders, it emphasizes on the contribution of traditional banking services as opposed to various non-banking activities. The contribution of banking is found to be influenced by its components: interests on loans tend to contribute negatively but banking fees positively. Besides banking fees, the valuation of the smaller BHC is also supported by customer investment services. The larger BHC may benefit from a broader spectrum of non-banking activities, such as insurance, as opposed to interests on loans. Trading has a negative influence for all specifications. These results are robust to underlying effects on ROE and risk. The hierarchy of value-contributions is next addressed. For all samples, of which also BHC with the highest banking fees within banking income, customer investment services over-perform banking. Insurance activities under-perform banking, even for the larger BHC and BHC with lowest banking fees intensities.

Business Complexity and Risk Management: Evidence from Operational Risk Events in U.S. Bank Holding Companies

Recent regulatory proposals tie the systemic importance of a financial institution to its complexity. However, we know little about how complexity affects a bank's behavior, including its risk management. Using the gradual deregulation of banks' nonbank activities during 1996-1999 as a natural experiment, we show that the frequency and magnitude of operational risk events in U.S. bank holding companies have increased significantly with their business complexity. This trend is particularly strong for banks that were bound by regulations beforehand, especially for those with an existing Section 20 subsidiary, and weaker for the other banks that were not bound and for nonbank financial institutions that were not subject to the same regulations to begin with. These results reveal the darker side of post-deregulation diversification, which in earlier studies has been shown to lead to improved stock and earnings performance. We use operational risk events as a risk management measure because (i) the timing of the origin of each event is well identified, and can be years before it is materialized into a loss in the balance sheet, and (ii) the risk events can serve as a direct measure of materialized failures in risk management without being influenced by the confounding factors that drive asset prices, such as implicit government guarantees. Our findings have important implications for the regulation of financial institutions deemed 'systemically important,' a designation tied closely to their complexity by the Bank for International Settlements and the Federal Reserve.

Operational Risk and Risk Management Quality: Evidence from U.S. Bank Holding Companies

This study documents the association between the quality of risk management practices and operational loss realizations at large financial institutions in the United States. Using detailed supervisory data, we find that companies with weak risk management practices experience higher and more volatile operational losses. We document the drivers of this relationship across different operational risk event types and risk management dimensions. In addition, we present evidence that the strength of risk management practices prior to the 2008-2009 Financial Crisis has explanatory power over loss realizations during the crisis period. Our analysis provides new evidence of the importance of risk management practices for curtailing risk realizations at financial institutions.

Mandatory Clearing of Derivatives and Systemic Risk of Bank Holding Companies

This paper investigates systemic risk of bank holding companies (BHCs) following the enactment of mandatory clearing of derivatives by the Dodd–Frank Act. We find that BHCs that were bigger users of derivatives experienced a larger drop in systemic risk after mandatory clearing, all else being equal. This relationship holds across different measures of systemic risk and across several robustness checks that account for potential endogeneity and self-selection bias, including data mining through high-dimensional methods. Overall, our results suggest that derivatives clearing can curtail systemic risk in the banking system.

Transmission of News in Eurozone Bank Holdings and European Bank Markets in the Light of the Greek Debt Crisis

This article examines the interdependence of European bank sectors under two different aspects. First, we investigate the symmetric transmission mechanism between six Eurozone countries’ (Germany, France, Greece, Ireland, Italy and Spain) bank holdings in order to uncover the volatility and error interrelationship of these holdings and their impact on the Greek bank holdings. Also, we analyse the impact from the Greek bank holdings on the other Eurozone countries’ bank holdings. In addition, we examine the impact of the Greek bank holdings on the transmission mechanism among all six cross-country bank indices. Second, we investigate the interrelationship of Greek bank market with two emerging cross-country bank indices and two developed ones. The two groups concern Greece, France and Germany and Greece, Poland and Czech Republic, respectively. We find very strong volatility and error spillovers for five Eurozone countries’ (Germany, Greece, Ireland, Italy and Spain) bank holdings, whereas French bank holdings are less integrated with the other five ones. Moreover, the results indicated that the Greek bank market is integrated better with the two emerging bank indices rather than the two developed ones. In addition, the Greek debt crisis seemed to play an important role on the volatility transmission mechanism since the volatility and error spillovers are larger in magnitude in the after-crisis period than in the pre-crisis period for both groups of countries. Based on the results regarding the degree of volatility persistence, the number of days that the innovations in the post-crisis period last is larger than the number of days of the pre-crisis period for both groups of countries under study. JEL Classification: G15, G20, C61, C3

Bank Holding Company Regulation in Kenya, Nigeria and South Africa: A Comparative Inventory and a Call for Pan-African Regulation

An overview of the regulation of bank holdings in three African jurisdictions (Kenya, Nigeria, South Africa), from a comparative legal perspective (EU and US), identifying regulation of a banking group's parent on the basis of ten identified elements of holding regulation, and calling for action to harmonise African bank holding regulation or adopt pan-African regulation. Submitted for publication in a law journal.

Heterogeneous Procyclicality of Bank Leverage: Empirical Evidence of U.S. Bank Holding Companies

Since the recent financial crisis, the procyclical leverage of banks has been highlighted, as it is an important mechanism in propagating financial shocks to the real economy. Procyclical leverage has been identified in investment banks due to the active balance sheet management based on the Value-at-Risk rule or mark-to-market accounting. However, the evidence for commercial banks and universal banks is ambiguous. In this study, I provide empirical evidence of heterogeneity in the procyclical leverage of U.S. commercial banks and universal banks across different periods and present some underlying mechanisms of heterogeneity. The findings shed light on the necessity of developing measures for heterogeneous procyclicality based on different business models and embedding the stylized facts in the macro-model for the study of business cycle dynamics.

Measuring Agency Costs and the Value of Investment Opportunities of U. S. Bank Holding Companies with Stochastic Frontier Estimation

By eliminating the influence of statistical noise, stochastic frontier techniques permit the estimation of the best-practice value of a firm’s investment opportunities and the magnitude of a firm’s systematic failure to achieve its best-practice market value – a gauge of the magnitude of agency costs. These frontiers are estimated from the performance of all firms in the industry and, thus, capture best-practice performance that is, unlike Tobin’s q ratio, independent of the managerial decisions of any particular firm. Using the frontier measure of performance applied to 2007 data on top-tier, publicly traded U. S. bank holding companies, we obtain evidence on market discipline: we find that higher managerial ownership at most banks tends to align the interests of insiders with those of outside owners and to be associated with improved financial performance; at most banks, higher blockholder ownership is associated with improved financial performance obtained from blockholders’ monitoring; and, at most banks, higher product-market concentration is associated with poorer financial performance and the so-called managerial quiet life. Using the frontier measure of investment opportunities, we find evidence that banks with relatively higher-valued investment opportunities achieve less of their potential market value, while banks with lower-valued opportunities achieve more of their potential value. In spite of their lower-valued opportunities, these banks, on average, achieve the same Tobin’s q ratio and, thus, appear better able to exploit their less valuable investment opportunities. Our results suggest that higher-valued opportunities may reduce managers’ performance pressure and provide a stronger incentive to consume agency goods.

Wealth Inequality in Sweden: What Can We Learn from Capitalized Income Tax Data?

This paper presents new estimates of wealth inequality in Sweden during 2000–2012, linking wealth register data up to 2007 and individually capitalized wealth based on income and property tax registers for the period thereafter when a repeal of the wealth tax stopped the collection of individual wealth statistics. We find that wealth inequality increased after 2007 and that more unequal bank holdings and apartment ownership appear to be important drivers. We also evaluate the performance of the capitalization method by contrasting its estimates and their dispersion with observed stocks in register data up to 2007. The goodness-of-fit varies tremendously across assets and we conclude that although capitalized wealth estimates may well approximate overall inequality levels and trends, they are highly sensitive to assumptions and the quality of the underlying data sources.

Reassessment of Diversification Effects in U.S. Bank Holding Companies: Aquantile Regression Approach

Heterogeneous patterns of the diversification effects are identified across the full distributions of various risk-adjusted performance measures and over time using a quantile regression of U.S. bank holding company data for the period 2000-2010. The net effect of income diversification is determined by a positive indirect effect from a diversified income structure and a negative direct effect from an increased share of non-interest income. The first main empirical finding shows a greater discount in the upper quantiles of the performance distributions. Second, the net diversification effect changes from a discount to a premium over time. These findings suggest that the diversification discount reflects a loss of comparative advantage at the early adjustment stage of income diversification. However, after the costly adjustment, the diversification benefit becomes dominant and the net effect becomes a diversification premium.

Should Islamic Bank Hold More Capital Compared to Conventional Banks? A Holistic Assessment of Risk Profile vis-a-vis Capital Adequacy Regulations

The expansive generalization on the assets of Islamic Banks (IB), being relatively riskier as compared to their conventional counterpart, stand justified owing to the contractual nature and the overall business model of IBs. These assets based or backed by trade (Murabaha, Salam, and Istisna) or lease (Ijarah) accompany the incremental risk on the books of the bank. Not only that the risks are unique, but the risk transformation across various phases of the contract’s life-cycle is tricky. Needless to mention here the rarely employed equity risk inherent in the PLS modes (i.e. Mudaraba and Musharaka) based assets. However, identifying the right level of capital (aka Capital Adequacy) warrants an intricate probe of the overall balance sheet risk both on the asset and the liability side. The well-established norm of Capital Adequacy Ratio of 8% of the risk weighted Asset (RWA) (Basel Accord) dictates not only the asset composition, but also indirectly influences the capital structure of a bank in terms of the amount of fixed deposits, reserves, subordinated debt and equity (classified as various tiers of capital in the Capital Adequacy (CA) regulations (Archer et al, 2006). Visualized as a pass-on structure based on a two-tier Mudaraba (Uzair, 1978), deposits in IBs are supposedly quasi-equity in its nature. This essentially has a significant implication on the overall risk profile and subsequently on the Capital Adequacy of an Islamic Bank. The paper attempted to carry out a discursive analysis to highlight the general and unique risk in an IB, to elaborate their capital requirement. Employing an intuitive and exploratory approach, the paper expanded on the risky assets of an IB and subsequently presented a holistic view of the overall risk profile, capital requirement and performance and their interplay to assess the sustenance of IBs as faith driven financial intermediary.

US bank holding companies: Structure of activities and performance through the cycles

The development of market-based finance has supported a larger involvement of banks in non-banking activities over the last decades. Does diversification beyond “traditional” banking result in actual diversification of earning risks and superior risk-return profile? Existing studies on bank performance address the effect of earnings based on accounting types and for specific time periods. With the exception of proprietary investments and financial leverage, knowledge with regard to underlying activities is scarce and little conclusive to date. Other studies, mainly stemming from central banks, do not focus on activity types or risk-return but evidence a marked influence of economic conditions and financial markets on banks' income.The paper proposes a twofold original contribution by addressing the influence of economic conditions and financial markets on specific activities conducted by banks. Based on granular data from a panel of US Bank Holding Companies (BHC), it first aims at estimating profitabilities related to “traditional” banking services and to (customers) investment services conditional to the environment. The study is then extended by the simulation of multiple scenarios to assess the expected performance of activities (profitability and risk) as well as the extent of uncertainty. Diversification into investment services is found to improve the expected risk-return. Also, well calibrated interest rate mismatch (between assets and liabilities) further supports performance. Deviations from historical volatilities and correlations of influential variables may cause diversification benefits to vary. Results however also suggest that the uncertainty of ROE associated with such diversification is limited compared to banking alone.

Thermodynamic Properties of the U.S. Banking System

We model the U.S. banking system as a thermodynamic system of interacting elements with individual banking firms representing those elements. Firms with similar asset and liability structures interact in the sense that they pursue similar objectives. These objectives include specialization in lending, processing, investing, etc. In this model of a thermodynamic system, each firm can pursue multiple objectives at the same time. The energy of a firm relative to a given objective determines to what extent the objective is achieved: the lower the energy, the closer the firm is to the objective. A firm’s total energy is determined as a weighted sum of its energies relative to individual objectives it is pursuing. As with any thermodynamic system, each firm’s overall objective is to reduce its total energy. The preliminary results of calibrating the model to the balance sheet structure of U.S. large banks using Uniform Bank Holding Company Performance Reports reveals that a slow buildup in herding (i.e., pursuing similar objectives) was occurring before the last crisis among some groups of banks. Significant change in the objectives is observed in the later stages of the crisis, however, especially in the direction of moving away from the objectives set before the crisis.

Bank Holding Companies' Accounting versus Economic Hedging Activities in the SFAS 133 Framework

The goal of this research was to investigate the controversy surrounding the inability of Statement of Financial Accounting Standard No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities to portray the economics of hedging. This research examined whether or not the possibility of increased volatility evolved from economic hedges that do not qualify for hedge accounting under SFAS 133 prompted Bank Holding Companies (BHCs) to adjust their corporate risk management strategy to one that is more accounting responsive. Based on the results of this research, BHCs' which increased the level of accounting hedges and decreased the level of economic hedges experienced a significant decrease in earnings volatility relative to pre-SFAS 133. The findings suggest that BHCs' ability to reduce earnings volatility and increase earnings smoothing to meet analysts' expectations after the 2008 amendment of SFAS 133 has an adverse impact on BHCs' continual use of economic hedges. Analysts and investors are recommended to evaluate further BHCs' risk strategies to gain a better representation of their risk paradigm with derivatives. This study extends prior research on corporate risk management activities of BHCs and contributes to social change by presenting new affirmation to investors of the influence of SFAS 133 economic hedges on earnings volatility.

Establishing The Relative Competitiveness Of South African Banking Shares: A Kalman Filter Approach

<p>It is argued that the Basel III Accord will undermine the ROE of South African banks, and with the downgrading of South African banks during August 2014, will force investors to revaluate South African banking shares as attractive investment options. However, results from the Sharpe and Omega ratios, based on returns forecast using the Kalman filter, accentuate the likelihood that the South African industry can still be expected to be a competitive and feasible investment option after the downgrade. Evidence suggests that Capitec Bank Holdings Limited and Standard Bank Group Limited will perform the worst of all the South African banks, whereas FirstRand Limited, Investec Limited, and Barclays African Group will exhibit more promise in the future, outperforming world indices, such as the DAX, FTSE 100 and the S&P 500.</p>

How Do Noninterest Income Activities Affect Bank Holding Company Performance?

We investigate whether noninterest income activities (both traditional and non-traditional), are associated with bank performance measures. We present evidence consistent with the theory that there is synergy between interest and noninterest income that improves performance. A decomposition of the main performance measure (ROA) into cost and revenue ratios reveals that the enhanced performance associated with noninterest income arises through both revenue and cost efficiency. In addition to ROA, we also use a risk adjusted performance measure and find consistent results. Our results also show that during the recent financial crisis, noninterest activities do not adversely affect BHC performance, and in some cases they even improve performance. We further address issues of the persistence of ROA and endogeneity by using a dynamic panel data approach, and our results remain consistent.