Bank Intervention Research Articles

The Impact of Government Intervention in Banks on Corporate Borrowers’ Stock Returns

AbstractWe investigate whether and how government interventions in the U.S. banking sector influence the stock market performance of corporate borrowers during the financial crisis of 2007–2009. We measure firms’ exposures to government interventions with an intervention score that is based on combined information on the firms’ structure of bank relationships and their banks’ participation in government capital support programs. We find that government capital infusions in banks have a significantly positive impact on borrowing firms’ stock returns. The effect is more pronounced for riskier and bank-dependent firms and for those that borrow from banks that are less capitalized and smaller.

Creditor Interventions and Firm Innovation: Evidence from Debt Covenant Violations

We examine the effect of bank interventions on corporate innovation and firm value via the lens of debt covenant violations, where control rights are shifted from equity holders to creditors. Using a difference-in-differences approach and a regression discontinuity design, we find that bank interventions have a negative effect on innovation quantity but not on quality. We further show that the reduction in innovation quantity is concentrated in innovation activities that are unrelated to the violating firm’s core business, which leads to a more focused scope of innovation investment and ultimately an increase in firm value. Human capital redeployment appears a plausible underlying mechanism through which bank interventions refocus firm innovation scope and enhance firm value. Our findings are consistent with the argument that banks help mitigate investment distortions in innovation arising from conflicts of interest between managers and shareholders. Our paper sheds new light on the real effect of bank financing.

Impulse Control of Interest Rates

This paper examines the effect that a central bank's interventions have on longer term interest rate securities by examining a stochastic short rate process that can be controlled by the central bank. Rather than investigate the motivations for the intervention, we assume that the bank is able to quantify its preferences and tolerances for various rates. We allow for a very general class of stochastic processes for the short rate, and most of the popular models in literature fall within this class. Interventions are best modeled as impulse controls, which are very difficult to handle, even computationally, except in very special cases. Allowing interventions to be modeled by impulse controls, we develop a computational method and provide relevant convergence results. We also derive error bounds for intermediate iterations. Using this method, we solve for the central bank's optimal control policy and also study the effect of this on longer term interest rate securities using a change of measure. The method developed here can easily be applied to a very wide range of impulse control problems beyond the realm of interest rate models.

Impulse Control of Interest Rates

Most academic studies on interest rate dynamics and derivative pricing assume that interest rates move freely in an open market, while there has been relatively little attention paid to the situation where a nation’s central bank has the power to intervene in the interest rate market. This paper examines the effect that a central bank's interventions have on longer term interest rate securities. We model the central bank’s intervention as an impulse control problem on a very general class of stochastic processes. As there is no known solution methodology to solve the posed problem, we develop a computational method and provide all the necessary theoretical guarantees. Using this method we solve for the central bank’s optimal control policy and also study the effect of this on longer term interest rate securities using a change of measure. The method developed here can easily be applied to a very wide range of impulse control problems beyond the realm of interest rate models.

Power of a Deposit Insurance Scheme’s Authority and a Banking Crisis

Using a large panel data set, this study analyzes effects of empowering the authority of an explicit deposit insurance scheme (EDIS) on banking crises. Findings suggest that the use of an EDIS increases the probability of a banking crisis. Moreover, this probability is greater if the EDIS is not empowered for the direct intervention in banks’ operations—e.g., the power to cancel or revoke banks’ deposit insurance contracts, or situations in which deposits are not explicitly covered before a bank failure but are to be covered after the failure . The probability is even greater if the EDIS is used in a less developed country while the scheme is not empowered for the direct intervention in bank operations or uncovered deposits are to be covered ex post to a bank failure.

Impulse Control with Random Reaction Periods and its Applications

We model an impulse control problem when the controller's action affects the state as well as the dynamics of the state process for a random amount of time. We apply our model to solve a central bank intervention problem in the foreign exchange market when the market observes and reacts to the bank's interventions.

Inflation Derivatives Under Inflation Target Regimes

Inflation targeting—the central bank practice of attempting to keep inflation levels within fixed bounds around a quantitative target—has been adopted by more than 20 economies. Such practice has an important impact on the stochastic nature of inflation and, consequently, on the pricing of inflation derivatives. We develop a flexible model of inflation targeting in which the central bank's intervention to steer inflation toward the target depends on past deviations and the policymaker's ability and will to enforce the target. We use our model to price inflation derivatives and demonstrate the impact of inflation targeting on derivative pricing.

The Impact of Government Intervention in Banks on Corporate Borrowers’ Stock Returns

Moving into and out of a financial and banking crisis is likely to be associated with spillover effects from the banking sector to the corporate sector. We investigate whether and how government interventions in the U.S. banking sector influence the stock market performance of corporate borrowers during the financial crisis of 2007-2009. We measure firms’ exposures to government interventions with an intervention score that is based on combined information on the firms’ structure of bank relationships and their banks’ participation in government capital support programs. We find that government capital infusions in banks have a significantly positive impact on borrowing firms’ stock returns. The effect is more pronounced for riskier and bank-dependent firms and those that borrow from banks that are less capitalized and smaller. Our study highlights positive effects from government interventions during the crisis, documenting that an alleviation of financial shocks to banks has led to significantly positive valuation effects in the corporate sector.

Bulgaria: 2012 Article IV Consultation--Staff Report; Public Information; and Statement by the Executive Director for Bulgaria

Bulgaria did not have any exchange rate crisis, international bailout, bank intervention, or build-up of public debt. This attests to the strength of the policy framework and policy implementation. The fiscal adjustment achieved so far should be preserved, but improving the composition of the budget would support growth. The financial system is stable with high buffers, but the low growth environment poses challenges. Executive Directors suggest the need for some structural reforms.

Does the central bank's intervention benefit trade balance? Empirical evidence from China

This paper employs the intervention indices measured from the modified Weymark (1997) model and modified trade models to evaluate the role of China's intervention behavior in the trade balances with its four major trade partners. In our constructed trade models, the intervention effects comprise direct and interactive phases, and their overall effects are diverse. Empirical results show that intervention actions actually create the largest trade advantage for China in the China–Japan case followed by the China–US case creating the next largest trade advantage for China. However, the trade balance is worsened in the China-European Unit case and in the China–Taiwan case. Considering the J-curve effect and the negative interactive effect in the China-European Unit case, the rate of the Chinese renminbi against the euro is not an appropriate intervention object for China.

The Impact of Government Intervention in Banks on Corporate Borrowers’ Stock Returns

The Impact of Government Intervention in Banks on Corporate Borrowers’ Stock Returns

Can intervention indices detect central bank's actual intervention behaviour?

This article employs the Weymark (1997) and Baig et al. (2003) models to evaluate the central bank's intervention behaviour and utilizes ex post intervention news to check the models' estimation results. Empirical results show that the Baig et al. model's evaluation performance in intervention behaviour is inferior to the Weymark model. The scale of intervention index is not an excellent indicator to detect intervention behaviour. Intervention indices and intervention news all support that the intervention frequency in expansion period is higher than in recession period and in face of fatal events the intervention exhibits cluster phenomenon.

RMB Exchange Market Pressure and Central Bank Exchange Market Intervention

AbstractThe present paper uses the model‐dependent and the model‐independent approach to measure the RMB exchange market pressure (EMP) and the central bank's intervention using monthly data from January 1999 to June 2008. It is determined that the RMB has been under great appreciation pressure over the past decade. However, the pressure has been weakening since 2005. The two approaches provide significantly different results in terms of the estimated RMB EMP indices and the estimated central bank's interventions. The differences may lead to different predictions of potential currency crises. According to the estimation of the RMB EMP, and based on the model‐independent approach, the paper shows that China has been under threat of an appreciation currency crisis since 2008. Therefore, China should adopt a more flexible exchange rate regime to prevent a potential crisis.

Challenging the Failed State Thesis: IMF and World Bank Intervention and the Algerian Civil War

With the onset of civil war in the early 1990s, Algeria appeared to join the growing list of failed African states. The idea of state failure has developed over the past 20 years and is now common currency amongst academics and political leaders alike. The aim of this article is to investigate the analytical usefulness of the academic state failure literature, and its ability to explain the onset and development of socio-political crises in post-colonial African states. The article identifies two important weaknesses in this literature: its dichotomisation of the international and domestic spheres, and the emphasis on domestic factors in its explanation of why such crises occur. Through its analysis of the International Monetary Fund's (IMF) and World Bank's interventions in Algeria between 1994 and 1999 the article substantiates the criticisms it makes of this literature.

Inflation Derivatives Under Inflation Target Regimes

Inflation targeting -- the central bank practice of attempting to keep inflation levels within fixed bounds around a quantitative target -- has been adopted by more than twenty economies. Such practice has an important impact on the stochastic nature of inflation and, consequently, on the pricing of inflation derivatives. We develop a flexible model of inflation targeting in which the central bank's intervention to steer inflation towards the target depends on past deviations and the policymaker's ability or will to enforce the target. We use our model to price inflation derivatives and demonstrate the impact of inflation targeting on derivative pricing.

Foreign-Exchange Intervention Strategies and Market Expectations: Insights from Japan

This study extends the traditional set of central bank's interventions to include official announcements in order to provide empirical evidence on two pivotal questions: i) are FX authorities able to influence market expectations with different instruments? ii) how should interventions be designed to have the greatest impact? Using Japanese data over 1992-2004 and an event-study approach, we estimate the effect of different strategies on the USD/JPY exchange rate risk neutral density. Overall, transparent policies (public and oral interventions) appear to be the most effective. Moreover, the effect is greater when policies involve a financial cost (risk) suggesting that simple announcements can only be deemed as an imperfect substitute for actual interventions.

Safe banking to avoid moral hazard

This paper argues that the moral hazard risk faced by a banking or non-banking firm can be dissipated by arbitrage trading in a market economy. This implies an optimal policy for (a) discontinuation of government insurance, regulation or bank intervention and (b) promotion of market-based safe banks that only invest in government securities and universal banks that invest in all assets. Safe banks can serve panic-prone depositors and thus minimise the systemic risk faced by an economy due to banking panics and runs. The risk premium on assets of a leveraged firm can be shown to be negatively related to asset volatility. The minimum asset-to-debt ratio threshold below which a firm goes bankrupt is an increasing function of the asset risk premium.

Foreign-exchange intervention strategies and market expectations: insights from Japan

This study extends the traditional set of central bank's interventions to include official announcements in order to provide empirical evidence on two pivotal questions: (i) are FX authorities able to influence market expectations with different instruments? (ii) how should interventions be designed to have the greatest impact? Using Japanese data over 1992–2004 and an event-study approach, we estimate the effect of different strategies on the USD/JPY exchange-rate risk-neutral density. Overall, transparent policies (public and oral interventions) appear to be the most effective. Moreover, the effect is greater when policies involve a financial cost (risk) suggesting that simple announcements can only be deemed as an imperfect substitute for actual interventions.

Is Central Bank Intervention Effective Under Inflation Targeting Regimes? the Case of Colombia

Policymakers in many emerging markets are attempting to resist currency appreciation while simultaneously meeting targets for inflation. Using the recent experience of Colombia between 2004 and 2007, this paper examines the effectiveness of the Central Bank's intervention in stemming domestic currency appreciation under an inflation targeting regime. The results indicate that exchange rate intervention was effective during 2004-2006, when foreign currency purchases were undertaken during a period of monetary easing. During 2007, on the other hand, intervention was ineffective in reversing or slowing down domestic currency appreciation, as large-scale intervention became incompatible with meeting the inflation target in an overheating economy. Currency derivative markets-which have grown in depth and sophistication-played a key role in blunting the effectiveness of intervention.

Is Central Bank Intervention Effective Under Inflation Targeting Regimes? The Case of Colombia

Policymakers in many emerging markets are attempting to resist currency appreciation while simultaneously meeting targets for inflation. Using the recent experience of Colombia between 2004 and 2007, this paper examines the effectiveness of the Central Bank's intervention in stemming domestic currency appreciation under an inflation targeting regime. The results indicate that exchange rate intervention was effective during 2004-2006, when foreign currency purchases were undertaken during a period of monetary easing. During 2007, on the other hand, intervention was ineffective in reversing or slowing down domestic currency appreciation, as large-scale intervention became incompatible with meeting the inflation target in an overheating economy. Currency derivative markets-which have grown in depth and sophistication-played a key role in blunting the effectiveness of intervention.