Fragile Banking System Research Articles

Monetary Policy, Institutional Quality and Banking System Fragility in Nigeria

The banking sector is dependent on the economy and environment in which it operates for survival and stability. Lack of effective and efficient institutions and bad monetary policies may spell doom for a country’s banking system. In Nigeria, over the years, many banks did not become distressed, they have folded up as a result of problems relating to institutional quality and unfriendly monetary policies. This study, therefore, examined the effect of both institutional quality indicators and monetary policies on the fragility of the Nigerian banking system from 2000 to 2022. We used a dataset comprising six institutional quality and three monetary policy variables as well as the banking system fragility indices for the period 2000 – 2022. Having examined the statistical properties and conducted some pre-estimation tests, we employed the autoregressive distributed lag (ARDL) technique to determine the short and long run effects of the institutional quality and monetary policy variables on the banking system fragility index for the period. We found that, in the short run, in terms of institutional quality, only voice and accountability index had a declining effect on banks’ stability (worsening fragility) while with respect to monetary policy, loan-deposit ratio had a positive effect on the fragility index (reducing fragility). In the long run, neither the institutional quality nor the monetary policy variables have significant effect on the fragility index of the Nigerian banking system during the period. We conclude that institutional quality and monetary policy affect the Nigerian banking system fragility significantly in the short run and that the former have no significant effect on the latter on the long run. We recommend a focused approach on institutional reforms and periodic assessments and adjustments of the reforms, capacity building, improvement of institutional coordination, and ensuring that policies are not only well-designed but also effectively implemented and a continuous fine-tuning of monetary policies to adapt to changing economic conditions.

Competition–banking stability: the moderating role of government intervention quality in North African countries

PurposeThis study investigates how bank competition affects financial stability and whether government intervention contributes to shaping this relationship in North African countries.Design/methodology/approachA review of the literature on the subject was conducted, combined with an empirical analysis that used a two-step system generalized method of moments (GMM) and a sample of 45 banks operating in North African countries over the period 2005–2019.FindingsThe findings reveal a quadratic relationship between competition and banking stability in North African countries. Competition–stability view and competition–fragility view could be applied at the same time for North African banks. Additionally, in this context, results highlight a negative impact of government intervention on financial stability in a competitive financial sector. North African banks operating in a high government intervention quality environment tend to engage in high-risk investments. Robustness checks with alternative measures of competition and banking stability also show consistent results.Originality/valueTo the authors’ knowledge, this is the first time that the North African context has been explored to determine the role of the quality of government intervention in the relationship between competition and banking system fragility. This paper seeks to cover the shadow field in existing literature through further new information. Thus, it contributes to the emerging market banking literature by showing that both high and low levels of competition can improve financial stability in North African countries. Moreover, it expands its contribution by displaying the moderator effect of intervention quality on the bank competition–stability relationship.

Analysis of Applying of Sustainability Business for Cooperative Reputation

The cooperative has been occurring poor performance, low competitiveness, lack of professionalism, unresponsiveness to changes in the business environment, inefficient management of the economy and business sector and the fragile banking system are fundamental weaknesses in cooperatives in Indonesia. The reputation of the Cooperative is a factor that Corporate Governance is one of the factors that can be analyzed as a lack of good relations between various stakeholders. The city of South Tangerang as a relatively new city has about 5 cooperatives that have been maintained by the Dinas Koperasi and have constraints such as reputation and cooperative governance. This research is qualitative research with a case study approach based on predetermined criteria. The results of this study are in the form of an overview of the cooperative management in South Tangerang and its recommendations.

BANKING SYSTEM FRAGILITY IN NIGERIA: HANGING ON THE PRECIPICE?

The health of a country’s banking system is a key determinant to the development of the country. A fragile banking system portends danger not only to the financial system but the entire economy. This study investigates the state of the Nigerian banking system in terms of stability or fragility from 1981 to 2020. We used the banking system fragility index (BSFI) proposed by Kibritçioğlu (2003) to analyze Nigerian banking industry aggregate data from three risk areas: credit, market and liquidity. We estimated that out of the 40 years examined, the banking system was fragile for 23 years given their BSFI less than 0 while it was not fragile for 17 years with BSFI = 0 or greater. We found that most of the years when the Nigerian banking system was fragile were periods of relaxed monetary policies, deregulation and credit expansion. Secondly, the years of banking system stability were when the county’s banking system was subjected to stiff regulation and consolidation. Given the number of years that the system was fragile, we observed that sustained economic growth and development requires that the banking system remain strong as long as possible, and that the Nigerian situation could not promote this important objective. We recommend that the financial regulatory authorities put in place more stringent policies as banks are more fragile during the deregulation of the banking industry.

Ownership Structure, Size, and Banking System Fragility in India: An Application of Survival Analysis

Abstract The Reserve Bank of India has put 11 public sector banks under prompt corrective action and is planning to put three more where public sector banks constitute 68.9% of the total asset of the Indian banking industry based on 2018 figures; this raises a genuine concern for the financial health of the Indian banking sector as a whole. Under these considerations, this study is conducted to estimate the survival of banks based on ownership and size and uses the Cox proportional hazards model. This study has not found any significant difference in the failure risk of both public and private sector banks based on ownership. However, the study found a significant difference in the failure risk of banks based on size. The smaller banks are indeed at a higher risk of failure than larger banks. The findings of this study can be used to create an early warning system for smaller banks in India.

Myanmar

The COVID-19 pandemic is expected to hit hard Myanmar’s economy via weaker exports, tourism, remittances and domestic demand. The economic and social costs of a widespread outbreak could be large, against the backdrop of a frail healthcare system and inadequate social safety nets, as well as already low international reserves and a fragile banking system. The measures to contain and alleviate the effects of the pandemic open up sizeable BOP and fiscal financing gaps in the near term.

Peripheral Banking System Fragility and its Effect on EMU Monetary Policy Transmission Mechanism

This article evaluates the transmission through intermediaries taking into consideration the dichotomy between peripheral and core banking systems with regards to the ECB’s standard and non- standard measures of monetary policy by the use of “shadow rate” as an indicator of the monetary policy stance. Bank sector is represented by lending surveys data (BLS) which contain robust quarterly information on changes in loan terms, conditions and standards for both firms and households. By using a Factor Augmented VAR (FAVAR) methodology, we conclude that our model performs well, but it only contradicts the predictions of theory as far as it concerns the credit volume impulse responses functions (IRFs). Selecting a sample of core and peripheral banking systems to apply our methodology, we find the theoretical predictions are confirmed only when the peripheral banking systems are neutralized, indicating that the erratic behaviour of IRFs results from the periphery’s banking system inclusion. We conclude that dislocation in the peripheral segment of European banking system impairs seriously the monetary policy transmission mechanism and, importantly, steps should be undertaken towards risk-sharing in EMU and risk reduction in peripheral banking systems to cure banking system imbalances in the context of EMU.

Peripheral Banking System Fragility and its Effect on EMU Monetary Policy Transmission Mechanism

This article evaluates the transmission through intermediaries taking into consideration the dichotomy between peripheral and core banking systems with regards to the ECB’s standard and non- standard measures of monetary policy by the use of “shadow rate” as an indicator of the monetary policy stance. Bank sector is represented by lending surveys data (BLS) which contain robust quarterly information on changes in loan terms, conditions and standards for both firms and households. By using a Factor Augmented VAR (FAVAR) methodology, we conclude that our model performs well, but it only contradicts the predictions of theory as far as it concerns the credit volume impulse responses functions (IRFs). Selecting a sample of core and peripheral banking systems to apply our methodology, we find the theoretical predictions are confirmed only when the peripheral banking systems are neutralized, indicating that the erratic behaviour of IRFs results from the periphery’s banking system inclusion. We conclude that dislocation in the peripheral segment of European banking system impairs seriously the monetary policy transmission mechanism and, importantly, steps should be undertaken towards risk-sharing in EMU and risk reduction in peripheral banking systems to cure banking system imbalances in the context of EMU.

Ownership Structure, Size and Banking System Fragility in India

Considering the fact that Reserve Bank of India (RBI) has put eleven Public sector Banks under Prompt Corrective Action (PCA) and planning to put three more, where Public sector banks constitute 68.9% of total Asset of Indian Banking Industry based on 2017 figures, this raises a genuine concern for Fragility of Indian Banking sector as whole. This study proposes to apply Cox proportional hazards model function to estimate the survival rate of Indian Banks. Ownership and size plays an important role on functioning of banks, so this study estimates if the probability of survival of Public sector Banks is more than Private sector banks and second, if large banks have more chances of survival than smaller Banks. This study found that, on the basis of ownership there is no statistical significant difference in the failure risk of Public sector banks and Private sector Banks. However, Smaller Banks are at the higher risk of failure than Large Banks. This study is based on Public and Private sector banks operating in India for the period 2000-2017 and findings of this study can be used to create an early warning systems for smaller Banks in India.

The Impact of Banking Regulation on the Emergence of Crises in Emerging Countries

In this study, we analyzed the regulatory, macroeconomic and institutional environmental effects on the probability of the emergence of banking crises in 78 emerging countries that had a fragile banking system in 1997 in a cross-sectional study using a logit model. The empirical examination validates a link between the weakness of certain regulatory and macroeconomic factors and of newly liberalized emerging market banking crises, this study want to examine weakness of regulatory and macroeconomic factors of newly liberalized, etc. banking concentration, restrictions on insurance, the financial market and the real estate sector were not related to the outbreak of banking crises in our estimates. On the basis of results, this study concludes that good regulation leads to bank stability. However, certain restrictions on inappropriate banking activity were the causes of the emergence of banking crises. As a result, the fragility of macroeconomic and institutional factors and the lack of diversification has clearly led to bank fragility and consequently to banking crises.

Contingent Contracts in Banking: Insurance or Risk Magnification?

We examine whether the economy can be insured against banking crises with deposit and loan contracts contingent on macroeconomic shocks. We study banking competition and show that the private sector insures the banking system through such contracts, and banking crises are avoided, provided that failed banks are not bailed out. When risks are large, banks may shift part of them to depositors. In contrast, when banks are bailed out by the next generation, depositors receive non-contingent contracts with high interest rates, while entrepreneurs obtain loan contracts that demand high repayment in good times and low repayment in bad times. As a result, the present generation overinvests, and banks generate large macroeconomic risks for future generations, even if the underlying productivity risk is small or zero. We conclude that a joint policy package of orderly default procedures and contingent contracts is a promising way to reduce the threat of a fragile banking system.

Monitoring Banking System Connectedness with Big Data

The need to monitor aggregate financial stability was made clear during the global financial crisis of 2008-2009, and, of course, the need to monitor individual financial firms from a microprudential standpoint remains. However, linkages between financial firms cannot be observed or measured easily. In this paper, we propose a procedure that generates measures of connectedness between individual firms and for the system as a whole based on information observed only at the firm level; i.e., no explicit linkages are observed. We show how bank outcome variables of interest can be decomposed, including with mixed-frequency models, for how network analysis to measure connectedness across firms. We construct two such measures: one based on a decomposition of bank stock returns, the other based on a decomposition of their quarterly return on assets. Network analysis of these decompositions produces measures that could be of use in financial stability monitoring as well as the analysis of individual firms' linkages.

Inflation Targeting, Fiscal Policy, and the Exchange Rate Regime

ABSTRACTUntil recently, Turkey’s economy was characterized by high inflation, undisciplined public finance management, and a fragile banking system and experienced multiple economic crises. After the economy was hit by another crisis in 2001, the central bank became independent, adopted inflation targeting as the monetary policy framework, and implemented reforms to adopt a more stringent fiscal policy. Inflation rates decreased to single-digit levels within 3 years after the independence of the central bank. This article analyzes the end of the high inflation period in the context of monetary and fiscal policy interactions within a Markov-Switching Dynamic Stochastic General Equilibrium model in which monetary and fiscal policies are allowed to switch between different regimes.

Sovereign default risk and state-owned bank fragility in emerging markets: evidence from China and Russia

In this paper we investigate the interdependence of the sovereign default risk and banking system fragility in two major emerging markets, China and Russia, using credit default swaps as a proxy for default risk. Both countries’ banking industries have strong ties with their governments and public sector, even after a series of significant reforms in the last two decades. Our analysis is built on the case studies of each country’s two biggest banks. We employ a bivariate vector autoregressive (VAR) and vector error correction (VECM) framework to analyse the short- and long-run dynamics of the chosen CDS prices. We use Granger causality to describe the direction of the discovered dynamics. We find evidence of a stable long-run relationship between sovereign and bank CDS spreads in the chosen time period. The more stable relationship is found in cases where the biggest state-owned universal banks in emerging markets are closely managed by the government. But the fragility of those banks does not directly affect the state of public finances. However, in cases where state-owned banks directly participate in large governmental projects, banking fragility may result in the deterioration of state funds, while raising the risk of sovereign default.

Calibrating limits for large interbank exposures from a system-wide perspective

We examine the role of imposing tighter limits on interbank exposures in reducing contagion and aggregate losses. In our model contagion risk arises as a result of the individual idiosyncratic failure of each bank in the banking system. Following Guerrero-Gomez and Lopez-Gallo (2004), we use a sequential default algorithm that is useful for tracing the path of contagion from a trigger bank to other banks during several contagion rounds. We test different types of limits on inter-SIB (systematically important banks) exposures, SIB to non-SIB exposures, and non-SIB to all other banks; and we study three different assumptions about banks’ behavioural responses under a stricter regulatory lending regime. We also “stress test” all banks within the banking system and extend the analysis on the benefits of using tighter limits in a fragile banking system. Calibrating the model to Mexican banking sector data, this network model shows that tighter limits for inter-SIB exposures are a useful tool for reducing contagion risk. Moreover, we find that tighter limits may lead to an increase in contagion risk under specific allocation assumptions.

The empirics of banking regulation

This paper empirically assesses whether banking regulation is effective at preventing banking crises. We use a monthly index of banking system fragility, which captures almost every source of risk in the banking system, to estimate the effect of regulatory measures (entry restriction, reserve requirement, deposit insurance, and capital adequacy requirement) on banking stability in the context of a Markov-switching model. Our methodology is less prone to selection and simultaneity bias which are common in this type of study. We apply this method to the Indonesian banking system, which has been subject to several regulatory changes over the last couple of decades, and at the same time, has experienced a severe systemic crisis. We draw the following findings from this research: (i) entry restriction reduces crisis duration as well as the probability of such an occurrence; (ii) larger reserve requirements reduce crisis duration, but increase banking instability; (iii) deposit insurance increases banking system stability and reduces crisis duration; (vi) capital adequacy requirement improves stability and reduces the expected duration of banking crises. Finally, we find that previous studies present a negative simultaneity bias for deposit insurance and a negative selection bias for capital adequacy requirement. We can infer from these findings that any relevant assessment of the impact of a regulation, which has been introduced during the recent period of banking instability, should account for simultaneity.

Financial Stability Indicators and Public Debt Developments

This paper investigates the inter-linkages between financial stability and fiscal policy. It analyzes the effect of selected financial stability indicators on the probability of future debt deterioration, controlling for several macroeconomic variables. We find significant evidence that a fragile banking system can put at risk public finances. Weak bank profitability, low asset quality and a weak capital base increase the fragility of the banking system, thus, raising the probability of future fiscal troubles.

The paradoxical genesis of too-big-to-fail

At least since the Global Financial Crisis of 2007-2009, the problem of too-big-to-fail (TBTF) has received widespread attention. The research conducted in this context has, however, generally focused on the econometric aspect and the contribution of the TBTF doctrine to the financial crisis of 2007-2009, while the economic historical approach has been confined to tracing the doctrine to its first appearance. This paper attempts to fill this gap in the academic literature by offering an explanation for why, as opposed to how, the TBTF doctrine has developed. This paper identifies the US population’s distrust and at times hostility against the prospect of concentration of power in large financial institutions as the causal factor leading to the TBTF phenomenon. The resulting socially non-optimal regulation favoured a fragmented and fragile banking system based on small unit banks at the cost of more diversified branch banks. The Great Depression impressively highlighted the deep structural flaws of the US banking system. At the same time, however, it caused a shift in the public opinion, which had generally been opposed to deposit insurance, and thereby aligned the public interest with that of small banks, which would profit most from deposit insurance. The newly acquired public and political support enabled weak unit banks to lobby successfully against reforming the banking structure and instead for the adaption of federal deposit insurance. However, the Federal Deposit Insurance Corporation (FDIC) only addressed the symptoms of the weak banking industry but not its causes. Moreover, the strongly biased FDIC policies have generally favoured creditors at large banks, which ultimately led to the TBTF doctrine which, in turn, provided banks with a non-technical incentive to grow in size in order to gain TBTF protection. Initially aimed at preserving the US financial landscape based on small unit banks, the FDIC as the main conduit for TBTF rescues thus became the main driver for big bank corporate welfare. Deposit insurance gave rise to TBTF and, at the same time, put small banks deemed “too-small-to-safe” at a competitive disadvantage, further accelerating the trend towards increasingly large and complex banks.

Financial stability indicators and public debt developments

This paper investigates the inter-linkages between financial stability and fiscal policy. It analyzes the effect of selected financial stability indicators on the probability of future debt deterioration, controlling for several macroeconomic variables. We find significant evidence that a fragile banking system can put at risk public finances. Weak bank profitability, low asset quality and a weak capital base increase the fragility of the banking system, thus, raising the probability of future fiscal troubles.

Determinants of Banking System Fragility: A Regional Perspective

Abstract: Banking systems are fragile not only within one country but also within and across regions. We study the role of regional banking system characteristics for regional banking system fragility. We find that regional banking system fragility reduces when banks in the region jointly hold more liquid assets, are better capitalized, and when regional banking systems are more competitive. For Asia and Latin-America, a greater presence of foreign banks also reduces regional banking fragility. We further investigate the possibility of contagion within and across regions. Within region banking contagion is important in all regions but it is substantially lower in the developed regions compared to emerging market regions. For cross-regional contagion, we find that the contagion effects of Europe and the US on Asia and Latin America are significantly higher compared to the effect of Asia and Latin America among themselves. Finally, the impact of cross-regional contagion is attenuated when the host region has a more liquid and more capitalized banking sector.