Behavior Of Financial Institutions Research Articles

The Impact of Sarbanes–Oxley and Dodd–Frank Legislation on Loan Loss Provisioning in US Banks

The Sarbanes–Oxley Act (SOX) of 2002 and the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act (DFA) were passed to address weaknesses in the internal control environment of the firm. Elements of these Acts reduce risky behavior of financial institutions by reducing informational asymmetry with borrowers. An important element of managing earnings quality in financial institutions is the loss provision, an annual expense set aside for uncollected loan and lease payments. These Acts affect the selection of loss provision expense levels in distinct ways. Using a dataset of community bank financial information observed between 1998 and 2017, it is shown that banks experience a complementary effect between SOX and DFA on loss provision expenses. Improved governance procedures to establish policy responses to nonperforming loans result in reduced expenses, whereas reduced information asymmetry tends to enhance a moral hazard effect. These results show that incentives for firm growth, income, capital, and loan specialization under the SOX and DFA regulatory environments complicate the loan risk management process.

Search for yield and business cycles

In the ultra-low interest rate environment after the financial crisis, it has been often pointed out that the “search for yield” behavior of financial institutions might have been intensifying interest rate decreases. One hypothesis to explain search for yield is that banks try to buy longer-term bonds even when they recognize negative term premiums in long-term rates because they myopically care about current portfolio income, not just expected holding-period returns. I study the potential impacts of this behavior on U.S. business cycles and long-term bond’s ex-post term premiums. I find that in an economy in which banks are exposed to the value-at-risk constraint, the existence of these myopic banks provides realistic moments of ex-post term premiums. In addition, their existence could generate higher output persistence under a productivity shock compared to an economy without them. This is because the difference between a myopic long-term bond pricing and a realized deposit rate path affects banks’ net worth. I study policy implications, too. In response to changes in the strength of banks’ capital regulation, the existence of myopic banks amplifies business cycles. Regarding monetary policy, it is necessary to consider ex-post term premiums, because ex-post term premiums tend to move in the same direction as the short-term interest rate and amplify business cycles in that direction when myopic banks exist.

How does investors' heterogeneous trust affect the complexity of financial products? A look into the development of online finance

We introduce “trusting effects” to market complexity strategy and, through modeling, measure the decision‐making behavior of financial institutions' complexity choices as online and offline finance develops into different stages. We find that the complexity of financial products is not only determined by the intrinsic value and structure of products but also largely influenced by the behavior of investors. In addition, the characteristics of financial institutions, as well as different investor structures, also affect the complexity of the products and the equilibrium. Therefore, financial institutions attempt to exploit investors' biases and cognitive limitations through complexity strategies and ultimately obtain excess returns.

Systemic risk: A game of lenses and clocks

Until recently the debate on systemic risk was reduced to examining sudden exogenous shocks. Today the reference literature emphasizes that systemic shocks may have a source in domestic or international environment, as a consequence of procyclicality in the behavior of financial institutions or their mutual correlation. In line with that, one may examine the cross-sectional and time dimension of the systemic risk. The modeling of macroprudential policy regulating and supervising systemic risks has been underway, and it is necessary to continuously improve the quality of analyses and availability of data, especially the indicators warning against the occurrence and accumulation of systemic risks. The process of shaping the new financial architecture, commenced in 2009, has still not been completed, but its contours are already pretty clear.

Comment on “Asia and the Reform of Global Governance”

Comment on “Asia and the Reform of Global Governance”

War die Finanzkrise vorhersehbar?

Abstract: The Queen's question “Why did no one see it coming” provoked professional economists as well. A fierce discussion arose how to modify and improve theory and models. A survey of the literature reveals that almost a hundred analyses warned against the instability of several mechanism, be it bubbles, oversupply of funds, financial innovations, behaviour of financial institutions or regulation. Most observers predicted a recession, nobody a worldwide crisis. The crisis arose as all these mechanisms worked together and produced a surprise. Surprises appear to be the central elements of deep financial crises. Therefore the chances are odd for forecasting.

Impact of Mandatory IFRS Adoption on the Financial Sector

We examine the effect of mandatory International Financial Reporting Standards (IFRS) adoption on the cost of equity and liquidity of European banks and insurance companies. We find a statistically and economically significant decrease in cost of equity and a statistically and economically significant increase in liquidity of banks and insurance companies after IFRS adoption. In additional analyses, we find an increase in earnings volatility and a decrease in the risk-taking behavior of financial institutions after 2005. Further, we find that IFRS adopters with higher exposure to fair value accounting show a lower cost of equity.

What Caused the Current Financial Mess and What Can We Do about It?

In our view, the financial crisis was largely due to wrong incentives affecting the behavior of financial institutions and investors that was set in motion by our government’s reluctance to let large financial institutions fail – i.e., the Too Big to Fail (hereafter, TBTF) policy. Also importantly, bank regulation became essentially ineffective due to the rise of “quasi-banks,” that is, large financial intermediaries that perform banking functions but are not chartered or regulated as banks. In order to prevent the recurrence of such a mess, we argue, the government must identify the quasi-banks and regulate them as banks. It must also credibly convince investors that the TBTF policy is a thing of the past. For that to happen, we call for two major changes in the current structure of financial supervision in the US.

Reflections on the crisis and on its lessons for regulatory reform and for central bank policies

This paper discusses the problems exposed by the global financial crisis in the areas of financial regulation and supervision and possible solutions. It describes and evaluates current proposals regarding the role of the central bank as a systemic regulator, the pros and the cons of locating financial supervision in the central bank, and the conflicts and synergies that such an arrangement entails. Once a crisis erupts, central bank liquidity injections constitute a first line of defense. But in the longer term these injections create a trade-off between price and financial stability, and may compromise central bank independence. Problems exposed by the crisis include the growth of a poorly regulated shadow financial system, shortermism in executive compensation packages and consequent adverse incentive effects, the too-big-to-fail problem, procyclicality in the behavior of financial institutions, conflicts of interest in the rating agencies industry and the trade-off between the scope of intermediation through securitization and transparency in the valuation of assets. The paper also discusses international dimensions including international cooperation in regulatory reform and the scope for limiting exchange rate variability. The conclusion points out inherent difficulties in distinguishing ex ante between a fundamentals based expansion and a “bubble.”

Factors that Prompt Financial Institutions to Close Branches in the Tohoku Region of Japan

This study deals with the behavior of financial institutions that recently restructured their branches or offices. Japanese financial institutions were under strict geographic banking restrictions until the mid 1990s. Although these restrictions are completely repealed now, the number of branches or offices providing financial services for individuals has decreased during this decade in Japan. According to Azegami[1](2005), this phenomenon may be caused by technological progress in finance, population decline in many municipalities, and the recession of the 1990s. Some studies show that the number of branches or offices is related to the population and the number of establishments in business areas. First we reexamined this relationship in the Tohoku Region of Japan consisting of six prefectures; Aomori, Iwate, Miyagi, Akita, Yamagata and Fukushima. The financial institutions here include city banks, regional banks, regional banks II, shinkin banks, credit unions and labor credit associations. The results support our prior studies and show that branches or offices concentrated not only in cities but also in certain small towns play a role as the economic center of the rural region. Next we investigated the relationship between the number of closed branches or offices (from the end of September in 2002 to the end of October in 2006) and several explanatory variables such as the change in population. We presumed that there were more closed branches in areas where the population or the number of establishments had decreased. From the results of our OLS analysis, we determined that the number of closed branches was significantly correlated with the decrease in establishments. Against our predictions, the coefficient of population change was positive, indicating branch closure was more frequent in the urban areas where population was still growing. Moreover, we clarified that institutions merging with others significantly decreased the number of branches. Finally, we found two cases in which one of two branches had been closed in a municipality and another two cases in which the only branch disappeared from a village. Such towns or villages are still few but inhabitants will have to pay extra transportation costs if the only branch in a town or village closes.JFL Classification: G21, R10

1997-1998, ¿Diferente naturaleza de las crisis en Asia y en América Latina?

La globalización financiera ha acarreado un fuerte flujo de capitales dentro de las economías emergentes. En Asia, los comportamientos poco prudentes de las instituciones financieras han favorecido una sobreinversión, origen de la disminución de rendimientos y de la baja de la valorización del capital, la cual se agravó por el declive de la competitividad a partir de 1995, debido, simultáneamente, al fuerte aumento de los salarios y a la apreciación de la moneda nacional. En América Latina, por el contrario, la crisis se debe sobre todo a causas macroeconómicas. Los regímenes de acumulación instaurados para superar la crisis de inflación de la década de 1980 descansan en una liberalización masiva de los mercados, en una tendencia a la apreciación de las divisas y en una lógica financiera que responde a la necesidad de cerrar la brecha entre las altamente crecientes necesidades de financiamiento de estas economías y sus más limitadas capacidades para conseguirlo. La manipulación de las tasas de interés constituye entonces la variable fundamental para atraer los capitales del extranjero, pero también para precipitar la recesión.

What Caused the Current Financial Mess and What Can We Do about It?

In our view, the financial crisis was largely due to wrong incentives affecting the behavior of financial institutions and investors that was set in motion by our government’s reluctance to let large financial institutions fail – i.e., the Too Big to Fail (hereafter, TBTF) policy. Also importantly, bank regulation became essentially ineffective due to the rise of “quasi-banks,” that is, large financial intermediaries that perform banking functions but are not chartered or regulated as banks. In order to prevent the recurrence of such a mess, we argue, the government must identify the quasi-banks and regulate them as banks. It must also credibly convince investors that the TBTF policy is a thing of the past. For that to happen, we call for two major changes in the current structure of financial supervision in the US.

Reflections on the Crisis and on Its Lessons for Regulatory Reform and for Central Bank Policies

This paper surveys the problems exposed by the global financial crisis in the areas of financial regulation and supervision and possible solutions. It also discusses a number of lessons for central bank policy as well as some international dimensions. The discussion is based on the view that suggestions for regulatory reform must be firmly anchored in prior understanding of the consequence of regulatory and supervisory factors that triggered the crisis. Specific issues include the growth of a poorly regulated shadow financial system, shortermism in executive compensation packages and consequent adverse incentive effects, the too big to fail problem, procyclicality in the behavior of financial institutions, conflicts of interest in the rating agencies industry and the tradeoff between transparency in the valuation of assets and broadening the scope of intermediation through securitization.

Effect of Information Asymmetry and Relationship Lending on Financial Intermediation of Small Firms in USA

The study applies a transaction costs framework to understand the economic behavior of financial institutions serving financial needs of small businesses in the U.S.A. Using survey data obtained from small- business- friendly financial institutions, hypotheses postulated by the Transaction Costs Theory were tested. This theory was also used to examine the potential for adoption of promising lender-borrower relationships to mitigate transaction costs incurred in financial intermediation. Measures of transaction costs and relationship lending variables were the opinions of key lending institutions towards performance of small businesses undertaking loan contracting in credit markets. These opinions were ranked on likert scales ranging from 1 to 6. An Ordered Multinomial Probit analysis was performed on the model of transaction costs and hypothesized determinants. Results show that a model of transaction costs of financial contracting that put into consideration the lender-borrower relationships had a greater explanatory power than one which ignored these relationships. The study concluded that lending technologies that incorporate relationship lending have potential of minimizing transaction costs especially in economies that experience severe information asymmetries. Key words: information asymmetry, lender-borrower relationships, relationship lending, small business, transaction costs Eastern African Journal of Rural Development Vol.20(1) 2004: 57-71

Banking Regulation and Network-topology Dependence of Iterative Risk-trading Games

In the context of understanding risk-regulatory behavior of financial institutions we propose a general dynamical game between several agents who pick their trading strategies depending on their individual risk-to-wealth ratio. The game is studied numerically for different network topologies. Consequences of topology are shown for the wealth time-series of agents, for the safety and efficiency of various types of networks. The model yields realistic-looking time-series of wealth and the cost of safety increases as a power-like function. The relevant model parameters should be controllable in reality. This setup allows a stringent analysis of the effects of different approaches of banking regulation as currently suggested by the Basle Committee of Banking Supervision. We find evidence that a tightening of the current regulatory framework does not necessarily lead to an improvement of the safety of the banking system. Moreover, the potential impact of catastrophic events like September 11, 2001, on the financial system can be measured within this framework.

Policy Implications Arising from the Impact of the Last Recession on the Capital Structure of UK SMEs

Different capital-structure theories are reviewed in order to formulate testable propositions concerning the levels of debt in small and medium-sized enterprises (SMEs), and a number of regression models are developed to test the hypotheses, The statistical results indicate that age and profitability, are negatively related to gearing, whereas size, asset structure, risk, nondebt tax shields, and the level of debtors each have a positive relationship with gearing. These relationships are maintained over time, but the magnitude and significance of the coefficients vary over business economic cycles, The results indicate that the last recession may have changed the borrowing behaviour of small businesses. After the dramatic experiences of the longest and deepest UK recession, small-business owners appear to be more cautious in raising external finance, and the results suggest that they may wish to grow only when there are sufficient internally generated funds, especially profits, to finance new investments. The results also suggest that the last recession had an effect on the lending behaviour of financial institutions, which still appear to be more cautious in their lending policies—even after the recession. The authors examine a number of policy implications that emanate from the findings, and discuss a number of possible actions that the government could undertake in order to enhance the financial development and prosperity of SMEs across the economic cycle.

Financial liberalisation, financial crisis and the new regime: The Korean experience

The financial restructuring measures under the IMF programme since the financial crisis far exceeded those carried out during the last 10 years in their depth and coverage. Starting from the observation that the financial crisis of late 1991 occurred after the well publicised entry into the OECD, this paper focuses on the relationship between the liberalisation and opening‐up of the financial market and the unprecedented financial crisis in Korea. It deals with issues raised as the Korean financial regulatory system moved from a controlled system to a market oriented system, and it reviews the policy initiatives of financial regulation and liberation in the period between the early 1980s and late 1991. This paper shows the importance of a multi‐staged system of information production and monitoring of the economy in the transformation into a market‐oriented system, suggesting that this transformation can damage the economy if related policies do not enhance the power of financial supervision to monitor the moral hazard behaviour of financial institutions.

Form of ownership and risk taking in banking: Some evidence from Massachusetts savings banks

In recent years there has been interest in the impact of the form of ownership on the behavior of financial institutions. In the 1980’s, there was a substantial movement away from mutual ownership to stock ownership in the thrift industry. The effect of this conversion process on risk taking and efficiency has been a matter of concern. The purpose of this paper is to examine the experience of savings banks in Massachusetts. A panel of 115 savings banks is analyzed for the years 1985 through 1993, a period that includes both rapid growth and a subsequent severe cyclical decline in property values. The credit quality of loan portfolios is related to the size of the portfolio, the structure of the portfolio, and the ownership status of the bank. Several models are estimated. In all cases, it was found that the cyclical decline in property values resulted in a decline in the credit quality of loan portfolios with a substantially greater impact on those savings banks that converted from mutual to stock status.

Time Series Analysis and Portfolio Selection: An Application to Mutual Savings Banks

A complete understanding of the mechanism by which monetary policy instruments affect real goods and the level of economic activity depends critically upon an adequate explanation of the behavior of financial institutions. A seemingly fruitful framework of analysis for the portfolio behavior of financial institutions has been put forward by several authors including Parkin [12]; Parkin, Gray, and Barrett [13]; I. Sharpe [16; 17]; W. F. Sharpe [18]; and Swan [20]. A typical decision maker is assumed to maximize expected utility of his portfolio return (profit) by choosing an optimum portfolio. In this study, we adopt an unconventional approach for testing the appropriateness of such a model. As the previously mentioned studies suggest, we shall divide the assets (liabilities are treated as negative assets) in a typical portfolio of a financial institution into a choice set and an exogenous set. The decision maker chooses the levels of the assets in the choice set and has no control over the levels of

Descriptive Theories of Financial Institutions under Uncertainty

This paper is a selective review of the received theory of financial institutions with some suggestions regarding future research on this topic. The major emphasis is placed on the positive economic theory of these firms. Financial institutions are considered to be firms that supply financial securities and contracts held as assets by other sectors of the economy and that use the proceeds of these sales to finance the purchase of financial securities and contracts which are the liabilities of other economic units. The theory discussed here is stripped of much of the regulatory and legal framework surrounding financial institutions. The primary reason for so limiting the scope of this paper is a conviction that a reasonably complete model of a simple financial institution is a necessary precursor to useful models of the positive economic behavior of financial institutions in any specific legal, regulatory, and operational framework. While recognizing that no tractable model of a financial institution is likely to be so general as to avoid the problem of model specificity, I take the view that many of the questions asked in the literature would be better answered in less specific models, i.e., in models capable of explaining additional important aspects of the behavior of the financial institution in question.