Charter Value Research Articles

Factors determining European bank risk

We investigate bank capital, charter value, off-balance sheet activities, dividend payout ratio and size as determinants of bank equity risk (systematic risk, total risk, interest rate risk and idiosyncratic risk) and credit risk. Using information for 117 financial institutions across 15 European countries over the period 1996–2010, we find evidence of a convex (U-shaped) relation between bank capital and bank systematic risk and credit risk. We find mixed evidence on the relation between charter value and our measures of bank risk. The results also show a positive association between off-balance sheet activities and bank risk. It is also evident that dividend payout ratio is negatively related to all risk measures. We find large banks reflect higher total risk and lower credit risk. Following the creation of the Economic Monetary Union, we also observe an increase in bank risk sensitivity to both bank capital and off-balance sheet activities and a decrease in the sensitivity of bank risk to charter value. Finally, with regard to the impact of the recent global financial crisis, we find that the largest decline in the coefficient value is observed for bank capital relative to credit risk. These results are robust to various model specifications.

Financial guarantors’ executive compensation, charter value and risk-taking

Financial guarantees have been extensively used recently as part of rescue packages to bail out troubled institutions and governments around the world. We propose a new incentive compensation model for studying agency conflict between the shareholders and the manager of a typical financial guarantor. In our model, the manager chooses the guarantor's risk level, with disutility to reduce risk (i.e., reducing the risk of the guarantor incurs a direct cost to the manager). Moral hazard causes the manager to select a level of risk that is higher than the level chosen in an otherwise first-best environment with no conflict of interest between the shareholders and the manager. However, in our proposed framework, charter value plays a self-disciplining role on the manager's appetite for risk, therefore it helps mitigate the extent of the deviation from first best with agency conflict found previously (e.g., Jensen and Meckling, 1976; Cadenillas et al., 2004, 2007). This suggests that researchers should study charter value, managerial compensation and risk decisions within a unified framework and not separately, as all studies have done in the past.

BANK RISK AND MARKET DISCIPLINE

This paper investigates the issue of bank risk taking. Specifically we investigate two main issues: (1) determinants of bank risk, and (2) market discipline to the banks either in implicit, explicit guarantee systems, and all periods. Using Indonesian data, we find that domestic, foreign, and ownership concentration have positive impact on bank risk. Bank shareholders engage in entrenchment behaviour, rather than convergence behaviour. We further find that charter value and compliance to regulation have negative impact on bank risk. Next, we find that market disciplines the banks. Market disciplines the banks at the same degree in implicit and explicit deposit guarantee systems. Our findings highlight the importance of paying close attention to banks ownership, charter value, and compliance to regulation. Furthermore, since we find that market disciplines the Banks at the same degree in explicit and implicit guarantee systems, we need to investigate this issue further. This finding highlights research potential in the future: to investigate disciplining behaviour from various types of depositors. Keywords: bank ownership, market discipline, risk, entrenchment, convergence, and deposit insurance

Competition and Risk-taking in Banking Industry

The aim of the paper is to investigate the relationship between competition and risk-taking in the banking industry. The paper provides a general theoretical model that incorporates the charter value models and models with contracting problems. In particular, the model contains a moral hazard problem and it enables investments into the risk-free asset. Competition on the loan side of the market is modeled as spatial competition. The model predicts that the relationship between competition and the probability of bank failure is non-monotonic and U shaped. The prediction of the model is verified by the empirical analysis conducted using the data from Czech banking sector. The Herfindahl-Hirschman index is used as a measurement of competition and the Z-score is used as measurement of the probability of bank failure.

The Niqab and Witness Testimony: Balancing the Interests

In R. v. N.S., 2010 ONCA 670, a unanimous Court of Appeal for Ontario ruled that preliminary inquiry judges can consider Charter values in evaluating matters relating to the preliminary inquiry and established a framework for establishing and reconciling competing rights claims. The matter is now under appeal to the Supreme Court of Canada, with oral arguments heard on December 8th, 2011.

The Effect of Government Bailouts on Default Risk and Charter Values in Banking

This paper examines the impact of the Troubled Asset Relief Program/Capital Purchase Program (TARP/CPP) participation and early repayments on the disciplinary role of bank charter values following the 2008 financial crisis. I find that the disciplinary role of bank charter value has been significantly impacted by the bailouts. TARP/CPP participants exhibit lower sensitivity of the market-based default risk to the changes in charter values compared to non-participants indicating the presence of moral hazard. The effect is most significant for the strongest banks that were able to repay the TARP/CPP funds early with private equity. This study contributes to the literature on the disciplinary role of bank charter values by focusing on the effects of the government bailouts.

No to Rawlsian Public Reason and Yes to the Enlarged Mentality: An Affirmative Role for Moral and Religious Arguments in Canadian Public Discourse in Light of Charter Values

This paper examines two different theories in relation to the optimal modes of public deliberation about constitutional values and the public good in the context of democratic pluralism: Rawlsian Public Reason and Nedelsky’s Enlarged Mentality.I challenge Rawlsian public reason’s claim to epistemic abstinence, autonomy and its claim to reflect a political conception of justice by examining certain contradictory aspects of its theoretical rendition. I argue that significant aspects of the picture of democracy that Rawlsian public reason reflects are unempirical. I argue that Rawlsian public reason’s concept of bracketing moral and religious argumentation from public deliberation is unjustifiable, unattainable and derogates from Canadian constitutional values.I proffer that Nedelsky’s enlarged mentality is preferable as it is more realistic and consonant with Canadian constitutional values. I argue that Nedelsky’s enlarged mentality is facilitative of genuine and meaningful dialogic exchange in spite of difference whilst managing the risk of democratic instability.

Banking Competition and Real Sector Stability: Does the Risk Shifting Channel Exist?

Recent theoretical literature in the field of banking competition and bank risk stresses the importance of interactions between banks and firms and suggests that banking competition impacts firm stability. But empirical evidence whether banking competition increases or decreases stability of firms in the real sector is scarce. This paper investigates the effect of banking competition on firm stability for a sample of small- and medium-size enterprises (SMEs) in Germany between 1996-2006. Results show that less banking competition is beneficial for firm stability. This rejects recent suggestions from the banking literature that banks may exploit their competitiveness and increase incentives for firms to undertake more risk. Thereby, this paper suggests the often cited charter value paradigm in banking to be right.

Competition and Bank Risk-Taking - An Empirical Study

The paper tests the effect of competition on bank risk-taking for a sample of up to 800 banks worldwide over the period 1995-2010. Following the theoretical literature on bank competition and risk more closely than previous empirical research, we measure competition at the bank level and separate the effects of competition in deposit and loan markets. We also condition the risk effect of competition on several factors, including proxies of charter value and deposit insurance coverage. Our results give clear evidence of a positive competition-risk effect for both risk measures tested. There is some indication, however, that this effect is strongly dependent on the existence of a deposit insurance-related moral hazard effect on risk, which is mitigated by increased market power. The frequently significant non-linearity of the competition-risk effect, and its dependence on safety-net characteristics could explain the conflicting results of previous empirical research.

Impact of Bank Capital, Charter Value and Market Discipline on Bank Risk Exposure: Evidence from Asia Pacific

We investigate the determinants of bank equity risk (systematic risk, total risk, and idiosyncratic risk) and credit risk, using bank balance sheet and market information for 220 financial institutions across 14 Asia -Pacific countries over the period from 1996 to 2006. The key explanatory variables are bank capital, market discipline and charter value. After controlling for the endogeneity of explanatory variables, the results show that bank risk is positively related to bank capital and negatively related to charter value. However, there is no appreciable evidence of a non-linearity between bank capital and bank risk. Market discipline is found to be negatively associated with bank risk consistent with capital standards Basel II and Basel III, Pillar 3. Further, the findings suggest that bank capital and market discipline may complement each other while market discipline and charter value may substitute each other in reducing bank’s risk taking incentives. The results are robust to different estimation specification.

Board Characteristics, Performance and Risk Taking Behaviour in Tunisian Banks

The existing literature provides conflicting views of the relationship among board characteristics; performance(Return on Assets and Return on Equity) and bank risk taking (Z-score). The relation between characteristics ofcorporate boards, firm performance and risk taking continues to be a fundamental issue in the corporategovernance literature. Findings of this literature are often inconclusive. The main contribution of this study is ananalysis of how board characteristics affect performance and incentives to take risk in banking industry. Weexplore this relationship by using both generalized least square (GLS) random effect (RE) and generalizedmethod of moments (GMM) system approaches. The empirical analysis based on a sample of 11 large Tunisiancommercial banks during 1997-2006, reports the following robust results: a small bank board is associated withmore performance and with more bank risk-taking, the presence of independent directors within the board ofdirectors affects negatively the performance, but has no significant effect on the risk-taking, a lower CEOownership is associated with lower performance in Tunisian banks, banks with high charter value are associatedwith lower ROA and ROE and more bank risk and the small size banks institutions appear to assume lower risks.Our results support the idea, commonly accepted, that bank board structure is a determinant factor for bankperformance and bank risk taking.

A Pigovian Approach to Liquidity Regulation

This paper discusses liquidity regulation when short-term funding enables credit growth but generates negative systemic risk externalities. It focuses on the relative merit of price versus quantity rules, showing how they target different incentives for risk creation. When banks differ in credit opportunities, a Pigovian tax on short-term funding is efficient in containing risk and preserving credit quality, while quantity-based funding ratios are distorsionary. Liquidity buffers are either fully ineffective or similar to a Pigovian tax with deadweight costs. Critically, they may be least binding when excess credit incentives are strongest. When banks differ instead mostly in gambling incentives (due to low charter value or overconfidence), excess credit and liquidity risk are best controlled with net funding ratios. Taxes on short-term funding emerge again as efficient when capital or liquidity ratios keep risk shifting incentives under control. In general, an optimal policy should involve both types of tools.

Factors Determining European Bank Risk

We investigate bank capital, charter value, off-balance sheet activities, dividend payout ratio and size as determinants of bank equity risk (systematic risk, total risk, interest rate risk and idiosyncratic risk) and credit risk. Using information for 117 financial institutions across 15 European countries over the period 1996-2010, we find evidence of a convex (U-shaped) relation between bank capital and bank systematic risk and credit risk. We find mixed evidence on the relation between charter value and our measures of bank risk. The results also show a positive association between off-balance sheet activities and bank risk. It is also evident that dividend payout ratio is negatively related to all risk measures. We find large banks reflect higher total risk and lower credit risk. Following the creation of the Economic Monetary Union, we also observe an increase in bank risk sensitivity to both bank capital and off-balance sheet activities and a decrease in the sensitivity of bank risk to charter value. Finally, with regard to the impact of the recent global financial crisis, we find that the largest decline in the coefficient value is observed for bank capital relative to credit risk. These results are robust to various model specifications.

Bank Competition and Stability: Reconciling Conflicting Empirical Evidence

Theoretical models and empirical results over conflicting evidence on the relationship between bank competition and bank stability. This paper aims to reconcile the seemingly contrasting evidence on the bank competition-bank soundness relationship. We develop a uni ed framework to assess how regulation, supervision and other institutional factors may make it more likely that the data favor one theory over the other (charter value paradigm versus risk-shifting paradigm). Cross-country heterogeneity in these factors allows us to test the assumptions and predictions of various theoretical models. We show that an increase in competition will have a larger impact on banks' risk taking incentives in countries with stricter activity restrictions, more herding in revenue structure, unconcentrated banking markets and more generous deposit insurance.

Distance to default, subordinated debt, and distress indicators in the banking industry*

AbstractThe recent financial crisis has highlighted the inadequacy of present supervisory arrangements to identify reliable ex‐ante indicators of banking distress. For a sample of US bank holding companies, we analyse the extent to which distance to default based on market data can be explained using accounting‐based indicators of risk. We show that a larger number of bank fundamentals help predict default for institutions that issue subordinated debt. For banks that issue sub‐debt, we find that higher charter values and low bank capitalizations further increase the power of bank fundamentals to predict default risk.

Charter value, Tobin's Q and bank risk during the subprime financial crisis

Charter value is important in the banking industry because of its ability to reduce the moral hazard incentives that result from government-provided deposit insurance. Previous research suggests that geographic deregulation in the 1970s and 1980s increased competition and eroded charter values. Yet, a common proxy for charter value, Tobin's Q, increased significantly in the 1990s and beyond even as bank deregulation continued. We show that Tobin's Q is a poor cardinal measure of charter value though it still has merit as an ordinal measure. Our findings suggest that charter value has been declining through time, contributing to the increase in risk-taking that led to the subprime financial crisis.

Does Section 2(B) Really Make a Difference? Part 1: Freedom of Expression, Defamation Law, and the Journalist-Source Privilege

The question this article poses is whether the common law must adopt Charter-specific doctrines or remedies when Charter values are at stake. The discussion focuses on the Supreme Court’s defamation decisions, but includes brief remarks about R. v. National Post, which considered whether the Wigmore test for a journalist-source privilege is consistent with the Charter.

From Competition to Cartel: Bank Mergers in the U.K. 1885 to 1925

We study the effects of bank mergers and acquisitions in the U.K. from 1885 to 1925. The lack of a regulatory authority and the confidential nature of merger negotiations allows us to precisely measure the wealth effects of M&As in a laissez-faire environment. We find positive wealth effects for bidders (0.7%-1%) and targets (6.7%-8%) over the announcement month. When takeovers took place in a competitive environment wealth creation appears to be related to efficiency gains. As competition decreased, gains to shareholders appear to be related to increased oligopoly power. In a less competitive environment, banks tended to reduce the amount of loans and increase their holdings of safe marketable securities. Banks with higher charter value displayed higher capital ratios.

Managerial Incentives, Market Power and Bank Risk-Taking

We investigate the effect of managerial incentives and market power on bank risk-taking for a sample of 212 large US bank holding companies over 1997-2004 (i.e. 1,534 observations). Bank managers have incentives to prefer less risk while bank shareholders have preference for ‘excessive’ risk. Likewise, the market power is the centre piece of any bank regulation. However, the literature is inconclusive as to the effect of managerial incentives and market power on bank risk-taking. Our results reveal a U-shape relation between bank risk and CEO ownership (proxy for managerial incentives) and between bank risk and charter value (proxy for market power). Particularly, we find that bank risk initially decreases and then increases with both CEO ownership and charter value. These convex relations are robust to various bank risk proxies, different estimation approaches to account for endogeneity and several bank specific control variables.

How bank capital buffers vary across countries: The influence of cost of deposits, market power and bank regulation

This paper analyzes the bank and country determinants of capital buffers using a panel data of 1337 banks in 70 countries between 1992 and 2002. After controlling for adjustment costs and the endogeneity of explanatory variables, the results show that capital buffers are positively related to the cost of deposits and bank market power, although the relations vary across countries depending on regulation, supervision, and institutions. Their impact is the result of two generally opposing effects: restrictions on bank activities and official supervision reduce the incentives to hold capital buffers by weakening market discipline, but at the same time they promote higher capital buffers by increasing market power. Institutional quality has the two opposite effects. Better accounting disclosure and less generous deposit insurance, however, have a clear positive effect on capital buffers by both strengthening market discipline and making charter value better able to reduce risk-taking incentives.