Individual Bank Level Research Articles

The impact of financial liberalization on bank efficiency: evidence from Latin America and Asia

This article investigates the impact of financial liberalization on bank efficiency, using data for a sample of over 4000 bank-year observations from ten emerging economies for the period 1991–2000. We use Data Envelopment Analysis (DEA) to calculate bank efficiency at the individual bank level. Bank efficiency measures are then aggregated at the country level to investigate the relationship between financial liberalization and bank efficiency, using a panel least square fixed-effects model. Overall, we find strong support for the positive impact of financial liberalization programmes on bank efficiency.

Systemic Risk Measures: The Simpler the Better?

This paper estimates and compares two groups of high-frequency market-based systemic risk measures from 2004 to 2009 using European and US data of interbank rates, stock prices and credit derivatives both at aggregate market level as well as the individual bank level. The former group of measures gauges the overall tension in the financial sector whereas second group relies on individual institution information to extract joint distress at portfolio level. We rank the measures using three criteria: i) Granger Causality tests, ii) Gonzalo and Granger metric, and iii) the correlation with an index of systemic events and policy actions. We find that the best systemic risk indicator based on aggregate market measures is the First Principal Component of a portfolio of Credit Default Swap (CDS) spreads whereas the best indicator based on individual institution’s measures is the Multivariate Densities computed from CDS spreads. These results suggest that the measures based on CDSs outperform measures based on interbank rates or stock market prices. Some implications for regulators and policymakers are discussed.

The Price of Liquidity: Bank Characteristics and Market Conditions

We identify frictions in the market for liquidity as well as bank-specific and market-wide factors that affect the prices that banks pay for liquidity, captured here by borrowing rates in repos with the central bank and benchmarked by the overnight index swap. We have price data at the individual bank level and, unique to this paper, data on individual banks’ reserve requirements and actual reserve holdings, thus allowing us to gauge the extent to which a bank is short or long liquidity. We find that the price a bank pays for liquidity depends on the liquidity positions of other banks, as well as its own. There is evidence that liquidity squeezes occasionally occur and short banks pay more the larger is the potential for a squeeze. The price paid for liquidity is decreasing in bank size and small banks are more adversely affected by an increased potential for a squeeze. Healthier banks pay less, but contrary to what one might expect, banks in formal liquidity networks do not.

Intra-Industry Contagion Effects of Earnings Surprises in the Banking Sector

In this paper we investigate whether contagion is present in the banking sector by analyzing how banks are affected by negative earnings surprises from their competitors. The banking sector is of crucial importance for the economy and, thus, highly regulated on an individual bank level. However, a high degree of contagion risk should call for a regulation of the financial network rather than solely regulating on an individual level. To be able to make a judgement about the magnitude of possible contagion effects we compare the results of the banking sector with the results of the non-banking industries. We find that earnings surprises cause significant contagion in the banking sector. In contrast, we do not find this effect in the non-banking sectors, including the insurance sector. The magnitude of contagion in the banking sector is positively related with the size of the bank reporting an earnings surprise, as well as the size of the affected banks.

Intra-industry contagion effects of earnings surprises in the banking sector

In this article we investigate whether contagion is present in the banking sector by analysing how banks are affected by negative earnings surprises from their competitors. The banking sector is of crucial importance for the economy and, thus, highly regulated on an individual bank level. However, a high degree of contagion risk should call for a regulation of the financial network rather than solely regulating on an individual level. To be able to make a judgement about the magnitude of possible contagion effects we compare the results of the banking sector with the results of the nonbanking industries. We find that earnings surprises cause significant contagion in the banking sector. In contrast, we do not find this effect in the nonbanking sectors, including the insurance sector. The magnitude of contagion in the banking sector is positively related with the size of the bank reporting an earnings surprise, as well as the size of the affected banks.

Non-Maturing Assets and Liabilities of Banks: Valuation and Risk Measurement

Non-maturing banking products are important asset and liability positions of banks. Their complexity inter alia arises from a non-trivial pass-through from market to product rates which makes the valuation and risk analysis challenging for both banks and banking supervisors. Based on a large data set, this paper provides a comprehensive analysis of the valuation and interest rate risk measurement of these products in the risk-neutral valuation framework of Jarrow and van Deventer (1998). We apply 6 term structure models and 4 interest rate pass-through models and estimate for each of these 24 model combinations the value and interest rate risk of 13 non-maturing product categories for up to 400 German banks on an individual bank level. We find that the choice of the term structure and the pass-through model is of limited importance for the valuation of non-maturing banking products. For ranking banks according to the interest rate risk of their products the pass-through process is of specific relevance. When the level of the interest rate risk is to be estimated, additionally an advanced term structure model should be chosen.

Financial Reform and Bank Efficiency: A Multi-Country Analysis

This paper investigates the impact of financial reform on bank efficiency. More specifically, we distinguish between financial liberalization measures and measures of the quality of bank regulation measures, and study their relationship to bank efficiency separately. Moreover, we analyze whether the impact of financial liberalization on bank efficiency is conditional on the quality of prudential regulation of the banking system. We apply stochastic frontier analysis to calculate bank efficiency at the individual bank level and use a new and detailed database that measures different aspects of financial reform. The dataset consists of a sample of over 26,000 bank-year observations from 41 countries for the period 1996-2002. Overall, we find support for the positive impact of financial liberalization policies, as well as for the quality of bank regulation, on bank efficiency. Moreover, we show that the impact of financial liberalization policies is conditional on the extent to which bank regulation has been adopted.

Bank Heterogeneity and Monetary Policy Transmission

Heterogeneity in the response of banks to a change in monetary policy is an important element in the transmission of this policy through banks. This paper examines the role of bank liquidity, capitalization and market power as internal factors influencing banks’ reaction in terms of lending and risk-taking to monetary policy impulses. The ultimate impact of a monetary policy change on bank performance is also considered. The empirical analysis, using large panel datasets for the United States and the euro area, elucidates the sources of differences in the response of banks to changes in policy interest rates by disaggregating down to the individual bank level. This is achieved by the use of a Local GMM technique that also enables us to quantify the degree of heterogeneity in the transmission mechanism. It is argued that the extensive heterogeneity in banks’ response identifies overlooked consequences of bank behavior and highlights potential monetary sources of the current financial distress.

Liquidity Matters: Evidence from the Russian Interbank Market

We suggest an additional transmission channel of contagion on the interbank market - the liquidity channel. Examining the Russian banking sector, we and that the liquidity channel contributes significantly to understanding and predicting interbank market crises. Interbank market stability Granger causes the interbank market structure, while the opposite causality is rejected. This bolsters the view that the interbank market structure is endogenous. The results corroborate the thesis that prudential regulation at the individual bank level is insufficient to prevent systemic crises. We demonstrate that liquidity injections of a classical lender of last resort can effectively mitigate coordination failures on the interbank market both in theory and practice. Apparently, liquidity does matter.

Explaining bank distress in Eastern European transition economies

This paper considers the joint role of macroeconomic, structural and bank-specific factors in explaining the occurrence of banking problems in the nineteen Eastern European transition countries over the last decade. With data at the individual bank level we show, using a discrete time survival model, that all three factors interact in their impact and have a rich dynamic profile, which underlines the highly volatile cycles challenging the stability of banks in this region. A fragile funding basis accompanied by high exposure to market risk in an environment of reforms and macroeconomic disturbances is the typical precursor of bank distress.

Inside the Credit Boom: Competition, Segmentation and Information – Evidence from the Serbian Credit Market

In the context of rapid credit growth, the present paper investigates the supply side of the Serbian credit market. We use an on-site survey of banks aiming to describe financial intermediation by scanning the interest rates and other lending terms in Serbia. Findings from the survey suggest that the credit market is largely non-homogeneous and segmented, but with an increasing presence of competition. Motivated by these findings, we further use an original data set from the financial statements of Serbian banks for a time span of 2001 to 2005. Using both qualitative and quantitative approaches, we observe the existence of segments in the banking sector. One segment is characterized by a stronger presence of foreign banks, higher transparency of clients and stronger effects of competition on lending interest rates (lower spreads). Another segment is one with more domestic banks, less transparent borrowers and relatively higher banks' market power (higher intermediation spreads). The sources of segmentation are in our case represented by funding costs and ultimately by bank ownership. Using the GLS estimator on our panel dataset, we estimate the main determinants of bank interest margins as indicators of market power on the individual bank level. Then we test the effect of foreign bank presence on overall asset quality. We use the model developed by Dell'Ariccia and Marquez (2004) in order to explain the results of our regressions and to describe the segmentation. Their model stresses the role of information in shaping bank competition, where a lender with an information advantage (in case of Serbia, local banks) competes with an outside lender (foreign-owned banks) with less information, but potentially having a cost advantage in extending a loan. We believe that the proposed pattern of segmentation is in place in the Serbian lending market. The findings from the qualitative survey support this argument as well.

The Price of Liquidity: Bank Characteristics and Market Conditions

We identify frictions in the market for liquidity as well as bank-specific and market-wide factors that affect the prices that banks pay for liquidity, captured here by borrowing rates in repos with the central bank and benchmarked by the overnight index swap. We have price data at the individual bank level and, unique to this paper, data on individual banks’ reserve requirements and actual reserve holdings, thus allowing us to gauge the extent to which a bank is short or long liquidity. We find that the price a bank pays for liquidity depends on the liquidity positions of other banks, as well as its own. There is evidence that liquidity squeezes occasionally occur and short banks pay more the larger is the potential for a squeeze. The price paid for liquidity is decreasing in bank size and small banks are more adversely affected by an increased potential for a squeeze. Healthier banks pay less, but contrary to what one might expect, banks in formal liquidity networks do not.

The Price of Liquidity: Bank Characteristics and Market Conditions

We identify frictions in the market for liquidity as well as bank-specific and market-wide factors that affect the prices that banks pay for liquidity, captured here by borrowing rates in repos with the central bank and benchmarked by the overnight index swap. We have price data at the individual bank level and, unique to this paper, data on individual banks’ reserve requirements and actual reserve holdings, thus allowing us to gauge the extent to which a bank is short or long liquidity. We find that the price a bank pays for liquidity depends on the liquidity positions of other banks, as well as its own. There is evidence that liquidity squeezes occasionally occur and short banks pay more the larger is the potential for a squeeze. The price paid for liquidity is decreasing in bank size and small banks are more adversely affected by an increased potential for a squeeze. Healthier banks pay less, but contrary to what one might expect, banks in formal liquidity networks do not.

Analyzing the Interest Rate Risk of Banks Using Time Series of Accounting-Based Data: Evidence from Germany

This paper describes the first thorough analysis of the interest risk of German banks on an individual bank level. We develop a new method that is based on time series of accountingbased data to quantify the interest risk of banks and apply it to analyze the German banking system. We find evidence that our model yields a significantly better fit of banks' internally quantified interest rate risk than a standard approach that relies on one-point-in-time data, and that the interest rate risk differs between banks of different size and banking group. Additionally, we find structural differences between trading book and non-trading book institutions.

Basel-II: International Competition Issues

Basel-II has been thoroughly discussed, both in Europe and in the US. While the discussion several years ago focused mainly on the expected cost due to the implementation of Basel-II on the individual bank level, the recent discussion pays increasing attention to international competition issues, as Europe is implementing the new capital accord rather quickly, while in the US there is significant doubt, whether Basel-II might cause severe disadvantages. This article highlights some topics, which may be important to assess the overall competition effects of Basel-II. Surprisingly, there are relatively few features of Basel-II that might lead to major disturbances in international competition, even if Basel-II will be implemented by some countries, while others choose not to do so.

The Impact of Financial Liberalization on Bank Efficiency: Evidence from Latin America and Asia

This paper investigates the impact of financial liberalization on bank efficiency, using data for a sample of over 4,000 banks from ten emerging economies for the period 1991-2000. We use the DEA approach to calculate bank efficiency at the individual bank level. Bank efficiency measures are then aggregated at the country level to investigate the relationship between financial liberalization and bank efficiency, using a panel least square fixed-effects model. Overall, we find strong support for the positive impact of financial liberalization programmes on bank efficiency.

State-Owned Banks as Competition Enhancers, or the Grand Illusion

We analyze the role of state ownership in the banking sector from the perspective of competition. That is, do state-owned banks play a special role as competition enhancers? Focusing on the market for mortgage loans in Switzerland, we test four hypotheses which are consistent with this view. First, are state-owned banks’ interest rates relatively cost sensitive? Second, are state-owned banks charging relatively low mark-ups? Third, are the state-owned banks’ interest rates particularly borrower friendly? And fourth, do state-owned banks exert a disciplinary effect on competitors’ prices? Based on a comprehensive database containing information at the individual bank level over the 1996–2002 period, our answer is ‘No.’

Deposit drains on “interest-paying” banks before financial crises

This paper conducts an econometric test of Diamond and Dybvig’s [Diamond, D., Dybvig, P., 1983. Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91, 401–420] theory of bank runs as interpreted by Chari [Chari, V.V., 1989. Banking without deposit insurance or banks panics: lessons from a model of the U.S. national banking system. Federal Reserve Bank of Minneapolis Quarterly Review 13, 3–19] and Calomiris and Gorton [Calomiris, C., Gorton, G., 1991. Origins of banking panics: models, facts, and bank regulation. In: Hubbard, R.G. (Ed.), Financial Markets and Financial Crises. NBER and Univ. Chicago press, Chicago, pp. 109–173]. We test whether or not seasonal deposit drains on New York banks coincide with the bank panics of 1873 and 1893 in the United States. We use individual bank level data to illuminate the reason for withdrawals. The evidence reveals that the panic of 1873 could have included a seasonal interior drain. A seasonal interpretation of Diamond and Dybvig’s model cannot be applied to the bank panic of 1893.

Financial Regulation, Credit Risk and Financial Stability

In contrast to recent successful developments in macro monetary policies, the modelling, measurement and management of systemic financial stability has remained problematical. Indeed, the focus of most effort has been on improving individual, rather than systemic, bank risk management; the Basel II objective has been to bring regulatory bank capital into line with the (sophisticated) banks‘ assessment of their own economic capital. Even at the individual bank level there are concerns over (i) appropriate diversification allowances, (ii) differing objectives of banks and regulators, (iii) the need for a buffer over regulatory minima, and (iv) the distinction between expected and unexpected losses (EL and UL). At the systemic level the quite complex and prescriptive content of Basel II raises dangers of ‘endogenous risk’ and procyclicality. Simulations suggest that this latter could be a serious problem.

Do Banks Diversify Loan Portfolios? A Tentative Answer Based on Individual Bank Loan Portfolios

Theory of financial intermediation gives contradicting answers to the question whether banks should diversify or focus their loan portfolios. Our aim is to find out which of the two strategies is predominant in the German banking market. To this end we measure diversification for all German banks in the period from 1993 to 2002. As measures we use a broad set of heuristic approaches which capture the deviation of a bank's portfolio from a specified benchmark. Conceivable benchmarks are naive diversification across all industries or, alternatively, the economy's industry structure. With this framework our analysis comprises the widespread measures of concentration, like the Hirschman-Herfindahl index, but also the less known and in this context innovative group of distance measures. We find that different statistical measures of diversification may indicate contradicting results on the individual bank level. Since distance measures are more appealing from a theoretical point of view, the common practice to rely on measures of concentration only in the debate about diversification and focus, may be misleading. We further find that, despite these differences on the individual bank level, both approaches reveal that the majority of banks significantly increased loan portfolio diversification over the last decade. This tendency is especially driven by the large number of credit cooperatives and savings banks. However, some banks (especially regional banks and subsidiaries of foreign banks) reveal a strategy that seems to be more focused on certain industries.