Lower Asset Quality Research Articles

The Effect of Cross-Listing, Institutional Ownership, External Monitoring, and Capital Stringency Regulation on Bank Performance: A Comparison of Developed and Developing Economies

A bank listed on a single exchange must endure complex rules and high compliance costs. Those rules and costs are magnified when a bank decides to cross-list on multiple exchanges especially when the exchanges are in countries with varying degrees of development. We study the impact of cross-listing, institutional ownership, external monitoring, and capital stringency regulation on banks’ performance in developed and developing economies. The effect of cross-listing from a more developed to a less developed country differs from the effect of cross-listing in the opposite direction. We find that cross-listing results in higher profit and lower asset quality in banks from developed economies and lower profit and higher asset quality in banks from developing economies due to higher regulations and compliance costs. Cross-listing is associated with higher capital in banks from developed countries and higher asset growth and loan growth in banks from developing economies, especially after the 2008 crisis period. Higher institutional ownership results in higher profits, better asset quality, and higher growth in all banks and in higher tier-1 capital in banks from developed countries. Higher external monitoring results in lower profit, better asset quality, and higher tier-1 capital but lower growth of assets and loans in banks from developing economies. Higher capital stringency regulation results in lower profits and higher tier-1 capital in developing countries and higher profits and better asset quality but lower growth in banks from developed countries.

Loan loss provisions and income smoothing – Do shareholders matter?

In this paper, we aim to analyse the role of shareholders in the creation of discretionary loan loss provisions (LLP) and the use of LLP in income smoothing. Using a sample of over 200 Central European banks, we demonstrate that LLP and income smoothing of foreign-owned banks and state-owned banks differ from those of domestic private banks. Foreign and state banks create higher discretionary LLP than private domestic banks. Foreign banks use these LLP to perform discretionary income smoothing, while state banks, in general, do not smooth income. Higher LLP of foreign banks are observed in banks with low asset quality and high profitability. Foreign banks with low profitability that operate in volatile economic environments do not create higher discretionary LLP than domestic private banks. This implies that their risk is not lower than that of locally owned banks, at least on the credit side. In the aftermath of the financial crisis, both foreign and state banks have become more prudent than domestic private banks, and their discretionary LLP are higher. Overall, we provide evidence that foreign and government ownership affect LLP policy in banks. This complements existing results on the differences in loan cyclicality and default risk between foreign, state and domestic private banks.

Gender diversity and bank risk-taking: an empirical investigation in Italy

PurposeThe purpose of this paper is to investigate the relationship between gender diversity and the risk profile of Italian banks during the period 2015–2019. This study examines whether the presence of female board directors or top executives has any significant effect on bank risk-taking.Design/methodology/approachTo explore the influence of women on bank risk-taking, the authors analyzed a sample of 387 Italian banks and developed an econometric model applying unbalanced panel data with firm fixed effects and controls per year. Within a multivariate regression model, the authors considered five risk dimensions to verify the effect of gender diversity.FindingsThe findings suggest that female board directors and executives are considerably more risk averse and less overconfident than their male colleagues, thus confirming a negative causality between risk-taking and gender diversity. The results reveal that banks headed by women are less risky because they report higher capital adequacy and equity to assets ratios. As credit risk in female-led banks is no different from male-led ones, higher capital adequacy does not derive from lower asset quality because it is linked to the higher risk aversion of female directors and top managers.Research limitations/implicationsFrom a theoretical standpoint, the results suggest that having women in executive positions entails different risk implications for Italian banks; from a managerial perspective, the results highlight conditions that may promote the role of women in the banking sector. The conclusions are of particular significance because they provide some support for the view that regulators should favor gender quotas in the board management of banks to reduce risk-taking behavior.Originality/valueThis paper offers an in-depth examination of the risk practices of banks and it attempts to bridge the gap in prior literature on the risk profile of the Italian banking industry given that few empirical studies have examined the determinants of risk-taking in this field, to date. The findings on the higher risk aversion of women directors advance the understanding of the determinants of risk-taking behavior in banks, suggesting that gender quotas in bank boards can contribute to reducing risk-taking behavior. This also unveils some policy implications for bank regulatory authorities.

Bail-in and interbank contagion risk: an application of FSQCA methodology

This work uses fuzzy set theory and qualitative comparative analysis (QCA) to determine the causal configurations leading to interbank contagion in a resolution event. This study pioneers the introduction of fsQCA methodology in banking crisis analyses. The event providing the necessary data for this study is the resolution of the Spanish bank Banco Popular. We develop sufficient and necessary condition analyses to find the key metrics that lead to interbank contagion. The results demonstrate that weak solvency metrics, low asset quality and belonging to the same country where the resolution has been triggered tend to lead to higher contagion.

Industrial Policy and State Ownership: Where Does Credit Go?

Using a novel dataset with bank-sector level annual loan data from 137 commercial banks in China from 2004 to 2017, along with a quantified industrial policy dataset based on text analyses, I explore how influential industrial policy is in the credit market. Overall, commercial banks do not necessarily allocate more credit to sectors promoted by the central government. Banks have heterogeneous sensitivities to industrial policy. Compared with other commercial banks, rural commercial banks tend to respond most positively to industrial policy. Banks with lower asset quality, a smaller size, a higher liquidity ratio, and not listed are more responsive to industrial policy. On the other hand, sectors that are mainly controlled by state-owned enterprises (SOEs) always benefit relatively more credit when an industrial policy is announced, no matter whether the policy is initially targeting its own sector or other sectors. This is because SOEs are less risky, both economically and politically. Thus, industrial policy is not that powerful in credit reallocation due to the banks' tradeoff between political pressure and profitability. Moreover, it leads to further distortions on financial resource allocation towards SOEs.

Efficiency, Asset Quality and Stability of the Banking Sector in Malaysia

Malaysia practices a dual banking system, where conventional banks coexist with Islamic banks. While conventional banks are well established, Islamic banks are growing rapidly. Since Islamic banks consist of two types, namely stand-alone or wholesome Islamic banks and Islamic subsidiaries of conventional banks, it would be revealing to examine if Islamic subsidiaries of conventional banks differ from standalone Islamic banks in terms of efficiency, stability and assets quality. A few studies in the literature that examine the issue have focused on comparisons between Islamic banks and conventional banks, with no consideration given to the differentiation between the two categories of Islamic banks. In this paper, we attempt to examine the differences among the players in the banking sector in Malaysia. This paper extends the traditional analysis of conventional versus Islamic banks to comparisons between stand-alone Islamic banks and Islamic subsidiaries of conventional banks. Using dynamic panel data “generalized methods of moments” (GMM), the study reports that there are differences among different types of banks, viz. conventional banks, Islamic subsidiaries of conventional parents, and stand-alone Islamic banks. It shows that Islamic subsidiaries of conventional banks perform better than stand-alone Islamic banks as well as their own conventional parents. Furthermore, the results show that Islamic subsidiaries are more stable in term of their financing income compared to the rest of the banks, while the stand-alone banks have lower asset quality in comparison with both Islamic subsidiaries and their parents.

Does CEO gender matter for bank risk?

This paper addresses the relation between CEO gender and bank risk. We exploit a unique dataset of 365 Polish cooperative banks, 42% of which are run by female CEOs. We find that banks headed by female CEOs are less risky: they report higher capital adequacy and equity to assets ratios. Credit risk in female-led banks is not different from male-led banks, and therefore higher capital adequacy does not stem from lower asset quality and is likely to be linked to higher risk aversion of female CEOs. Our evidence supports the view that women are more risk averse bank CEOs than men. Our findings suggest that gender quotas in bank boards can contribute to reduce risk-taking behavior.

The Default Risk of China’s Credit Market from the Perspective of Industries

Nowadays, the credit industry of China's commercial banks is highly concentrated in industries such as manufacturing, wholesale and retail, which have high non-performing loan rates and low credit asset quality, leading to poor overall credit asset quality of commercial banks. Optimizing the industrial structure of commercial bank credit can effectively improve the quality of commercial bank assets. This paper evaluates the industrial structure of China's credit market from the perspective of industry, and proposes recommendations for the credit funds of different industries based on industry evaluation.

Lending conditions in EU: The role of credit demand and supply

We analyse the bank lending activity after the financial crisis and focus on bank-specific supply factors. Using a rich microeconomic dataset from Bankscope and macroeconomic shocks data, we employ OLS and 2SLS fixed effects models with banking controls, macroeconomic shocks and institutional quality. The banks’ loan-rate spreads increased despite the recent policy of low interest rates and quantitative easing. We use the bank asset quality as instruments to capture exogenous changes in loan supply. The empirical evidence shows that loan-rate spread and through this the supply of loans is negatively affected by a low asset quality and capital ratios.

Determinants of bank profitability in Tunisia: does corruption matter?

PurposeIn this paper, the author aims to examine the effect of perceived level of corruption on bank profitability.Design/methodology/approachThe analysis is based on a balanced panel of ten commercial banks in Tunisia over the period 2003-2014. The author uses the generalized method of moments estimator technique described by Arellano and Bover (1995).FindingsThe author finds a positive relationship between the bank profitability and the corruption level. This surprising result suggests that Tunisian commercial banks take advantage from the high level of corruption. Regarding the others determinants, the findings reveal that bank profitability is positively related to capitalization level and liquidity. By contrast, a low asset quality is associated with low profitability.Originality/valueThe novelty of this study consists in the inclusion of the corruption level as a determinant of bank profitability.

Short-Sale Constraints and Credit Runs

This paper studies how short-sale constraints affect the informational efficiency of market prices and the link between prices and economic activity. I show that under short-sale constraints security prices contain less information. However, short-sale constraints increase the informativeness of prices to some agents who learn about the quality of an investment opportunity from market prices and have additional private information.Then I apply this observation when modeling a run on an investment bank by its short-term creditors, who are endowed with dispersed information and also learn from the price of an asset the bank holds. I show that short-selling constraints in the financial market lead to the revival of self-fulfilling beliefs about the beliefs and actions of others, and create multiple equilibria. In the equilibrium where agents rely more on public information (i.e., the price), creditors with high private signals are more lenient to roll over debt, and a bank with lower asset quality remains solvent. This leads to higher allocative efficiency in the real economy. My result thus implies that the decrease in average informativeness due to short-sale constraints can be more than compensated by an increase in informativeness to some agents.

Bank credit default swaps and deposit insurance around the world

We investigate the impact of deposit insurance schemes on banks' credit risk – a predictor of failure and a key element in the current financial crisis. Unlike most studies, which use balance sheet measurements of risk, we adopt a forward-looking and market-based measure of bank credit risk: the credit default swap (CDS) spread. We find that banks in countries with explicit deposit insurance systems have higher CDS spreads, supporting the “moral hazard” view. The results suggest that deposit insurance design features that lessen the adverse impact are risk-adjusted premium, coinsurance systems, government-established systems, “risk-minimizing” systems, and systems with dual-funding sources. Full coverage appears to stabilize bank risk only during the financial crisis period. More stringent bank regulation, such as capital adequacy regulation and independent supervision, could reduce the undesirable impact of deposit insurance. Deposit insurance seems to help stabilize volatile markets, as evidenced during the financial crisis and in countries with greater market volatility. In addition, we find that the adverse impact of deposit insurance on bank credit risk is more pronounced for banks with low asset quality and low liquidity.

The Effects of Banking Regulation on Asset Quality: A Panel Analysis

This paper attempts to investigate the effects of banking regulation on asset quality. This has been conducted using a sample of 14 countries from 1) Middle East & Africa, 2) Europe & Central Asia, 3) Latin America & Caribbean and 4) East Asia & Pacific, over the period from 2006 to 2012. Asset quality is measured by “bank nonperforming loans to gross loans” according to The World Bank database regarding World Development Indicators, while banking regulation is measured by the “response to Basel implementation” according to FSI survey of July 2013. Results indicate that implementation of SA “Standardized Approach” and Conserv “Capital conservation buffer” may affect “asset quality” for low-asset quality countries (Middle East & Africa and Europe & Central Asia groups), while implementation of BIA “Basic indicator approach “ and P2 “Pillar2” may affect “asset quality” for high-asset quality ones (Latin America & Caribbean and East Asia & Pacific groups).

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.

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.

Macro and micro prudential regulatory failures between banks in the United Kingdom and Australia 2004‐2009

PurposeThis paper compares the performance of the big four UK banks and four Australian banks between 2004‐2009. The banks are chosen according to the total assets as listed in The Banker magazine 2009. The purpose is to analyse why UK banks were more vulnerable to the financial crisis of 2007‐2009 than Australian banks. The consequence of this study is what improvements can be made in relation to liquidity, leverage, loan to deposit, asset quality and capital ratios.Design/methodology/approachThe author adopts an empirical approach and gathers data from the annual reports of the big four UK banks and Australian banks and the database “Factiva” and the Financial Times. The data contains liquidity, debt, capital, asset quality and profitability ratios during 2004‐2009.FindingsThe author's data show UK banks had on average higher cash ratios, higher leverage ratios, higher loan to deposit ratios, higher capital ratios, lower asset quality, lower ROA but higher ROE than the Australian banks.Research limitations/implicationsThe results support the findings in the Financial Development Index 2011 of the World Economic Forum. UK banks should ameliorate its ranking on financial stability by improving the quality of loans and capital.Practical implicationsThe analysis is of use to regulators who are contemplating the need for reforms aimed at improving financial ratios of banks. Basel III Accord has introduced some recommendations but has its limitations.Originality/valueThis paper's value lies in providing analysis of the top four UK and Australian banks' performances during 2004‐2009. There is room for improvement in providing a more stable financial environment in the UK.

Macro and Micro Prudential Regulatory Failures Amongst Financial Institutions in the United Kingdom: Lessons from Australia

Purpose – This paper compares the performance of the big four UK banks and four Australian banks between 2004-2009. The banks are chosen according to the total assets as listed in The Banker magazine 2009. The purpose is to analyse why UK banks were more vulnerable to the financial crisis of 2007-2009 than Australian banks. The consequence of this study is what improvements can be made in relation to liquidity, leverage, loan to deposit, asset quality and capital ratios. Design/methodology/approach – The author adopts an empirical approach and gathers data from the annual reports of the big four UK banks and Australian banks and the database ‘Factiva’ and the Financial Times. The data contains liquidity, debt, capital, asset quality and profitability ratios during 2004-2009. Findings –The author’s data show UK banks had on average higher cash ratios, higher leverage ratios, higher loan to deposit ratios, higher capital ratios, lower asset quality, lower ROA but higher ROE than the Australian banks. Research implications- The results support the findings in the Financial Development Index 2011 of the World Economic Forum. UK banks should ameliorate its ranking on financial stability by improving the quality of loans and capital. Practical implications- The analysis is of use to regulators who are contemplating the need for reforms aimed at improving financial ratios of banks. Basel III Accord has introduced some recommendations but has its limitations. Originality/value – This paper's value lies in providing analysis of the top four UK and Australian banks’ performances during 2004-2009. There is room for improvement in providing a more stable financial environment in the UK.

EFFECT OF FED POLICY ACTIONS ON THE DEFAULT LIKELIHOOD OF COMMERCIAL BANKS

AbstractUsing a measure of default likelihood based on an option pricing method, we provide evidence that Fed policy actions affect the financial distress of commercial banks. When the Fed increases (decreases) interest rates, the measure of default likelihood increases (decreases). We show that when the Fed uses a tight money policy, the increase in default likelihood is more pronounced for banks that have less capital, have greater financial leverage, are smaller, have fewer growth opportunities, and have lower asset quality. Additionally, the effects on bank default likelihood are more pronounced when the Fed's policy signals less concern about economic growth, as indicated by its bias toward further tightening, and when there is a market expectation of higher short‐term market rates in the future.