Recent Banking Crises Research Articles

Do short sellers exploit risky business models of banks? Evidence from two banking crises

We find that changes in short interest predict banks’ stock returns during two recent banking crises. Furthermore, before the 2007–2008 crisis, short interest increased more for banks with worse performance during the Long-Term Capital Management crisis of 1998. We also find that changes in short interest predicted banks’ loan quality and default risk during the 2007–2008 crisis. The results are stronger for banks with higher levels of risk-taking. Overall, our findings indicate that short sellers were informed about the persistent risky business models of banks and shorted those banks before the 2007–2008 crisis.

Regulatory Responses by Countries to Banking/Financial Crises

Banking/financial crises have occurred in countries at all levels of income and in all parts of the world. These crises not only occur too frequently, but also are too costly. Countries everywhere therefore have enacted laws that established regulatory authorities with responsibility to implement appropriate regulations and supervisory practices to promote healthy and stable banking systems. However, relatively recent information has become available that indicates that countries do not choose to regulate and supervise their banks in exactly the same way. Such information helps enable researchers to examine what regulations and supervisory practices work best. The results of these examinations can be extremely important to policy makers when considering changes to make in regulatory regimes in response to the most recent banking crisis.

European Banking Union to the Rescue? How Supranational Institutions Influenced Crisis Management in Italy

ABSTRACTThis article examines the management of the recent banking crisis in Italy. In particular, we investigate the changing coalitional dynamics among Italian banks with a view to identifying the conditions under which banks are more likely to share the costs of crisis management. We argue that banks’ preferences are significantly shaped by the institutional context within which they operate. In particular, the establishment of Banking Union in the European Union (EU) significantly weakened the traditional coalitional dynamics among Italian banks by injecting uncertainty about the distributional effects of crisis management policy solutions.

Making Depositors Greedy and Careless: Government Safety Nets and the Degradation of Depositor Discipline

In emerging countries, deposits play an important role in banks’ total funding; hence depositor discipline may impact significantly banking performance and the financial system’s stability. My paper investigates the reaction of bank depositors to interest rates as well as signs of banks’ risk, before and after the recent banking crisis in Vietnam. I demonstrate that before the crisis, the level of deposit financing in banks depended on the interest rates offered, but also on measures of the banks' risk-taking. After the crisis, the second relationship wanes: Bank customers still react actively to interest rates but not to risk, presumably because they have learned that their deposits are safe, whatever risk the bank is taking.

Social networks in the global banking sector

We show that banks with shared social connections partner more often in the global syndicated loan market and that central banks in the network play dominant roles in various interbank transactions, indicating that social connections facilitate business connections. However, more centralized banks in the network also contribute significantly to the global systemic risk. Moreover, we find the soft information generated by social networks is particularly valuable when potential partners operate under different accounting and regulatory standards. Finally, we show that the recent banking crisis significantly limited the positive soft information effects of social networks in the global banking system.

Financial Digital Disruptors and Cyber-Security Risks: Paired and Systemic

The scale and intensity of digital financial criminality has become more apparent and audacious over the past fifteen years. To counteract this escalating threat, financial technology (FinTech) and monetary and financial institutions (MFI) have attempted to upgrade their internal technological infrastructures to mitigate the risk of a catastrophic technological collapse. However, these attempts have been hampered through the financial stresses generated from the recent international banking crises. Significant contagion channels in the aftermath of cybercriminal events have also been recently uncovered, indicating that a single major event may generate sectoral and industry-wide volatility spillovers. As the skillset and variety of tactics used by cybercriminals develops further in an environment of stagnating and underfunded defensive technological structures, the probability of a devastating hacking event increases, along with the necessity for regulatory intervention. This paper explores and discusses the range of threats and consequences emanating from financial digital disruptors through cybercrime and potential avenues that may be utilised to counteract such risk.

Contagion Effect from US Banking to Conventional and Islamic Banking in Dual-Banking System During the Global Financial Crisis

Tremendous efforts and initiatives have been proposed by policy makers to minimize the sever shocks of the recent banking crisis through variety of domestic macro gears as the international transmission shocks are evidently challenging to handle. This study aims to explore the global contagion spillovers from crisis-oriented country (US) to nine selected countries with dual-banking system during the crisis from 2007 to 2009. Empirical findings indicate that Islamic banking industries in all countries are exposed to at least one specific type of contagion effect, suggesting that Islamic banking model is not operating out in an isolated island and that the growth momentum of the industry will continue to integrate in world’s banking system. Together, results suggest that Islamic banks are vulnerable to international transmission shocks from crisis-oriented country and that signal crucial need for developing more advanced risk management tools for this banking model.

Do short sellers exploit the persistent risk culture of banks? Evidence from two banking crises

We find that change of short interests predict banks’ stock returns during the two recent banking crises. More interestingly, before the 2007-2009 crisis, short interests increase more for the banks that suffered more in the LTCM crisis. We also find that change in short interests predict banks’ loan quality and default risk during crises. The results are stronger for banks with higher risk-taking behavior. Overall, our findings indicate that short sellers are informed about the risk exposure of banks for the two financial crises and target those with a culture for risky business models.

Banking Crises, R&D Investments and Slow Recoveries

This paper studies the effect of banking crises on the composition of investment and economic growth. It builds a partial equilibrium growth model with a banking sector and two types of investment projects: a safe, low return technology and an innovative, high productivity one. Investments in innovation are risky since they are subject to a liquidity cost which entrepreneurs cover by borrowing from the banking sector. When bank creditors are sufficiently pessimistic about the aggregate liquidity needs of the real sector, they will run on the bank and cause a credit freeze. This leads banks to tighten credit supply after the crisis, which decreases disproportionately investment in innovation and slows down economic growth. Industry-level data on R&D investment supports this hypothesis for 13 recent banking crises episodes. Industries that depend more on external finance, in more bank-based economies, invest disproportionately less in R&D following episodes of banking distress. These industries also have a relatively lower share of R&D in total investment, suggesting a shift in the composition of investment after the crisis. Such differential effects across sectors imply that the drop in R&D spending is, at least partially, the result of a credit supply shock.

How should we measure bank capital adequacy for triggering Prompt Corrective Action? A (simple) proposal

In this study, we test the predictive power of several alternative measures of bank capital adequacy in identifying U.S. bank failures during the recent crisis period. We find that an unconventional ratio – the non-performing asset coverage ratio (NPACR) – significantly outperforms Basel-based ratios including the Tier 1 ratio, the Total Capital Ratio, and the Leverage ratio – throughout the crisis period. It also outperforms in predicting failures among “well-capitalized” banks (as defined by the current Prompt Corrective Action guidelines). Based on our results, we argue that NPACR outperforms other ratios in at least five aspects: (i) it aligns capital and credit risks – the two primary risks of bank failures – in one measure; (ii) it is easier to calculate than the Tier 1 and Total Capital ratios, as it requires calculation of no complex risk weights; (iii) it allows one to account for various time period and cross-country provisioning rules and regimes, including episodes of regulatory forbearance and cross-country differences; (iv) it removes the incentives of both banks and regulators to mask capital deficiencies by creating/requiring insufficient loan-loss reserves; and (v) it outperforms all other commonly used capital ratios in predicting bank failures. We believe that all the above features of proposed measure promise its effective use in the prompt corrective actions by bank regulators. We also expect that this single and informative measure of bank risk can be efficiently used in empirical banking studies. The results of this study also shed light on regulatory forbearance during the recent banking crisis.

Ethical Screening and Financial Performance: The Case of Islamic Equity Funds

Whether ethical screening affects portfolio performance is an important question that is yet to be settled in the literature. This paper aims to shed further light on this question by examining the performance of a large global sample of Islamic equity funds (IEFs) from 1984 to 2010. We find that IEFs underperform conventional funds by an average of 40 basis points per month, consistent with the underperformance hypothesis. In line with popular media claims that Islamic funds are a safer investment, IEFs outperformed conventional funds during the recent banking crisis. However, we find no such outperformance for other crises or high volatility periods. Based on fund holdings-based data, we provide evidence of a negative curvilinear relation between fund performance and ethical screening intensity, consistent with a return trade-off to being more ethical.

What did Margaret Thatcher do for the UK economy?

The Thatcher reforms brought inflation under control and raised growth and living standards, by injecting competition into most areas of the economy. The recent banking crisis is not attributable to Big Bang but rather to the 1997 Labour government’s removal of supervisory powers from the Bank of England. The fact that most large continental economies have failed to achieve supply-side reform puts the Thatcher achievement in stark perspective

Interconnectedness of the Banking Sector as a Vulnerability to Crises

This paper uses domestic and cross-border linkages to measure the interconnectedness of the banking sector, and relates it to banking crises in Europe. Beyond cross-border financial linkages of the banking sector, we also account for financial linkages to the other main financial and non-financial sectors within the economy. We enrich conventional early-warning models using macro-financial vulnerabilities, by including measures of banking sector centrality as potential determinants of banking crises. Our results show that a more central position of the banking sector in these so-called macro-networks significantly increases the probability of a banking crisis. By analyzing the different types of risk exposures, our evidence shows that credit as well as market risks are important sources of vulnerabilities. Finally, the results show that early-warning models augmented with interconnectedness measures outperform traditional models in terms of out-of-sample predictions of recent banking crises in Europe.

The Federal Deposit Insurance Corporation: A Plunge to Irrelevance

What was the role for the FDIC as the financial industry began to collapse in 2008? One must remember that when it was created as part of the Banking Act of 1933, the prime directive of the FDIC was policing banking activities to prevent reckless and speculative activities with the money entrusted to banks by depositors. With the passage of the Graham-Leach-Bliley Act in 1999, the FDIC became an insurer of gambling losses. It was still responsible to depositors when gambling losses occurred; but it had very little control over the gambling activities themselves. Considering the magnitude of the 2008-2009 collapse, common sense should have dictated that if financial institutions had become too big to fail, then they had also become too big to regulate. As part of the bailout process, one would think that the federal government should have taken a page out of Teddy Roosevelt’s playbook and set out on a mission to bust these trusts rather than further contributing to their unbridled growth. If the collapse and taxpayer bailout was precipitated by reckless behavior among institutions that were too big to fail, the sensible response by the U.S. government would seem to have been a passage of legislation disallowing future corporate mergers that create such institutions. However in its feckless state during the recent banking crises, the FDIC not only facilitated more growth, it worked at cross-purposes to its original mandate. In the 21st century, it has instead become the quintessential facilitator of the moral hazards that continue to permeate the U.S. banking industry today. With the FDIC insuring these hazards, the American taxpayer will most certainly be called upon once again to foot the bill for reckless behavior by the big banks. It’s just a matter of time.

Banking Reform Struggles On

The Financial Services (Banking Reform) Act 2013 was passed as part of an ongoing process to improve the stability of the United Kingdom’s banking system. It does not sit in isolation but is part of a process that has involved the creation of the Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA), and the adoption of the European Union’s (EU’s) Capital Requirements Directive IV which brings the Basel III banking regulations into EU law. The background for the statute’s content was Sir John Vickers’ Report1 into banking reform, published in September 2011, which led in turn to the June 2012 White Paper.2 At the same time, the Parliamentary Commission on Banking Standards was examining accountability and corporate governance in the context of the London Interbank Offered Rate scandal as well as the issues of banking stability and competition.3 However, the content and aims of the statute sit oddly with the causes and processes of the most recent banking crisis and had it existed at the time it is unlikely to have made much difference. This article will examine the aims and content of the Act and consider what its consequences are likely to be.

The role of financial frictions during the crisis: An estimated DSGE model

After the recent banking crisis in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. This paper provides a quantitative assessment of the impact of financial frictions on the U.S. business cycle. The analysis compares the original Smets and Wouters model (2003, 2007) with an alternative version augmented with the financial accelerator mechanism á la Bernanke, Gertler and Gilchrist (1996, 1999). Both versions are estimated using Bayesian techniques over a sample extended to 2012. The analysis supports the role of financial channels, namely the financial accelerator mechanism, in transmitting dysfunctions from financial markets to the real economy.The Smets and Wouters model, augmented with the financial accelerator mechanism, is suitable to capture much of the historical developments in U.S. financial markets that led to the financial crisis. The model can account for the output contraction in 2008, as well as the widening in corporate spreads, and supports the argument that financial conditions have amplified the U.S. business cycle and the intensity of the recession.

How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking

Thanks to the recent banking crises interest has grown in banks and how they operate. In the past, the empirical and institutional market micro-structure of the operation of banks had not been a primary focus for investigations by researchers, which is why they are not well covered in the literature. One neglected detail is the banks' function as the creators and allocators of about 97% of the money supply (Werner, 1997, 2005), which has recently attracted attention (Bank of England, 2014a,b; Werner, 2014b,c). It is the purpose of this paper to investigate precisely how banks create money, and why or whether companies cannot do the same. Since the implementation of banking operations takes place within a corporate accounting framework, this paper is based upon a comparative accounting analysis perspective. By breaking the accounting treatment of lending into two steps, the difference in the accounting operation by bank and non-bank corporations can be isolated. As a result, it can be established precisely why banks are different and what it is that makes them different: They are exempted from the Client Money Rules and thus, unlike other firms, do not have to segregate client money. This enables banks to classify their accounts payable liabilities arising from bank loan contracts as a different type of liability called ‘customer deposits’. The finding is important for many reasons, including for modelling the banking sector accurately in economic models, bank regulation and also for monetary reform proposals that aim at taking away the privilege of money creation from banks. The paper thus adds to the growing literature on the institutional details and market micro-structure of our financial and monetary system, and in particular offers a new contribution to the literature on ‘what makes banks different’, from an accounting and regulatory perspective, solving the puzzle of why banks combine lending and deposit-taking operations under one roof.

Modelling and measuring business risk and the resiliency of retail banks

The recent banking crisis has revealed the existence of strong resiliency factors in the retail banking business model. On average, retail banks suffered less than other financial institutions from unexpected market changes. This paper proposes a new methodology to measure retail banks’ business risk, which is defined as the risk of adverse and unexpected changes in banks’ profits coming from sudden changes in the banks’ activities. This methodology is based on the efficiency frontier methodology, and, more specifically, on the duality property between the directional distance function and the profit function. Using the distance function to compute banks’ profitability, we take the distance to the frontier of best practices as a measure of profit inefficiency, i.e. of unexpected losses related to underperformance. In this approach, shifts in the efficiency frontier induced by adverse shocks to banks’ volumes serve as a measure of business risk. This measure of profit volatility allows a measurement to be made of the impact of volume changes on banks’ profits. This method is applied to a database containing half yearly regulatory accounting reports over the 1993–2011 period for a sample of quite all French banks running a retail banking business model. Our results verify a low level of business risk in retail banking, thus confirming the resiliency of the retail banks’ business model.

How Should We Measure Bank Capital Adequacy? A (Simple) Proposal

In this study, we test the predictive power of several alternative measures of bank capital adequacy in identifying U.S. bank failures during the recent crisis period. We find that an unconventional ratio — the non-performing asset coverage ratio — significantly outperforms Basel-based ratios including the Tier 1 ratio, the Total Capital Ratio, and the Leverage ratio — throughout the crisis period. It also outperforms in predicting failures among ― well-capitalized banks (as defined by the current Prompt Corrective Action guidelines). Based on our results, we argue that NPACR outperforms other ratios in at least five aspects: (i) it aligns capital and credit risks — the two primary risks of bank failures — in one measure; (ii) it is easier to calculate than the Tier 1 and Total Capital ratios, as it requires calculation of no complex risk weights; (iii) it allows one to account for various time period and cross-country provisioning rules and regimes, including episodes of regulatory forbearance and cross-country differences; (iv) it removes the incentives of both banks and regulators to mask capital deficiencies by creating/requiring insufficient loan-loss reserves; and (v) it outperforms all other commonly used capital ratios in predicting bank failures. We believe that all the above features of proposed measure promise its effective use in the prompt corrective actions by bank regulators. We also expect that this single and informative measure of bank risk can be efficiently used in empirical banking studies. The results of this study also shed light on regulatory forbearance during the recent banking crisis.

The Role of Auditors in the Recent Nigerian Banking Crisis

In market societies people routinely have to transact with faceless corporations about whom they have little personal knowledge. In such societies external auditing and auditors are promoted as a trust engendering technology and watchdog with the capacity to promote a particular kind of social order. Investors and depositors in a number of banks in Nigeria have lost several billions of Naira due to the lack of implementing qualified audit report theory and practices of accountants and auditors, which has resulted in the distress of a number of banks. This research work has examined the contemporary auditing and the role of accountants and auditing firms in causing the collapse of banks. The paper locates the role of auditors within the broader dynamics of professionalism and the pursuit of profits to argue that major accountancy firms are becoming more and more willing to increase their profits by indulging in anti-social practices that show scant regard for social norms and even legal rules and regulations. Contrary to their claims to be protecting the public interest, accountants and auditors may be partly responsible for cases of distress and the collapse of banks in Nigeria, as they failed to qualify their reports when there were indications of financial difficulties in the banks. There is also evidence to show that auditors have collected large sums in audit and non-audit fees. Such events raise questions about the value of company audits, auditor independence and the quality of audit work. This paper argues that the basic auditing model is flawed since it makes auditors financially dependent on companies. The conventional approach to ‘audit quality’ is also inadequate as it pays little attention to the organizational pursuit of profits and the social