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Independent Directors’ Connectedness and Bank Risk-Taking
Amin A., Mollah S., Kamal S., Zhao Y., Simsek R.
Q1
The leverage ratio, risk-taking and bank stability
Acosta-Smith J., Grill M., Lang J.H.
Q1
This paper analyses the trade-off between additional loss-absorbing capacity and potentially higher bank risk-taking associated with the introduction of the Basel III Leverage Ratio. This is addressed in both a theoretical and empirical setting. Using a theoretical micro model, we show that a leverage ratio requirement can incentivise banks that are bound by it to increase their risk-taking. This increase in risk-taking however, should be outweighed by the benefits of higher capital, thereby leading to more stable banks. These theoretical predictions are tested and confirmed in an empirical analysis on a large sample of EU banks. Our baseline empirical model suggests that a leverage ratio requirement leads to a significant decline in the distress probability of highly leveraged banks.
Market reaction to the expected loss model in banks
Onali E., Ginesti G., Cardillo G., Torluccio G.
Q1
We investigate how investors perceive the adoption of the expected-loss model (ELM) for impairment incorporated in IFRS 9. Using a sample of European listed banks covering the period of the standard-setting process of IFRS 9, we examine whether the market perceives the new regulation to increase shareholder wealth. First, we document a positive market reaction to the ELM adoption events. Second, we find that investors perceive that the potential benefits of ELM are more pronounced for larger banks, banks with lower profitability and higher systemic risk, and for those that received a public bailout and with more positively skewed returns. Overall, these results support a “monitoring” channel suggesting that ELM may lead to greater bank transparency and more effective market discipline, fundamental for improving financial stability.
Bank capital regulation and risk after the Global Financial Crisis
Anginer D., Bertay A.C., Cull R., Demirgüç-Kunt A., Mare D.S.
Q1
We explore and summarize the evolution in bank capital regulations and bank risk after the global financial crisis. Using a new survey of bank regulation and supervision covering more than 120 economies, we show that regulatory capital increased, but some elements of capital regulations became laxer. Analyzing bank-level data, we also document the importance of defining bank regulatory capital narrowly as the quality of capital matters in reducing bank risk. This is particularly true for banks that have more discretion in the computation of regulatory capital ratios and are subject to weaker market monitoring.
Shifts in global credit and corporate access to finance
Banti C., Bose U.
Q1
Employing a dataset of 1,160 Indian firms, we study the impact of global financing conditions on firms’ borrowings abroad across different phases of global credit. While the abundant credit in the post global financial crisis period allowed firms to take advantage of relatively cheap financing abroad, we show that firms’ access to external finance has declined since 2013. We find that since 2013, lenders are differentiating across borrowers and it is specifically the less risky and more profitable firms that are increasing their foreign borrowings even at the times of higher global risk. We do not find evidence of regional and domestic credit offsetting this global effect. Furthermore, we find that the reduced access to external finance in the post-2013 period is associated with a decline in firms’ real investment activities, highlighting the real effects of global credit dynamics.
Firm-level political risk and stock price crashes
Makrychoriti P., Pyrgiotakis E.G.
Q1
In this study, we examine the relationship between firm-level political risk and stock price crash risk. Using a broad dataset of 4230 U.S. firms, 38,097 firm-year observations from 2002 to 2019, we reveal a positive association between political risk and stock price crash risk. These findings are robust to several model specifications and endogeneity checks. By using the Brexit referendum as a quasi-natural experiment, we provide evidence of a causal relationship between political risk and crash risk. Through channel analysis, we identify that this relationship is mediated via higher idiosyncratic volatility, lower price informativeness, and higher distress risk. We also find that our results are more pronounced in intangible-intensive firms. Interestingly, we show that managers of these firms respond to political risk by engaging in bad news hoarding. Finally, strong (external or internal) corporate governance mechanisms can moderate the positive relationship between political risk and stock price crash risk.
Green-Adjusted Share Prices: A Comparison Between Standard Investors and Investors with Green Preferences
Quaye E., Tunaru D., Tunaru R.
Q1
We employ the green revenue factors of firms, used in the computation of the FTSE Russell 1000 Green Revenues index to create corresponding green-adjusted share prices. We compute the firm betas, under both the standard and the green-adjusted share pricing. Our findings suggest that tilting of firm stock returns towards green finance could change temporarily asset pricing views. The Fama-French risk factors display very high correlations between the two settings. Nevertheless, there are some significant differences between standard and green-adjusted betas during periods associated with green activism and positive political decisions of financially supporting the global climate action.
Bank deregulation and corporate social responsibility
Liu F.H., Wu Q., Zhou Y.
Q1
We show how external credit market development can affect corporate social responsibility. Using a sample of US public firms over the period 1991–2010, we find that bank deregulation negatively affects CSR performance. We argue that deregulation-induced banking competition enhances credit accessibility, thereby reducing firms' incentives to pursue CSR as a means of securing stakeholder rewards. Empirical evidence shows that firms increase their use of debt financing in response to the intensified banking competition, and these firms experience a more pronounced decline in CSR performance. We alleviate the potential concern that the observed decline in CSR could be attributed to changes in bank monitoring following deregulation. Further analyses find that firms reduce CSR regardless of their material nature, suggesting that the primary driver of CSR could be the trade-off between costs and returns. Overall, our findings shed light on the strategic motives of CSR, which exhibits adaptability in response to business dynamism.
Climate Change Exposure, Financial Development, and the Cost of Debt: Evidence from EU Countries
Trinh V.Q., Trinh H.H., Li T., Vo X.V.
Q1
Utilising climate-related narratives in conference call transcripts to measure firm-level exposure to climate risks, we examine the association between such exposure and the corporate cost of debt financing. Using a sample of 21 European countries from 2001 to 2020, we find that firms exposed to greater climate change experience higher debt costs. The impact is even more extreme when using climate-related opportunity and regulatory exposure measures. We further find critical economic channels through which the higher debt costs occur: financial development and credit supplies. Specifically, our findings hold only for firms in weakly developed financial markets and institutions as measured by the new broad-based multi-dimensional financial development indices. We also find some other conditioning factors. (1) The higher the carbon intensity level, the greater the debt cost a firm with more climate change exposure must pay. (2) Debtholders appear to punish firms with high environmental and social disclosure that are exposed to more climate change. (3) The findings are more pronounced in financially constrained firms.
Automatic versus manual investing: Role of past performance
Kaawach S., Kowalewski O., Talavera O.
Q1
Open-economy macroeconomics with financial frictions: A simple model with flexible exchange rates
Agénor P.
Q1
A simple macroeconomic model with banking, financial frictions, and flexible exchange rates is used to study the performance of fiscal, monetary and macroprudential policy combinations in response to domestic and external shocks. After characterizing the transmission process of each instrument, a diagrammatic analysis of how these policies should be used, either individually or jointly, to promote economic and financial stability, is provided. The analysis shows that whether a policy should be assigned to internal or external balance, and whether it should be contractionary or expansionary, depends not only on the nature of the shocks impinging on the economy but also on the range of tools available to policymakers and the strength of financial frictions. In particular, in response to an external financial shock, monetary policy should be assigned to external balance, and fiscal policy or macroprudential regulation to internal balance. These two policies are substitutes when used in combination with monetary policy.
Structural shifts in bank credit ratings
Ballis A., Ioannidis C., Sifodaskalakis E.
Q1
We investigate the time variation in credit rating standards awarded to financial institutions of commercial bank credit ratings awarded by the three principal CRAs from 1990 to 2015 in a world-wide context by testing for well-defined structural shifts. We focus on the part of the ratings that cannot be accounted using publicly available information. We test whether major financial events are conditioning, ex-post such changes Distinctively in this paper's timespan our analysis covers four periods: (i) before and (ii) after the 2001-2 corporate collapses, followed by (iii) before the global financial crisis and (iv) after the global financial crisis. We find substantial differences in the assignment of bank credit ratings among the three major agencies, Moody's, Fitch, and S&P. Agencies differ both in terms of re-adjustment of ratings but also on the speed of response to the evens. All three agencies tightened ratings during the 2008 crisis and kept reducing them in its aftermath.
Decentralization illusion in Decentralized Finance: Evidence from tokenized voting in MakerDAO polls
Sun X., Stasinakis C., Sermpinis G.
Q1
Decentralized Autonomous Organization (DAO) is very popular in Decentralized Finance (DeFi) applications as it provides a decentralized governance solution through blockchain. We analyze the governance characteristics in the Maker protocol, its stablecoin DAI and its governance token Maker (MKR). To achieve that, we establish several measurements of centralized governance. Our empirical analysis investigates the effect of centralized governance over a series of factors related to MKR and DAI, such as financial, network and Twitter sentiment indicators. Our results show that governance centralization influences the Maker protocol and that the distribution of voting power matters. The main implication of this study is that centralized governance in MakerDAO very much exists, while DeFi investors face a trade-off between decentralization and performance of a DeFi protocol. This further contributes to the contemporary debate over whether DeFi can be truly decentralized.
The macroeconomic costs of the bank tax
Borsuk M., Przeworska J., Saunders A., Serwa D.
Q1
In this paper, we investigate the real effects of special taxation on banks. We provide evidence that the introduction of a new fiscal levy on banks significantly impairs their performance and has an adverse impact on the real economy through the lending channel. Using micro-level data on lending relationships, we identify the credit supply shock related with a bank tax controlling for loan demand factors. We compute a firm-specific measure of firm exposure to burdened credit institutions. We find a negative impact of the tax shock on investment and output. Our results are important from a policy perspective as they shed light on the economic consequences of double taxation on banks.
A model of managerial compensation, firm leverage and credit stimulus
Chakraborti R., Dahiya S., Ge L., Gete P.
Q1
We study a model in which leverage and compensation are both choice variables for the firm and borrowing spreads are endogenous. First, we analyze the correlation between leverage and variable compensation. We show that allowing for endogenous compensation and leverage can explain the conflicting findings of the empirical literature. We uncover a new channel of complementarity between effort and leverage that induces a correlation sign opposite to what current theoretical models predict. Second, we study the dynamics of leverage and compensation design after a credit stimulus. We derive a set of new empirical predictions. For outward-shifts in credit supply, variable compensation is increasing in leverage growth. Moreover, variable compensation increases after the credit stimulus, especially for firms with low idiosyncratic risk.
Bank capital, liquidity creation and the moderating role of bank culture: An investigation using a machine learning approach
Thi Nguyen L.Q., Matousek R., Muradoglu G.
Q1
This empirical study investigates whether a strong bank culture may help strengthen, weaken, or have no effect on the relationship between regulatory capital and liquidity creation. Using a machine learning approach and banks' 10-K reports, we first measure the corporate culture of selected bank holding companies (BHCs) in the United State (U.S.) over the period between 1995 and 2019. We find that bank culture does affect the link between regulatory capital and liquidity creation. In particular, while we find that regulatory capital has a negative impact on bank liquidity creation, a strong culture in a bank weakens this negative association. We also find that an increase in asset-side liquidity creation is the main channel through which bank culture exerts its moderating role. Finally, our results are largely driven by smaller banks, banks with a more traditional funding structure and more profitable banks. The results of this study suggest that regulators should consider bank culture as being a crucial element in the monitoring approach when designing bank regulation and supervision.
Uncertainty, non-linear contagion and the credit quality channel: An application to the Spanish interbank market
Carro A., Stupariu P.
Q1
Using granular data from the Spanish Credit Register, we study the contagion of financial distress via the credit quality channel in the Spanish interbank market. We propose a non-linear contagion mechanism dependent on banks' balance-sheet structure (specifically, their leverage ratios). Moreover, we explicitly model uncertainty in lenders' assessments of the probability of default of their borrowers, thus incorporating agents' lack of complete information and heterogeneous expectations in their assessment of future outcomes. We perform multiple simulations across a wide range of possible levels of stress in the system, and we focus on disentangling the effects of these two key model components by comparing the results of our model with those of a linear and deterministic counterpart. In this way, we find that non-linear contagion leads to substantially larger losses than its linear counterpart for a wide range of intermediate levels of stress in the system, while its effects become negligible for very low and very high stress levels. Regarding uncertainty, we find that its effects, while smaller than those of non-linear contagion, are nonetheless relevant and most important around levels of stress at which different parts of the system become unstable. Interestingly, losses can be amplified or mitigated with respect to the deterministic case depending on the specific level of stress considered. Finally, the interaction between both model components—non-linear contagion and uncertainty—alters the area where uncertainty matters.
“Thank me later”: Why is (macro)prudence desirable?
Cokayne G., Gerba E., Kuchler A., Roulund R.P.
Q1
We examine the social desirability of macroprudential measures, particularly those aimed at riskier home buyers. We examine the effectiveness of these measures against social costs, such as reduced access to the housing ladder for poorer households. Our analysis shows that the measures implemented so far have not limited access to credit or the housing markets. They have been effective in limiting the riskiest loans, minimizing negative equity episodes, reducing systemic risks by debilitating the house price-leverage spiral, and limiting the depths of contractions of a range of macro-financial variables. The welfare of households has also improved. Costs from these measures have been limited and have materialized through a rise in the age-income profile of first-time buyers, and somewhat more attenuated booms. Our results point to the conclusion that macroprudence is desirable when insulated from short-term interference and quick gains. The economy becomes more robust and even households in the lowest decile of the wealth distribution benefit from the general equilibrium effects of more stable financial provision.
Modelling fire sale contagion across banks and non-banks
Caccioli F., Ferrara G., Ramadiah A.
Q1
We examine the impact of fire sales on the UK financial system through commonly held assets across different financial sectors. In particular, we model indirect contagion via fire sales across UK banks and non-banks subject to different types of constraints. We find that performing a stress simulation that does not account for common asset holdings across multiple sectors can severely underestimate the fire sale losses in the financial system. In addition, pro-rata liquidation strategy would result in a higher level of fire sale losses in the system as whole, but a waterfall strategy may produce a higher spillover effect for a passive institution (or a passive sector) that chooses not to promptly liquidate any of its assets during distress while other institutions decide to do so.
Assessing the systemic risk impact of bank bail-ins
Siebenbrunner C., Guth M., Spitzer R., Trappl S.
Q1
Financial regulation has introduced bail-ins (i.e. enforced debt-to-equity swaps) as a tool for orderly bank resolution, and hence it is the authorities' task to decide when to apply this tool in a resolution. We present a quantitative framework to support this decision by computing the systemic impact of a bail-in. Our model takes into account systemic feedback effects using state-of-the-art multilayer contagion models, which we extend to include liquidation losses. Using real-world data for the Austrian banking system, we perform an empirical assessment of the systemic risk impact of idiosyncratic and systemic shocks. Our results show that bail-ins have the potential to reduce systemic risk compared to insolvencies for the Austrian banking system. They also incur lower social cost than bail-outs, but only for moderate, idiosyncratic crises. Our findings quantitatively corroborate earlier discussions that bail-ins may be an inadequate tool to deal with systemic crises. This suggests that the bail-in mechanism alone may not be sufficient to rule out future bail-outs.
Shock amplification in an interconnected financial system of banks and investment funds
Sydow M., Schilte A., Covi G., Deipenbrock M., Del Vecchio L., Fiedor P., Fukker G., Gehrend M., Gourdel R., Grassi A., Hilberg B., Kaijser M., Kaoudis G., Mingarelli L., Montagna M., et. al.
Q1
This paper shows how the combined endogenous reaction of banks and investment funds to an exogenous shock can amplify or dampen losses to the financial system compared to results from single-sector stress testing models. We build a new model of contagion propagation using a very large and granular data set for the euro area. Based on the economic shock caused by the Covid-19 outbreak, we model three sources of exogenous shocks: a default shock, a market shock and a redemption shock. Our contagion mechanism operates through a dual channel of liquidity and solvency risk. Our analysis reveals that adding the fund sector to our model for banks leads to additional losses through fire sales and a further depletion of banks' capital ratios by around one percentage point. The main driver of additional bank losses are endogenous market losses generated by investment funds' asset liquidation.
How does the repo market behave under stress? Evidence from the COVID-19 crisis
Hüser A., Lepore C., Veraart L.A.
Q1
We examine how the repo market operates during liquidity stress by applying network analysis to novel transaction-level data of the overnight gilt repo market including the COVID-19 crisis. We find that during this crisis the repo network becomes more connected, with most institutions relying on previously used counterparties. There are however important changes in the repo volumes and spreads during the stress relative to normal times. There is a significant increase in volumes traded with the central counterparties (CCPs) sector. At the same time non-banks, except hedge funds, decrease borrowing and face higher spreads in the bilateral segment. Overall, this evidence reflects a preference for dealers and banks to transact in the centrally cleared rather than the bilateral segment. Our results can inform the policy debate around the behaviour of banks and non-banks in recent liquidity stress and on widening participation in CCPs by non-banks.
Social responsibility and bank resiliency
Gehrig T., Iannino M.C., Unger S.
Q1
We find strong evidence that measures of social responsibility contribute to increasing the resilience of banks. This finding holds when social responsibility is measured by aggregated ESG scores provided by Thomson Reuters, both according to their older Asset 4 categorization and to the reformed ESG Refinitiv classification, and resilience is proxied by various measures of systemic and systematic risk. The results hold on the level of subcategories of the ESG pillars, where we find that, particularly, variables related to the long-term perspective enhance resilience. Moreover, in our international study, we find significant transatlantic differences.
Who Consumes the Credit Union Subsidies?
Goddard J., McKillop D.G., Wilson J.O.
Q1
Credit unions in the United States (US) are exempt (benefit from subsidies) from federal corporate income taxes, which are traditionally justified by their non-profit cooperative status and mission of meeting the financial needs of individuals of modest means. In recent years, the efficacy and fairness of these subsidies has been debated extensively as the traditional demarcation between banks and credit unions and their respective customer bases have blurred. To investigate how credit unions allocate subsidies to various stakeholders, we estimate a structural profit model for matched pairs of credit unions and commercial banks. We find that credit unions use most (approximately 90%) of their tax exemption for the benefit of their membership via above-market deposit interest rates.
Gender Diversity in Leadership: Empirical Evidence on Firm Credit Risk
Aguir I., Boubakri N., Marra M., Zhu L.
Q1
We study the relation between firm financial stability and gender diversity in leadership and highlight its dependence on the initial financial conditions of the firm and the role played by the women leaders. Consistent with the glass cliff and the upper echelon theories, we find that close-to-default firms are more likely to appoint women top executives and that under their leadership, subsequent firms’ risk of default decreases in the short to medium term. In parallel, independent women directors are not associated with firms’ past credit risk, and their presence is more likely to increase the firm’s subsequent default risk, as established by the tokenism and signaling theory. Our results are robust to alternative specifications and endogeneity corrections.
