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Abstract
Looking at a sample of nearly 2,400 banks in 69 countries, we find that stronger creditor rights tend to promote greater bank risk taking. Consistent with this finding, we also show that stronger creditor rights increase the likelihood of financial crisis. On the plus side, we find that stronger creditor rights are associated with higher growth. In contrast, we find that the benefits of information sharing among creditors appear to be universally positive. Greater information sharing leads to higher bank profitability, lower bank risk, a reduced likelihood of financial crisis, and higher economic growth.
... The study of the direct effect of banking regulation and investors' protection on the banks' risk-taking behavior, as discussed above, is then complemented with another strand of literature that recognizes the existence of important channels through which banking regulation influences risk: market power (Agoraki et al., 2011;and Danisman and Demirel, 2019), deposit insurance (Ashraf et al., 2020), bank ownership (Laeven and Levine, 2009;and Boubakri et al., 2020), financial transparency (Houston et al., 2010), and political institutions (Dutra et al., 2020;Damette and Kouki, 2022). ...
... Second, we contribute to the law and finance literature by providing further evidence of the direct effect of banking and investors' protection on banks' risk. Third, regarding the determinants of banks' risk, we contribute to the existing literature, such as Laeven and Levine (2009), Houston et al. (2010), Anginer et al. (2014), Haq et al. (2014), Fang et al. (2014), Luo et al. (2016), Ashraf (2017), Wang and Sui (2019), Teixeira et al. (2020a) and Dutra et al. (2020). Finally, we perform additional tests to understand how the effect on banks' risk of banking regulation provided through investors' protection changes during the systemic banking crisis period and whether this effect is different for larger banks than for smaller ones. ...
... For banks, the theory is supported by the empirical evidence of Fang et al. (2014), who find that strengthened creditors' rights are likely to promote a higher degree of banking stability, Cole and Turk-Ariss (2018), who find that banks reduce their loan positions and consequently take on less risk when creditors' rights are stronger, and Biswas (2019), who find empirical evidence that stronger creditors' rights enhance bank stability through the market power channel. On the other hand, the "bright side" literature, proposed by Houston et al. (2010), argues that strengthened creditors' rights can promote greater bank risk, as stronger legal protections foster the confidence to lend to risky enterprises with poorer credit ratings. This relation finds support in the empirical evidence of Houston et al. (2010) and Teixeira et al. (2020a). ...
... Laeven and Levine [52] study the interplay between banking regulation (activity restriction and capital stringency) and the ownership structure of each bank as determinants of banks' risk. Houston et al. [47] further include financial transparency, information sharing and creditors' rights in this analysis. More recently, Danisman and Demirel [36] study the role of market power, Ashraf et al. [12] examine the importance of deposit insurance and Teixeira et al. [75] consider whether investors' protection mitigates or reinforces the effect of banking regulation on risk. ...
... The measure incorporates information on banks' stock price volatility, capturing banks' total risk: idiosyncratic and market risk. In the robustness tests section, we use the Z-score variable as an alternative measure for banks' risk, as in Laeven and Levine [52], Houston et al. [47], Ashraf [10], Ashraf et al. [12], Biswas [19], Li [56], Dias [39], among others. ...
This paper examines whether the influence of banking regulation on banks’ risk is channeled through the quality of political institutions. As banking regulatory factors, we consider capital stringency, activity restrictions and supervisory power. The overall effect of banking regulation on banks’ risk is conditional on the quality of political institutions. Activity restrictions and capital stringency have a statistically significant positive effect on banks’ risk. This effect is mitigated by better political institutions. In contrast, stringent supervisory power tends to reduce banks’ risk, and better political institutions reinforce this effect. The results are robust for alternative estimation methods and risk measures.
... For example, Roy (1952) computes a Z-Score for banks, based on the volatility of each bank's return on assets (ROA), and nominates it as a measure of bank risk. Several subsequent studies use the natural log of Roy's Z-Score to proxy for bank risk-taking behavior (e.g., Houston, C. Lin, P. Lin, and Ma 2010;Demirg€ uç-Kunt and Huizinga 2010;Laeven and Levine 2009). Similarly, Kanagaretnam, Lobo, Wang, and Whalen (2019) nominate the 1 In the Online Appendix, we present a timeline of Basel pronouncements since 1988. ...
... As before, ELPR is the ratio of shareholder equity to the amount of loan portfolio risk in logarithmic form. Following prior work (e.g., Laeven and Levine 2009;Houston et al. 2010), we calculate Z-Score as ln((CAR + ROA)/ r(ROA)), where CAR is the regulatory capital adequacy ratio, ROA is return on assets, and r(ROA) is the standard deviation of ROA. r(NIM) is the standard deviation of the bank's net interest margin, as proposed by Kanagaretnam et al. (2019). ...
We develop and evaluate an accounting-based Loan Portfolio Risk (LPR) variable that captures time-varying contagion effects in default risk for a portfolio of bank loans. Our results show that an Equity-to-LPR ratio (ELPR) is additive in predicting bank failure up to five years in advance, after controlling for all the capital adequacy, asset quality, management experience, earnings, liquidity, and sensitivity to market risks (CAMELS) variables as well as other fundamental-based bank risk measures from prior studies. Further, we find that publicly listed banks with higher ELPR have lower market-implied costs of capital, especially under market stress conditions. We conclude that ELPR captures key aspects of bank risk that are missing in current Basel Committee risk-weighted-asset calculations.
JEL Classifications: E32; G14; G21; K23; M41; M48.
... Z-score has been calculated by adding ROA and equity to total assets divided by the standard deviations of return on assets. According to Houston et al. (2010), this value signifies the deviation from the mean by which the profit of the bank would fall to drain the equity capital of the bank. So Z-score is the distance of any bank from solvency (Laeven & Levine, 2009). ...
... So Z-score is the distance of any bank from solvency (Laeven & Levine, 2009). It has been used to measure the riskiness of bank by several empirical studies (Khan et al., 2017;Ramayandi et al., 2014;Delis et al., 2014;Houston et al., 2010). It is calculated as under; ...
... To achieve this goal, banks strive to allocate resources toward the most productive projects that contribute to realizing their objectives, by focusing on the macroeconomic variables, such as gross domestic product GDP, inflation, population density, gross national income, and country risk variables as discussed in (Demirgü. -Knut and Detragiache, 2011;Houston et al., 2010). ...
... Based on previous literature, bank return has been classified into three types of risk based on macroeconomic factors: debt, stock, and foreign exchange markets (Saunders et al., 1990;Sharpe, 1964;). In addition, there are a number of studies that have measured risk using different risk indexes (Laeven and Levine, 2009;Beck et al., 2010;Houston et al., 2010;Demirgü. -Knut and Detragiache, 2011;Al-Gasaymeh, 2018 The MENA region is characterized by substantial variations in economic, political, and social factors across countries, necessitating a tailored examination to comprehend the determinants of risk on banking sector profitability. ...
Supervised student publication.
... The risk associated with stock price volatility is another popular metric [84][85][86][87][88][89][90][91][92]. Moreover, a Z-score is an accounting-based indicator of default risk [83,[93][94][95][96][97][98][99][100][101][102][103]. Alternatively, there is a market-based metric based on Merton's structural distance-to-default model [104][105][106][107][108][109][110][111][112][113]. ...
... Empirical evidence indicates that collateral is often associated with riskier borrowers, loans, and banks. The remaining top-cited articles cover various factors affecting bank risk-taking, including regulation, board composition, creditor rights, interest rates, and accounting discretion [42,93,95,135,[160][161][162][163][164]. It is worth noting that ref. [157] has the most local citations. ...
This study maps the conceptual structure of the body of knowledge concerning bank risk to understand this research strand better. A bibliometric analysis including 671 publications from January 1978 to October 2022 was conducted to achieve the aim of the study. The analysis of descriptive indicators identifies the main traits of scholars debating bank risk in terms of the annual production of publications; most productive authors, countries, affiliations, and journals; and most cited articles in the dataset. This study performs a co-word analysis by adopting social network analysis tools to analyze the conceptual structure of the dataset. The results highlight growing academic interest in bank risk research topics, especially following the global financial crisis. The bibliometric analysis reveals three main topics concerning the consideration of bank risk: (1) the adoption of risk management and bank risk, (2) the use of bank risk during the financial crisis, and (3) the interrelations between corporate governance and bank risk.
... Credit information sharing gives banks easy access to information about the credit worthiness of new and potential borrowers to make safe lending decisions and to effectively monitor borrower behavior. Existing evidence, rarely based on developing countries, supports this view by documenting that countries with functional credit information-sharing schemes experience improved access to credit and reduced default rates (e.g., Brown, Jappelli, and Pagano, 2009;Houston, Lin, Lin, and Ma, 2010;Fosu, Danso, Agyei-Boapeah, Ntim, and Adegbite, 2020a). ...
We investigate the effect of credit information sharing on cost of debt, with particular focus on the introduction of credit bureaus in developing countries. Using a large dataset of firms from 28 developing countries over the period 2004–2019, we find that firms’ average cost of debt significantly declines following the introduction of credit bureaus. This finding is robust to an alternative measure of cost of debt, several firm‐ and country‐level controls and to firm‐ and year‐fixed effects. The reduction in cost of debt is more pronounced for less transparent firms and for firms domiciled in countries with weak institutional framework.
... Previous study has proven a link between financial innovations and their influence on banking systems and economic growth within countries [29][30][31]. According to [32], which proposes the technology compared to an innovative-growth approach, developments in financial technology and innovations can have positive and detrimental impacts on the growth of the economy [29,33,34], contend that financial innovations facilitate risk sharing, cultivate industry integration, and enhance resource allocation efficiency. However, it is essential to observe that the excessive credit provision that may result from financial innovations may contribute to financial crises [35]. ...
The study seeks to better comprehend the ecological footprint of the United States by analyzing the effects of digital financial inclusion (FinTech) as well as renewable and non-renewable energy usage. Data from 2005 Q1 to 2020 Q4 were analyzed using the quantile autoregressive lag (QARDL) method. It also used Granger causality in quantiles to analyze the correlation between variables and draw conclusions about their relative importance. Quantile-wise, the error correction parameter is statistically significant with the predicted negative sign, as shown by the results obtained using the QARDL method. Indications are mounting that the relationship between these variables and the United States' ecological footprint is returning to its long-term equilibrium. However, in the long/short-run period, across all quantiles, economic growth and consumption of non-renewable energy have a positive impact on the ecological footprint. The environmental Kuznets curve (EKC) theory was also examined, which holds that an inverted U-shaped link exists between economic growth and environmental degradation. The QARDL study's findings corroborated the presence of an EKC in the US, lending credence to the theory that while economic growth at first promotes environmental deterioration, further progress ultimately promotes environmental improvement. The study additionally checked the results of the QARDL test for robustness using the ARDL approach. Recommendations for public policy are included in the paper for consideration by legislators and policymakers.
... This study measures the RTB of insurance businesses by calculating Z score on ROA and ROE, i.e. a measure of solvency as seen in numerous earlier research such as Saeed et al. (2021), Akbar et al. (2017) and Houston et al. (2010). Z score on ROA (RTB1) is determined as follows: ...
... Financial Innovation encourages and facilitates the creation of new products by financial institutions that capitalize on customers' lack of understanding of the underlying mechanisms of financial markets. According to Houston et al. (2010), financial innovation-induced arbitrage is weakened, cannot ensure the appropriate allocation of resources to facilitate development, and instead encourages financial instability. This position is supported by Brunnermeier and Pedersen (2008), who argue that the extraordinary increase in credit creation that resulted in the subprime mortgage crises in the United States was caused by financial Innovation. ...
The economic contribution of small and medium enterprises (SMEs) has been well appreciated and documented in the literature. On the other hand, another domain of studies has concentrated on discovering the key determinants of SMEs' growth and survival. The motivation of the study is to gauge the nexus between financial innovation, technological innovation, clean energy, environmental degradation, and SME performance in Bangladesh for the period 1991-2019. The study has implemented Autoregressive Distributed Lagged (ARDL), Nonlinear ARDL, and the Toda-Yamamoto causality test. Referring to output derived with ARDL, a study has exposed a positive and statistically significant link between explanatory variables, that is, financial innovation, technological innovation, and clean energy consumption and SMEs' contribution to GDP both in the long-run and short-run. At the same time, environmental degradation has been revealed to be adversely connected to SME performance. The results of the standard Wald test have established an asymmetric association between explained and explanatory variables in the long-run and short run. In terms of the directional causality test, the study disclosed bidirectional causal effects running between clean energy and SMEs performance [CEßàSME], foreign direct investment, and SMEs performance [FDIßàSME]. Based on the study findings, the policy suggestions have been introduced in light of future development in SMEs in Bangladesh.
... Chỉ số Z-score càng cao hàm ý xác xuất xảy ra mất thanh khoản càng thấp hay nói cách khác Z-score càng cao thì ngân hàng càng ổn định (Ahmed, Sihvonen, & Vähämaa, 2019;Vučinić, 2020). Tính toán Z-score được đưa về dạng logarit tự nhiên nhằm giảm thiểu sự biến động mạnh trong số liệu và gia tăng hiệu quả các ước lượng (Houston, Lin, Lin, & Ma, 2010;Laeven & Levine, 2009). Theo Köhler (2015), chỉ số Z-score là chỉ tiêu đo lường ổn định, rủi ro của ngân hàng thương mại. ...
Sự tác động của hoạt động đầu tư công nghệ đặt ra nhiều thách thức đối với sự ổn định tài chính trong hệ thống ngân hàng. Dựa vào bộ dữ liệu gồm 25 Ngân Hàng Thương Mại (NHTM) tại Việt Nam trong giai đoạn 2009 - 2019, nghiên cứu sử dụng phương pháp SGMM (Arellano & Bond, 1991) nhằm kiểm định tác động của hoạt động đầu tư công nghệ đến khả năng chấp nhận rủi ro của các ngân hàng thương mại tại Việt Nam. Kết quả cho thấy hoạt động đầu tư công nghệ có tác động làm tăng khả năng chấp nhận rủi ro của các NHTM tại Việt Nam. Bên cạnh đó, chúng tôi thấy rằng khả năng chấp nhận rủi ro của ngân hàng tương đối nhạy cảm với một số yếu tố mang tính đặc thù của ngành ngân hàng (cấu trúc tài chính, quy mô ngân hàng, rủi ro tín dụng, đa dạng hoá) và các yếu tố vĩ mô (tốc độ tăng trưởng và lạm phát). Trên cơ sở đó, tác giả đưa ra một số hàm ý đối với hoạt động quản trị và các chính sách quản lý vĩ mô nhằm giảm thiểu rủi ro cho các ngân hàng thương mại tại Việt Nam.
... Research indicates that financial privacy information sharing can effectively reduce the occurrence of adverse selection and moral hazard phenomena (Houston, Lin, Lin, & Ma, 2010). Pagano and Jappelli (1993) studied the practical effects of credit information sharing in the credit market, and the results show that the lack of information sharing mechanisms can lead to severe adverse selection, which can exclude borrowers with good credit from the credit market. ...
The goal of this study is to clarify how privacy protection affects the insurance of central bank digital currency (CBDC). By constructing a tripartite game model involving consumers, commercial banks, and regulators, this paper explores the impact of privacy protection on the issuance of CBDC. The findings show that privacy protection is critical to ensuring successful adoption of CBDCs. The central bank must strike a balance between protecting user privacy while also regulating usage and ensuring convenience for users. However, due to opportunistic behavior by both commercial banks and consumers during this process, negative reactions are possible. Based on the findings of this research, it is suggested that central banks should encourage commercial banks to participate in CBDC issuance by promoting appropriate data sharing and offering guidance. Additionally, they should focus on consumer education and expectation management to promote CBDC adoption. Commercial banks must also embrace digital transformation and adapt to the changing financial landscape to remain competitive while providing innovative financial services to customers.
... Chỉ số Z-score càng cao hàm ý xác xuất xảy ra mất thanh khoản càng thấp hay nói cách khác Z-score càng cao thì ngân hàng càng ổn định (Ahmed, Sihvonen, & Vähämaa, 2019;Vučinić, 2020). Tính toán Z-score được đưa về dạng logarit tự nhiên nhằm giảm thiểu sự biến động mạnh trong số liệu và gia tăng hiệu quả các ước lượng (Houston, Lin, Lin, & Ma, 2010;Laeven & Levine, 2009). Theo Köhler (2015), chỉ số Z-score là chỉ tiêu đo lường ổn định, rủi ro của ngân hàng thương mại. ...
Sự tác động của hoạt động đầu tư công nghệ đặt ra nhiều thách thức đối với sự ổn định tài chính trong hệ thống ngân hàng. Dựa vào bộ dữ liệu gồm 25 Ngân Hàng Thương Mại (NHTM) tại Việt Nam trong giai đoạn 2009 - 2019, nghiên cứu sử dụng phương pháp SGMM (Arellano & Bond, 1991) nhằm kiểm định tác động của hoạt động đầu tư công nghệ đến khả năng chấp nhận rủi ro của các ngân hàng thương mại tại Việt Nam. Kết quả cho thấy hoạt động đầu tư công nghệ có tác động làm tăng khả năng chấp nhận rủi ro của các NHTM tại Việt Nam. Bên cạnh đó, chúng tôi thấy rằng khả năng chấp nhận rủi ro của ngân hàng tương đối nhạy cảm với một số yếu tố mang tính đặc thù của ngành ngân hàng (cấu trúc tài chính, quy mô ngân hàng, rủi ro tín dụng, đa dạng hoá) và các yếu tố vĩ mô (tốc độ tăng trưởng và lạm phát). Trên cơ sở đó, tác giả đưa ra một số hàm ý đối với hoạt động quản trị và các chính sách quản lý vĩ mô nhằm giảm thiểu rủi ro cho các ngân hàng thương mại tại Việt Nam.
... Banks in common law countries allocate a noticeably larger percentage of their assets to risky loans than banks in civil law countries (Widarjono, Wijayanti, & Suharto, 2022). In a research conducted by Houston, Lin, Lin, and Ma (2010) and argued that banks in countries with stronger creditor rights assume more risk, while banks in countries with explicit information-sharing systems assume less risk. ...
The development of digital innovation is a clear indication of the expansion of financial technology (Fintech) businesses over the previous ten years. Fintech concepts have only lately begun to be accepted by established players in the financial sector. Despite recent bank purchases of Fintech firms, the majority of these businesses are self-funded and accessible to other banks. Because many banks, besides the well-known big ones, continue to provide outdated, outrageously expensive, and bureaucratic financial services, Fintech companies have the potential to replace many crucial tasks presently carried out by traditional banks. In other words, it's expected that Fintech firms will have a replacement effect, forcing banks to abandon certain kinds of business. The incentives for a bank to take risks and increase its effectiveness and profitability may have altered as a result of Fintech advancements. This exemplifies how Fintech developments will affect bank risk, efficiency, and profitability because they offer a competitive source of credit to conventional banks. The purpose of this research is to look into the problems from a global standpoint.
... The information sharing offices (ISO) such as private credit bureaus (PCB) and public credit bureaus (PCR) have been implemented as indices of sharing information. , Houston et al. (2010) and Jappelli and Pagano (2002) have found that information sharing like PCRs and PCBs act as an intermediary for providing the banks' required information. These intermediaries can reduce the transaction costs through the expertise they have gained. ...
The present study aims to investigate the role of ICT in reducing the effect of information asymmetry on financial development. The research's data associated with the selected countries of MENA during the timeframe of 2004-2015 are extracted from official sources. Then, the research model is evaluated in the short and long term using the dynamic generalized method of moments and FMOLS, respectively. First, the results show information asymmetries negatively affect financial development. Second, ICT reduces but cannot eliminate the negative effect of information asymmetry on financial development. Third, the threshold effect of ICT on the information asymmetry and thus on financial development was within the minimum and maximum ICT indices. Due to the role of ICT in reducing the information asymmetry in the financial system of the examined countries, the policy proposal of this paper is to expand the various areas of access, benefit, and use of ICT in the financial sector.
... From a theoretical standpoint, the impact of creditor rights on labour choice is ambiguous at best. On the one hand, a strengthening of creditor rights can ensure high value of the entity as a going concern and thereby improve recovery prospects, lowering borrowing costs (Vig 2013) and improving credit supply (Djankov et al. 2007;Visaria 2009;Haselmann et al. 2010;Houston et al. 2010). Relatedly, it can also increase the risk-taking incentives of distressed firms and thereby enable the continuation of otherwise viable business (Singh et al. 2022). ...
Using 3-digit industry data at the state-level during 2009-2018, the paper assesses the impact of the Insolvency and Bankruptcy Code (IBC) on growth across industries with varying degrees of financial dependence. The findings show that IBC positively impacted industry growth, although this occurred by altering the capital-labour mix in favour of the latter. Robustness tests across industry type and state labour regimes support these findings
... Thirdly, we used the volatility of net interest margin as a proxy for bank operational risk (Shabir et al., 2021;Danisman and Demirel, 2019) and denoted by (ORK), which indicates the level of risk in a bank's operations (Houston et al., 2010). Higher volatility in net interest margin results from a riskier lending strategy. ...
Bu çalışma, ekonomik özgürlük ile bankaların finansal performansı arasındaki ilişkiyi araştırmaktadır. Bu amaçla, 2006-2021 yılları arasında Türkiye'de faaliyet gösteren mevduat bankaları incelenmiştir. Çalışmada, banka performans ölçütü olarak, ortalama aktif getirisi, ortalama özkaynak getirisi ve net faiz marjı kullanılmıştır. Ekonomik özgürlüğün üç alt bileşeninin (iş özgürlüğü, parasal özgürlük, finansal özgürlük) banka performansına etkisi ayrıca incelenmiştir. Analizler panel veri tekniği ile gerçekleştirilmiştir. Ampirik bulgular, daha yüksek (düşük) genel ekonomik özgürlüğün banka performansını kötüleştirdiğini (iyileştirdiğini) göstermektedir. Diğer yandan, daha yüksek iş özgürlüğü bankaların performansına olumlu yansımaktadır. Ayrıca sonuçlar, daha yüksek parasal ve finansal özgürlüğün bankaların performansı üzerinde olumsuz bir etkiye sahip olduğunu ortaya koymaktadır. Bulgular, sektör paydaşlarının, Türkiye’deki ekonomik özgürlük düzeyini ve bu düzeyin banka performansları üzerindeki etkisini dikkate almaları gerektiğini vurgulamaktadır.
This study investigates the relationship between prudential regulation and banking risk in the West African Economic and Monetary Union contingent on institutional quality. The empirical analysis employed panel data from 63 banks spanning 2006–2019. The key findings reveal that stringent banking regulations and supervision enhance banks’ stability. Capital regulations, activity restrictions, and supervisory authorities reduce the risk of bank insolvency. The results suggest that a favorable institutional climate promotes rigorous enforcement of regulatory standards and robust supervision, thereby amplifying their efficacy. Overall, this study concludes that prudential policies exhibit risk-mitigating effects in West African Economic and Monetary Union countries conditional on sound institutional frameworks.
Purpose
The academic literature has examined why bank runs happen based on the work of 2022 Nobel Prize-winning economists Diamond and Dybvig. They have found the source of banking/financial crisis in terms of mismatch between liabilities (deposits being short term and savers wanting to short-term access to their money) and assets (long term and illiquid). The Lakshmi Vilas Bank (LVB) crisis intensified when it came under Prompt Corrective Action (PCA) of the Reserve Bank of India (RBI). This situation provides the opportunity to study whether the elements embodied in the theoretical models like Diamond and Dybvig hold true for LVB crisis. This study aims to examine the reasons for the demise of LVB in India using DuPont financial model, peer group analysis and time series structural break in crucial financial parameters.
Design/methodology/approach
The study examines the reason for insolvency of LVB using financial ratios, financial models (DuPont), financial distress model ( Z -score) and asset-liability management. The study also adopts univariate structural break models using quarterly financial data covering the key financial measures used in the RBI’s PCA framework.
Findings
LVB crisis is like Diamond–Dybvig model, in the sense, savers requiring short-term access to their money (liquidity for their deposits) on the information of high non-performing assets, which further deteriorates the illiquid nature of loan portfolio (assets) of banks. The study finds its profit margin (net interest margin and non-interest margin) and managerial efficiency had started deteriorating since 2018. The study finds that LVB’s main weakness lies in its limited credit appraisal ability, its monitoring and weak internal controls. Lending to sensitive sectors (like real estate, capital markets and commodities) and exposure to large business groups also contributed to its weakness. The study also finds huge, elevated asset-liability mismatch, especially in the short-term maturity buckets. Using univariate econometric time series model, the study also confirms financial weakness being evident much earlier than the time when resolution was undertaken by the RBI through PCA.
Research limitations/implications
The study has implications for analysing and monitoring financial distress of banks. The study also has implications for devising banking regulation and supervision.
Originality/value
The study brings in a perspective of the banking regulations using the application of PCA framework on a listed private sector bank. The authors combine an accounting ratio model and combine risk measures that could identify the incipient risks in a bank. The authors believe this will help in refinement of banking regulations and better monitoring mechanisms.
The effects of board gender diversity (BGD) on financial stability of financial institutions have long been an important topic, creating a rich strand of literature that focuses extensively on banks. Meanwhile, little is known about the implications of BGD on risk in microfinance institutions (MFI). This study aims to fill this gap. Using a data sample retrieved from the MIX Market database spanning the 2009-2018 period and the random effects estimator, we find that the proportion of female directors on the board is positively associated with financial stability of MFIs measured by the Z-score. The result is robust when using alternative measures of financial stability and BGD, and alternative estimation techniques. In addition, we document a negative relationship between BGD and risk-taking behavior of MFIs. Further, the research result favors the critical mass theory rather than tokenism. Lastly, we find that BGD links with financial stability in a monotonic instead of non-monotonic manner.
Guided by the extreme value theory, this study empirically investigates the impact of tail risk measures on financial distress of publicly traded bank holding companies (BHCs) in the United States. Our results show that tail risk measures namely, value‐at‐risk and expected shortfall, are significantly and positively related to banks distress risk. Implying that BHCs with more frequent extreme negative daily equity returns induce higher tail risks, thereby increasing their likelihood of experiencing financial distress. Our results also show that tail risk measures enhance the explanatory power of traditional models explaining banks distress risk based on accounting information. These results indicate that market discipline is generally beneficial in managing and regulating banks, bolstering claims of the importance of macro‐prudential supervision of financial institutions.
This study examines the effectiveness of macroprudential policies in reducing the banks' risk during the COVID‐19 pandemic and compares these results with the systemic banking crises years. Based on a sample of 624 banks across 40 countries during the period 2006–2020, we find that loosening capital‐aimed macroprudential policies effectively reduced banks' risk during the COVID‐19 pandemic, while this behavior led to increased risk during the systemic crises years. In contrast, tightening the remaining macroprudential policies during the systemic crises years and during the pandemic proved effective in reducing banks' risk. Furthermore, we show that the magnitude of the impact of macroprudential policies was stronger during the systemic crisis than that during the pandemic. Finally, we show that the results are driven by the capital requirement prudential policy, both during the systemic crisis and the COVID‐19 pandemic, although the conservation buffer and the leverage limit also contributes to the ineffectiveness of these policies during the COVID‐19 pandemic. The banks' leverage and loan growth also play an enhancing role of the effects of the macroprudential policies.
Using a comprehensive dataset of Italian SMEs, we find that differences between private and public information on firm creditworthiness affect the decision to issue bonds. Our evidence supports favorable (rather than adverse) selection in corporate bond markets. Specifically, holding public information constant, firms with better private fundamentals are more likely to access bond markets. These effects are weaker for opaque firms and stronger for firms with worse publicly observable risk. Additionally, credit conditions improve for issuers following the bond placement, compared with a matched sample of non-issuers. This is consistent with a model where banks offer more flexibility than markets during financial distress and firms use market lending to signal credit quality to outside stakeholders.
U.S. generally accepted accounting principles (GAAP) allows banks to offset derivative assets against derivative liabilities with the same counterparty and report only the net amount on the balance sheet. Derivative offsetting under international financial reporting standards (IFRS) is much more restrictive, resulting in the single largest difference in balance sheet presentation between U.S. GAAP and IFRS. Two important factors dominate the standard-setting discussion on this issue: (1) whether these derivatives are informative about bank risk and (2) whether disclosing them substitutes for recognition on the balance sheet. Using a hand-collected global sample of banks, we first show that offsetable derivatives are positively associated with bank risk, based on multiple risk measures, suggesting that these derivatives are informative about bank risk. Next, exploiting the differential accounting treatment across U.S. GAAP and IFRS banks, we find that disclosure versus recognition of offsetable derivatives matters for the risk assessment of equity investors but not for that of (more sophisticated) credit default swap investors. Additional tests corroborate the inference that investor sophistication helps explain the differential investor assessment of recognized versus disclosed offsetable derivatives. Collectively, our findings suggest that offsetable derivatives convey information about bank risk and that, for less sophisticated investors, disclosing them may not substitute for recognizing them.
This paper was accepted by Eric So, accounting.
Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2023.4831 .
Research question/issue
Since the global financial crisis triggered by the collapse of Lehman Brothers, board gender diversity has attracted growing attention among academia and policy makers. The “Lehman Sisters” hypothesis argues for more female representation on bank director boards based on the stereotyped gender gap in risk preference, which has been widely supported by empirical studies on nonfinancial firms. However, due to the constraint of data unavailability, empirical research on board gender diversity and bank risk‐taking is relatively scarce and mostly confined to individual developed markets with inconclusive findings. In this paper, we examine the impact of board gender diversity on bank risk‐taking using a large hand‐collected dataset covering 480 commercial banks across 18 developed and 21 developing countries over the period 2007–2016.
Research findings/insights
We find that lower bank risk‐taking is associated with greater board gender diversity, supporting the “Lehman Sisters” hypothesis in the international context; however, this effect is significantly weakened in countries with more hostile perception toward working women. We also confirm the critical threshold of three female directors to play a significant role in reducing bank risk‐taking, providing novel international evidence in support of the critical mass theory from the banking sector.
Theoretical/academic implications
Our findings help to reconcile existing contradictory empirical evidence from different countries by highlighting the importance of cultural effects.
Practitioner/policy implications
We provide the first international empirical evidence in support of the policies aimed to promote representation of women on director boards, particularly in the banking sector. We confirm that a critical mass number of female directors on a bank board is important to avoid the tokenism problem. In countries with less support toward working women, policy makers also need to work on improving the overall working environment for women in order to achieve the expected outcome.
Using a new dataset on international competition laws, we examine the relationship between country-level competition laws and corporate risk-taking in 58 countries from 1990 to 2010. Consistent with the disciplinary effect hypothesis, we document robust evidence of a negative relation between corporate risk-taking and the stringency of competition laws. The negative relation between competition laws and corporate risk-taking is more pronounced among financially constrained firms and less pronounced among firms situated in high-trust jurisdictions. Further analysis shows that competition laws affect corporate risk-taking by mitigating agency problems and enhancing information transparency. Overall, these findings are consistent with the view that competition plays a critical external corporate governance role in shaping corporate behaviors.
This study aims to investigate the effect of macroprudential regulation on banks’ profitability during financial crises, to find out whether the instruments of the Central Bank of Jordan (CBJ) enhance the performance of the Jordanian banking sector in terms of increasing banks’ profitability and reducing banking sector exposure to financial crisis vulnerability. The sample of the study consists of twelve listed banks in Jordan over the period 2000–2018. The bank’s return on assets (ROA) was regressed on instruments by using the fully modified ordinary least square (FMOLS) method. The results had shown a slightly weak significant effect of stress testing (ST) on the banks’ ROA. Capital adequacy ratio (CAR) had no significant effect, leverage ratio had the deepest effect, and banks are highly leveraged with more debt-to-equity ratio. In addition to that, a good number of the banks maintain CAR, loan-to-value (LTV), and leverage ratios higher than the minimum limit required by the CBJ and Basel requirements, suggesting that the Basel standards did not take into consideration the particularity of some countries. The results also revealed that CBJ prudential regulation instruments are succeed in keeping the stability of the banking sector profitability during previous financial crises, but still need to enhance the level of gearing for banks against future shocks
We empirically examine the cash flow statements for Japanese banks and whether their managers engage in classification shifting to temper concerns about risk exposure. To create a buffer against liquidity shocks, they shift cash flows from investing and/or financing activities to operating activities. We also find robust evidence that classification shifting intensifies in higher risk situations. Although prior research on managerial discretion focuses on earning management, we are the first to show cash flow management to avoid sequential negative changes in operating cash flows. We show that these activities convey valuable information about changes in banks' risk exposure.
We analyze how creditor rights affect the nonsynchronicity of global corporate credit default swap spreads (CDS-NS). CDS-NS is negatively related to the country-level creditor-control rights, especially to the “restrictions on reorganization” component, where creditor-shareholder conflicts are high. The effect is concentrated in firms with high investment intensity, asset growth, information opacity, and risk. Pro-creditor bankruptcy reforms led to a decline in CDS-NS, indicating lower firm-specific idiosyncratic information being priced in credit markets. A strategic-disclosure incentive among debtors avoiding creditor intervention seems more dominant than the disciplining effect, suggesting how strengthening creditor rights affects power rebalancing between creditors and shareholders. (JEL G14, G15, G33, G34)
Received September 21, 2021; editorial decision March 9, 2023 by Editor Isil Erel
Using the 2007–2009 financial crisis as a quasi‐natural experiment, we show that banks with investors holding simultaneously both equity and bonds (dual‐holders) exhibit lower risk and superior performance. Dual‐holders' influence is higher in more opaque banks, indicating that the mechanism of transmission is through a decrease in information asymmetry and a reduction in debtholder–shareholder conflict. This effect translates into higher unconditional and risk‐adjusted stock returns. These economically large results show that a market mechanism implemented by outside investors is strongly effective in mitigating excessive risk taking by banks thus providing important normative implications for the stability of financial systems.
This study empirically explores the effects of bank funding diversity on Vietnamese commercial banks' profitability and risk in the context of the COVID-19 pandemic. The panel regression method was used to analyze quarterly data from 27 Vietnamese commercial banks from Q1-2016 to Q1-2021. The study findings demonstrate that commercial banks with diverse financing sources are more profitable and riskier. In the meanwhile, the COVID-19 outbreak did not diminish the short-term profitability of Vietnamese commercial banks, but it did increase their exposure to risk. On the basis of the empirical findings, this paper also proposes a number of strategies to assist Vietnamese commercial banks in operating more effectively and securely in the context of the COVID-19 pandemic.
We investigate empirically the determinants of the quality of governments in a large cross-section of countries. We assess government performance using measures of government intervention, public sector efficiency, public good provision, size of government, and political freedom. We find that countries that are poor, close to the equator, ethnolinguistically heterogeneous, use French or socialist laws, or have high proportions of Catholics of Muslims exhibit inferior government performance. We also find that the larger governments tend to be the better performing ones. The importance of (reasonably) exogenous historical factors in explaining the variation in government performance across countries sheds light on the economic, political, and cultural theories of institutions.
This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries. The results show that common law countries generally have the best, and French civil law countries the worst, legal protections of investors, with German and Scandinavian civil law countries located in the middle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protections, consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.
We examine the relation between the cost of debt financing and a governance index that contains various antitakeover and shareholder protection provisions. Using firm-level data from the Investors Research Responsibility Center for the period 1990 through 2000, we find that antitakeover governance provisions lower the cost of debt financing. Segmenting the data into firms with strongest management rights (strongest antitakeover provisions) and firms with strongest shareholder rights (weakest antitakeover provisions), we find that strong antitakeover provisions are associated with a lower cost of debt financing while weak antitakeover provisions are associated with a higher cost of debt financing, with a difference of about thirty-four basis points between the two groups. Overall, the results suggest that antitakeover governance provisions, although not beneficial to stockholders, are viewed favorably in the bond market.
We formulate a simple theoretical model of a banking industry that we use to identify and construct theory-based measures of systemic bank shocks (SBS). These measures differ from “banking crisis” (BC) indicators employed in many empirical studies, which are constructed using primarily information on government actions undertaken in response to bank distress. Using both country-level and firm-level samples, we show that SBS indicators consistently predict BC indicators, indicating that BC indicators actually measure lagged policy responses to systemic bank shocks. We then re-examine the impact of macroeconomic factors, bank market structure, deposit insurance, and external shocks on the probability of systemic bank shocks (SBS) and on “banking crisis” (BC) indicators. We find that the impact of these variables on the likelihood of a policy response to banking distress (as represented by BC indicators) is frequently quite different from that on the likelihood of a systemic bank shock (SBS). We argue that disentangling the effects of systemic bank shocks and policy responses is crucial in understanding the roots of banking crises. We believe that many findings of a large empirical literature need to be re-assessed.
Numerous papers in the “law and finance” literature have established that countries with better functioning legal institutions enjoy better developed capital markets, and that legal origin is a fundamental determinant of legal institutions (La Porta et al. 1997, 1998, 2006; Djankov et al. 2007). In this study, we test whether banks are willing to grant more credit to the private sector when they enjoy superior legal protection. We test this hypothesis using bank-level data over the period 2000-2006 from 102 emerging-market countries and a random-effects model that controls for bank heterogeneity. We find that lenders allocate a significantly higher portion of their assets to loans (i) where they enjoy Socialist legal origin rather than English or French legal origin; (ii) where enforcement of debt contracts is more efficient and (iii) where banks enjoy fewer restrictions on their operations. These findings support our hypothesis that superior legal protection leads to more bank credit, which, in turn, should lead to higher economic growth. However, these findings contradict the predictions based upon the theory of legal origin.
In cooperation with Lex Mundi member law firms in 109 countries, we measure and describe the exact procedures used by litigants and courts to evict a tenant for nonpayment of rent and to collect a bounced check. We use these data to construct an index of procedural formalism of dispute resolution for each country. We find that such formalism is systematically greater in civil than in common law countries, and is associated with higher expected duration of judicial proceedings, less consistency, less honesty, less fairness in judicial decisions, and more corruption. These results suggest that legal transplantation may have led to an inefficiently high level of procedural formalism, particularly in developing countries. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
We describe the operation of credit bureaus and public credit registers in Europe and extract potential lessons for upgrading credit registers in other countries. The evidence that we report is based on questionnaires directed to private credit bureaus and central banks, on direct interviews and on official sources. The European experience highlights a set of important issues. First, European privacy protection laws affect greatly the amount and type of information shared between lenders. Second, credit bureaus tend to originate from local lenders. Third, in Europe as elsewhere there are powerful forces pushing towards consolidation of the credit bureaus industry. While this process reflects the "natural monopoly" feature of the industry, its pace has been accelerated by technological factors and, especially within Europe, by the increasing international integration of capital markets. Three annexes complete the paper, reporting detailed descriptions of private credit bureaus activity in European countries, the main features of European public credit registers, and privacy protection restrictions to the activity of credit bureaus and public credit registers in Europe.
The authors report on the latest version of the worldwide governance indicators, covering 213 countries and territories and measuring six dimensions of governance from 1996 until end-2005: voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption. The latest indicators are based on hundreds of variables and reflect the views of thousands of citizen and firm survey respondents and experts worldwide. Although global averages of governance display no marked trends during 1996-2005, nearly one-third of countries exhibit significant changes [for better or for worse]on at least one dimension of governance. Three new features distinguish this update. (1) The authors have moved to annual reporting of governance estimates. This update includes new governance estimates for 2003 and 2005, as well as minor backward revisions to biannual historical data for 1996-2004. (2) The authors are, for the first time, publishing the individual measures of governance from virtually every data source underlying the aggregate governance indicators. The ready availability of the individual data sources underlying the aggregate governance indicators is aimed at further enhancing the transparency of the methodology and of the resulting aggregate indicators, as well as helping data users and policymakers identify specific governance challenges in individual countries. (3) The authors present new evidence on the reliability of expert assessments of governance which, alongside survey responses, form part of the aggregate measures of governance.
How does the management and resolution of the current crisis compare with the response of the Nordic countries in the early 1990s, widely regarded as exemplary? We argue that, while intervention has been prompter, the measures taken so far remain less comprehensive and in-depth. In particular, the cleansing of balance sheets has proceeded more slowly, and less attention has been paid to reducing excess capacity and avoiding competitive distortions. In general, policymakers have given higher priority to sustaining aggregate demand in the short term than to encouraging adjustment in the financial sector and containing moral hazard. We argue that three factors largely explain this outcome: the more international nature of the crisis; the complexity of the instruments involved; and, hardly appreciated so far, the effect of accounting practices on the dynamics of the events, reflecting in particular the prominent role of fair value accounting (and mark to market losses) in relation to amortised cost accounting for loan books. There is a risk that the policies followed so far may delay the establishment of the basis for a sustainably profitable and less risk-prone financial sector.
If banks have an informational monopoly about their clients, borrowers may curtail their effort level for fear of being exploited
via high interest rates in the future. Banks can correct this incentive problem by committing to share private information
with other lenders. The fiercer competition triggered by information sharing lowers future interest rates and future profits
of banks. But, provided banks retain an initial informational advantage, their current profits are raised by the borrowers’
higher effort. This trade-off determines the banks’ willingness to share information. Their decision affects credit market
competition, interest rates, volume of lending, and social welfare.
The law and finance literature highlights the role of investor rights in financial development, firm corporate governance, and financing patterns. For a panel of 35 countries, we investigate how bankruptcy use relates to countries' creditor rights and judicial efficiency. Bankruptcies are higher in countries with more creditor rights, except for a "no automatic stay on assets" provision. Higher judicial efficiency is associated with more bankruptcies and appears as a substitute with more creditor rights. Although only a first step, our findings suggest creditor rights are complex, balancing prioritization of claims, ex ante risk-taking incentives, and an efficient resolution of distressed firms. Copyright 2005, Oxford University Press.
Faced with a systemic financial sector crisis, policymakers need to make difficult choices under pressure. Based on the experience of many countries in recent years, few have been able to achieve a speedy, lasting and low-cost resolution. This volume considers the strengths and weaknesses of the various policy options, covering both microeconomic (including recapitalization of banks, bank closures, subsidies for distressed borrowers, capital adequacy rules and corporate governance and bankruptcy law requirements) and macroeconomic (including monetary and fiscal policy) dimensions. The contributors explore the important but little understood trade-offs that are involved, such as between policies which take effect quickly, those which minimize long-term fiscal and economic costs, and those which create favorable incentives for future stability. Successfully implementing crisis management and crisis resolution policy required attention to detail and a good flow of information. © The International Bank for Reconstruction and Development 2005 and Cambridge University Press, 2009.
We investigate empirically the determinants of the quality of governments in a large cross-section of countries. We assess government performance using measures of government intervention, public sector efficiency, public good provision, size of government, and political freedom. We find that countries that are poor, close to the equator, ethnolinguistically heterogeneous, use French or socialist laws, or have high proportions of Catholics or Muslims exhibit inferior government performance. We also find that the larger governments tend to be the better performing ones. The importance of historical factors in explaining the variation in government performance across countries sheds light on the economic, political, and cultural theories of institutions.
We exploit differences in European mortality rates to estimate the effect of institutions on economic performance. Europeans adopted very different colonization policies in different colonies, with different associated institutions. In places where Europeans faced high mortality rates, they could not settle and were more likely to set up extractive institutions. These institutions persisted to the present. Exploiting differences in European mortality rates as an instrument for current institutions, we estimate large effects of institutions on income per capita. Once the effect of institutions is controlled for, countries in Africa or those closer to the equator do not have lower incomes. (JEL O11, P16, P51).
Are market-based or bank-based financial systems better at financing the expansion of industries that depend heavily on external finance, facilitating the formation of new establishments, and improving the efficiency of capital allocation across industries? We find evidence for neither the market-based nor the bank-based hypothesis. While legal system efficiency and overall financial development boost industry growth, new establishment formation, and efficient capital allocation, having a bank-based or market-based system per se does not seem to matter much.
Historical narrations of the Gregorian Reform tend to cultivate a certain machismo. The traditional narrative emphasizes a struggle for dominance between two men, Pope Gregory VII and Emperor Henry IV, which escalated from epistolary sparring to armed combat and culminated in a dramatic scene in which one man was on his knees before the other at Canossa. Even the newer narratives, such as the late Karl Leyser's “Gregorian Revolution,” while highlighting broad social and religious transformations attendant upon the movement, still privilege a revolutionary cadre, a handful of reformers (all male, of course) gathered around Gregory VII, who artfully channeled the discontents of the masses into a permanent reordering of western society.
Using a unique dataset of the Euro-area and the U.S. bank lending standards, we find that low (monetary policy) short-term interest rates soften standards for household and corporate loans. This softening—especially for mortgages—is amplified by securitization activity, weak supervision for bank capital, and low monetary policy rates for an extended period. Conversely, low long-term interest rates do not soften lending standards. Finally, countries with softer lending standards before the crisis related to negative Taylor rule residuals experienced a worse economic performance afterward. These results help shed light on the origins of the crisis and have important policy implications.
The version of record [Bank Risk-taking, Securitization, Supervision, and Low Interest Rates: Evidence from the Euro-area and the U.S. Lending Standards, Angela Maddaloni and José-Luis Peydró, The Review of Financial Studies, June 2011, 24(6): 2121-2165] is available online at https://academic.oup.com/rfs/article-abstract/24/6/2121/1587432; DOI: https://doi.org/10.1093/rfs/hhr015
Also available: European Central Bank Working Paper no. 1248 (https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1248.pdf)
We explore the effect of governance on the costs and ratings of firms' bonds. We use the wedge between the voting and cash-flow rights of the controlling shareholders and the identity of the ultimate owners to proxy for the strength of the internal governance mechanisms. We find strong evidence that the voting/cash-flow rights wedge and the family control have a positive and significant effect on bond costs and a negative and significant effect on bond ratings. Moreover, our results suggest that control in the hands of widely held financial firms has a positive effect on bond ratings only, and that State control has no effect on either bond costs or ratings. When we control for national governance systems, we find that a higher protection of debtholders' rights generally reduces bond costs and increases corporate bond ratings. More importantly, we find that what really matters for both bondholders and rating agencies is debt laws enforcement rather than the existence of those laws themselves.
Major conceptual contributions of a number of Nobel-laureates in putting forth a framework linking the citizenry's right to know and access to information with development, have already had a major influence in various fields. However, implementation of transparency-related reforms on the ground remains checkered around the globe. Further, in contrast with other dimensions of governance - such as rule of law and regulatory burden - there is a gap between the extent of the conceptual contributions in the transparency field and the progress on its measurement and empirical analysis, which has been wanting. And there has been an absence of writings which decompose (or 'unbundle') the generic notion of transparency into specific components, so to provide tools useful for policy advise and interventions. Our paper is a contribution attempting to partly fill these empirical and policy-related gaps. We review the existing literature, present various definitions of transparency, provide an initial empirical framework towards worldwide indicators on various dimensions of transparency, suggest some initial empirical results, and address concrete policy and institutional innovations related to transparency reforms. We contribute to empirics by undertaking an initial construction of a transparency index for 194 countries based on over twenty 20 independent sources. An Unobserved Component Model (UCM) was used to generate the country ratings and the margins of error. The indices comprise an aggregate transparency index with two sub-components: economic/institutional transparency, and political transparency. The results emphasize variance. First, the preliminary evidence based on these initial indicators suggests enormous variation across countries in the extent of transparency. Exemplary transparency is not the exclusive domain of a particular region, and there are transparency-related challenges in countries in each region and income categories. Further, there is significant within-country variation, with large differences in performance between economic/institutional and political dimensions of transparency. Mindful of the challenges in inferring causality, we also find that transparency is associated with better socio-economic and human development indicators, as well as with higher competitiveness and lower corruption. We suggest that much progress can be attained without requiring inordinate amount of resources, since transparency reforms can be substantial net 'savers' of public resources, and often can serve as a more efficient and less financially costly substitute to creating additional regulations and/or regulatory or governance bodies. We emphasize that different types of transparency reforms are warranted for different stages of political-economic development, and that much more prominence ought to be given to transparency reforms as a core component of second-generation institutional reforms. We provide a number of concrete examples of specific transparency-related reforms within a strategic framework, as well as a brief country illustration - the case of Chile.
Better investor protection could lead corporations to undertake riskier but value-enhancing investments. For example, better investor protection mitigates the taking of private benefits leading to excess risk-avoidance. Further, in better investor protection environments, stakeholders like creditors, labor groups, and the government are less effective in reducing corporate risk-taking for their self-interest. However, arguments can also be made for a negative relationship between investor protection and risk-taking. Using a cross-country panel and a U.S.-only sample, we find that corporate risk-taking and firm growth rates are positively related to the quality of investor protection.
Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow intertemporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely. Why do different countries have such different financial systems? Is one system better than all the others? Do different systems merely represent alternative ways of satisfying similar needs? Is the current trend toward market-based systems desirable? Franklin Allen and Douglas Gale argue that the view that market-based systems are best is simplistic. A more nuanced approach is necessary. Financial institutions are not simply veils, disguising the allocation mechanism without affecting it, but are crucial to overcoming market imperfections. An optimal financial system relies on both financial markets and financial intermediaries.
We propose that stronger creditor rights in bankruptcy affect corporate investment choice by reducing corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions that are value-reducing, to acquire targets whose assets have high recovery value in default, and to lower cash-flow risk. Also, corporate leverage declines when creditor rights are stronger. These relations are usually strongest in countries where management is dismissed in reorganization and are also observed over time following changes in creditor rights. Our results thus identify a potentially adverse consequence of strong creditor rights.
This article develops a framework for efficient IV estimators of random effects models with information in levels which can accommodate predetermined variables. Our formulation clarifies the relationship between the existing estimators and the role of transformations in panel data models. We characterize the valid transformations for relevant models and show that optimal estimators are invariant to the transformation used to remove individual effects. We present an alternative transformation for models with predetermined instruments which preserves the orthogonality among the errors. Finally, we consider models with predetermined variables that have constant correlation with the effects and illustrate their importance with simulations.
This paper examines whether executive compensation in banking is structured to promote risk taking. We find that, on average, bank CEOs receive less cash compensation, are less likely to participate in a stock option plan, hold fewer stock options, and receive a smaller percentage of their total compensation in the form of options and stock than do CEOs in other industries. Cross-sectional differences in the structure of compensation contracts within banking are also examined. We find a positive and significant relation between the importance of equity-based incentives and the value of the bank's charter. This result is inconsistent with the hypothesis that compensation policies promote risk taking in banking.
Building on the important study by Beck, Demirguc-Kunt, and Levine [2006. Bank supervision and corruption in lending. Journal of Monetary Economics 53, 2131-2163], we examine the effects of both borrower and lender competition as well as information sharing via credit bureaus/registries on corruption in bank lending. Using the unique World Bank data set (WBES) covering more than 4,000 firms across 56 countries with information on credit bureaus/registries, assembled by Djankov, McLiesh, and Shleifer [2007. Private credit in 129 countries. Journal of Financial Economics 84, 299–329], and bank regulation data collected by Barth, Caprio, and Levine [2006. Rethinking Bank Regulation: Till Angels Govern. Cambridge University Press, New York] to measure bank competition and information sharing, we find strong evidence that both banking competition and information sharing reduce lending corruption, and that information sharing also helps enhance the positive effect of competition in curtailing lending corruption. We also find that the ownership structure of firms and banks, legal environment, and firm competition all exert significant impacts on lending corruption.
Theory predicts that information sharing among lenders attenuates adverse selection and moral hazard, and can therefore increase lending and reduce default rates. Using a new, purpose-built data set on private credit bureaus and public credit registers, we find that bank lending is higher and credit risk is lower in countries where lenders share information, regardless of the private or public nature of the information sharing mechanism. We also find that public intervention is more likely where private arrangements have not arisen spontaneously and creditor rights are poorly protected.
This paper conducts the first empirical assessment of theories concerning risk taking by banks, their ownership structures, and national bank regulations. We focus on conflicts between bank managers and owners over risk, and we show that bank risk taking varies positively with the comparative power of shareholders within the corporate governance structure of each bank. Moreover, we show that the relation between bank risk and capital regulations, deposit insurance policies, and restrictions on bank activities depends critically on each bank's ownership structure, such that the actual sign of the marginal effect of regulation on risk varies with ownership concentration. These findings show that the same regulation has different effects on bank risk taking depending on the bank's corporate governance structure.
Creditors often share information about their customers’ credit records. Besides helping them to spot bad risks, this acts as a disciplinary device. If creditors are known to inform one another of defaults, borrowers must consider that default on one lender would disrupt their credit rating with all the other lenders. This increases their incentive to perform. However, sharing more detailed information can reduce this disciplinary effect: borrowers’ incentives to perform may be greater when lenders only disclose past defaults than when they share all their information. In some instances, by ‘fine-tuning’ the type and accuracy of the information shared, lenders can raise borrowers’ incentives to their first-best level.
Motivated by public policy debates about bank consolidation and conflicting theoretical predictions about the relationship between bank concentration, bank competition and banking system fragility, this paper studies the impact of national bank concentration, bank regulations, and national institutions on the likelihood of a country suffering a systemic banking crisis. Using data on 69 countries from 1980 to 1997, we find that crises are less likely in economies with more concentrated banking systems even after controlling for differences in commercial bank regulatory policies, national institutions affecting competition, macroeconomic conditions, and shocks to the economy. Furthermore, the data indicate that regulatory policies and institutions that thwart competition are associated with greater banking system fragility.
This paper reviews, appraises, and critiques theoretical and empirical research on the connections between the operation of the financial system and economic growth. While subject to ample qualifications and countervailing views, the preponderance of evidence suggests that both financial intermediaries and markets matter for growth and that reverse causality alone is not driving this relationship. Furthermore, theory and evidence imply that better developed financial systems ease external financing constraints facing firms, which illuminates one mechanism through which financial development influences economic growth. The paper highlights many areas needing additional research.
Using a sample of 1,560 new debt financings, we examine the choice among bank debt, non-bank private debt, and public debt. The primary determinant of the debt source is the credit quality of the issuer. Firms with the highest credit quality borrow from public sources, firms with medium credit quality borrow from banks, and firms with the lowest credit quality borrow from non-bank private lenders. Non-bank private debt thus plays a unique role in accommodating the financing needs of firms with low credit quality. In addition, the choice of debt source is (weakly) influenced by managerial discretion.
We investigate whether information sharing among banks has affected credit market performance in the transition countries of Eastern Europe and the former Soviet Union, using a large sample of firm-level data. Our estimates show that information sharing is associated with improved availability and lower cost of credit to firms. This correlation is stronger for opaque firms than transparent ones and stronger in countries with weak legal environments than in those with strong legal environments. In cross-sectional estimates, we control for variation in country-level aggregate variables that may affect credit, by examining the differential impact of information sharing across firm types. In panel estimates, we also control for the presence of unobserved heterogeneity at the firm level, as well as for changes in macroeconomic variables and the legal environment.
Swedish bankruptcy filing automatically terminates the employment of the chief executive officer (CEO) and triggers an auction of the firm. Critics of this system warn of excessive shareholder risk-shifting incentives prior to filing. We argue that private benefits of control induce managerial conservatism that may override shareholder risk-shifting incentives. By investing conservatively, the CEO increases the joint probability that the auction results in a going-concern sale and that the CEO is rehired. This uniquely implies that the rehiring probability is increasing in private control benefits, which our empirical results support. We also find that buyers in the auction screen on CEO quality. Overall, labor market discipline is dramatic, as filing CEOs suffer large income losses relative to CEOs of matched, non-bankrupt firms. Firms emerging from auction bankruptcy appear healthy as they typically go on to perform at par with industry rivals.JEL classification: G33; G34
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
Differences in culture, proxied by differences in religion and language, cannot be ignored when examining why investor protection differs across countries. We show that a country's principal religion predicts the cross-sectional variation in creditor rights better than a country's natural openness to international trade, its language, its income per capita, or the origin of its legal system. Catholic countries protect the rights of creditors less well than Protestant countries. A country's natural openness to international trade mitigates the influence of religion on creditor rights. Culture proxies are also helpful in understanding how investor rights are enforced across countries.
This paper is a first attempt at measuring financial sector outreach and investigating its determinants. First, we present new indicators of banking sector outreach across 99 countries, constructed from aggregate data provided by bank regulators. Second, we show that our indicators closely predict harder-to-collect micro-level statistics of household and firm use of banking services, and are associated with measures of firm financing obstacles in the expected way. Finally, we explore the association between our outreach indicators and standard determinants of financial sector depth. We find many similarities but also some differences in the determinants of outreach and depth.
This paper investigates the impact of stock markets and banks on economic growth using a panel data set for the period 1976–1998 and applying recent generalized-method-of moments techniques developed for dynamic panels. On balance, we find that stock markets and banks positively influence economic growth and these findings are not due to potential biases induced by simultaneity, omitted variables or unobserved country-specific effects.
This study investigates senior management turnover in financially distressed firms. In any given year, 52% of sampled firms experience turnover if they are either in default on their debt, bankrupt, or privately restructuring their debt to avoid bankruptcy. A significant number of changes are initiated by firms' bank lenders. Following their resignation from these firms, managers are not subsequently employed by another exchange-listed firm for at least three years. Results are consistent with managers experiencing large personal costs when their firms default.
We show that country-level creditor rights influence dividend policies around the world by establishing the balance of power between debt and equity claimants. Creditors demand and managers consent to a more restrictive payout policy as a substitute for weak creditor rights in an effort to minimize the firm's agency costs of debt. Using a sample of 120,507 firm-years from 52 countries, we find that both the probability and amount of dividend payouts are significantly lower in countries with poor creditor rights. A reduction in the creditor rights index from its highest value to its lowest value implies a 41% reduction in the probability of paying a dividend, and a 60% reduction in dividend payout ratios. These results are robust to numerous control variables, sample variations, model specifications, and alternative hypotheses. We also show that the agency costs of debt play a more decisive role in determining dividend policies than the previously documented agency costs of equity. Overall, our findings contribute to the growing literature arguing that creditors exert significant influence over corporate decision-making outside of bankruptcy.
We analyze the link between creditor rights and firms’ investment policies, proposing that stronger creditor rights in bankruptcy reduce corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions, which result in poorer operating and stock-market abnormal performance. In countries with strong creditor rights, firms also have lower cash flow risk and lower leverage, and there is greater propensity of firms with low-recovery assets to acquire targets with high-recovery assets. These relationships are strongest in countries where management is dismissed in reorganization, and are observed in time-series analysis around changes in creditor rights. Our results question the value of strong creditor rights as they have an adverse effect on firms by inhibiting management from undertaking risky investments.
This paper provides a survey on studies that analyze the macroeconomic effects of intellectual property rights (IPR). The first part of this paper introduces different patent policy instruments and reviews their effects on R&D and economic growth. This part also discusses the distortionary effects and distributional consequences of IPR protection as well as empirical evidence on the effects of patent rights. Then, the second part considers the international aspects of IPR protection. In summary, this paper draws the following conclusions from the literature. Firstly, different patent policy instruments have different effects on R&D and growth. Secondly, there is empirical evidence supporting a positive relationship between IPR protection and innovation, but the evidence is stronger for developed countries than for developing countries. Thirdly, the optimal level of IPR protection should tradeoff the social benefits of enhanced innovation against the social costs of multiple distortions and income inequality. Finally, in an open economy, achieving the globally optimal level of protection requires an international coordination (rather than the harmonization) of IPR protection.
This paper evaluates the importance of property rights institutions', which protect citizens against expropriation by the government and powerful elites, and contracting institutions', which enable private contracts between citizens. We exploit exogenous variation in both types of institutions driven by colonial history, and document strong first-stage relationships between property rights institutions and the determinants of European colonization (settler mortality and population density before colonization), and between contracting institutions and the identity of the colonizing power. Using this instrumental variables strategy, we find that property rights institutions have a first-order effect on long-run economic growth, investment, and financial development. Contracting institutions appear to matter only for the form of financial intermediation. A possible interpretation for this pattern is that individuals often find ways of altering the terms of their formal and informal contracts to avoid the adverse effects of contracting institutions but are unable to do so against the risk of expropriation.
Countries that have experienced occasional financial crises have, on average, grown faster than countries with stable financial
conditions. Because financial crises are realizations of downside risk, we measure their incidence by the skewness of credit
growth. Unlike variance, negative skewness isolates the impact of the large, infrequent, and abrupt credit busts associated
with crises. We find a robust negative link between skewness and GDP growth in a large sample of countries over 1960–2000.
This suggests a positive effect of systemic risk on growth. To explain this finding, we present a model in which contract
enforceability problems generate borrowing constraints and impede growth. In financially liberalized economies with moderate
contract enforceability, systemic risk taking is encouraged and increases investment. This leads to higher mean growth but
also to greater incidence of crises. In the data, the link between skewness and growth is indeed strongest in such economies.
The authors study an incentive model of financial intermediation in which firms as well as intermediaries are capital constrained. They analyze how the distribution of wealth across firms, intermediaries, and uninformed investors affects investment, interest rates, and the intensity of monitoring. The authors show that all forms of capital tightening (a credit crunch, a collateral squeeze, or a savings squeeze) hit poorly capitalized firms the hardest, but that interest rate effects and the intensity of monitoring will depend on relative changes in the various components of capital. The predictions of the model are broadly consistent with the lending patterns observed during the recent financial crises. Copyright 1997, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
It is commonly believed that equity finance for banks is more costly than deposits. This suggests that banks should economize on the use of equity and regulatory constraints on capital should be binding. Empirical evidence suggests that in fact this is not the case. Banks in many countries hold capital well in excess of regulatory minimums and do not change their holdings in response to regulatory changes. We present a simple model of bank moral hazard that is consistent with this observation. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to guarantee monitoring because it allows higher borrower surplus.
This paper identifies factors that influence decisions about a country's financial safety net, using a comprehensive data set covering 180 countries during the 1960-2003 period. Our analysis focuses on how private interest-group pressures, outside influences, and political-institutional factors affect deposit-insurance adoption and design. Controlling for macroeconomic shocks, quality of bank regulations, and institutional development, we find that both private and public interests, as well as outside pressure to emulate developed-country regulatory schemes, can explain the timing of adoption decisions and the rigor of loss-control arrangements. Controlling for other factors, political systems that facilitate intersectoral power sharing dispose a country toward design features that accommodate risk-shifting by banks.
Arguing that a relatively high cost of deposit insurance indicates that a bank takes excessive risks, this article estimates the cost of deposit insurance for a large sample of banks in 14 economies to assess the relationship between the risk-taking behavior of banks and their corporate governance structure. The results suggest that banks with concentrated ownership tend to take the greatest risks, and those with dispersed ownership engage in a relatively low level of risk taking. Moreover, as a proxy for bank risk, the cost of deposit insurance has some power in predicting bank distress. Copyright 2002, Oxford University Press.