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The Politics of Bank Failures: Evidence from Emerging Markets


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This paper studies large private banks in 21 major emerging markets in the 1990s. It first demonstrates that bank failures are very common in these countries: about 25 percent of these banks failed during the seven-year sample period. The paper also shows that political concerns play a significant role in delaying government interventions to failing banks. Failing banks are much less likely to be taken over by the government or to lose their licenses before elections than after. This result is robust to controlling for macroeconomic and bank-specific factors, a new party in power, early elections, outstanding loans from the IMF, as well as country-specific, time-independent factors. This finding implies that much of the within-country clustering in emerging market bank failures is directly due to political concerns.
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... Using receiver operating characteristic (ROC) curves, precision recall (PR) curves, and other prediction analytics, we show that ELPR is superior to T1CR in reducing both types of misclassification errors. The advantage of ELPR over T1CR is large under a wide range of test parameters (Demers and Joos 2007;Jones 2017;Cook and Ramadas 2020;Borio and Drehmann 2009) and relative misclassification cost assumptions (Martin 1977;Sinkey 1975). This finding remains robust if we focus solely on the performance of each predictor among banks with the highest predicted risk (Bharath and Shumway 2008;Beaver, Correia, and McNichols 2012). ...
... However, the relative cost of a Type 1 error to a Type 2 error may depend on the specific regulatory setting. To address this asymmetric loss problem, we conducted extensive misclassification cost analyses using a wide range of relative cost assumptions that are consistent with prior literature, including Frydman, Altman, and Kao (1985), Tam and Kiang (1992), and Borio and Drehmann (2009) (see Online Appendix for details). Our results show that ELPR dominates T1CR across a wide spectrum of relative cost assumptions. ...
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.
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... Our analysis complements our understanding of the interaction between banks and politicians by showing how the relationship between the favors extended from bankers to politicians (Khwaja and Mian (2005), Chu and Zhang (2022)) and vice versa (Brown and Dinc (2005), Calomiris and Chen (2022)) can be a crucial determinant of the economic outcome. We thus generate hypotheses that can be tested by future empirical analyses, using data from both the political and the banking side of the game. ...
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