Content uploaded by Serdar Dinc
Author content
All content in this area was uploaded by Serdar Dinc on Dec 13, 2013
Content may be subject to copyright.
A preview of the PDF is not available
The Politics of Bank Failures: Evidence from Emerging Markets
Abstract and Figures
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.
Figures - uploaded by Serdar Dinc
Author content
All figure content in this area was uploaded by Serdar Dinc
Content may be subject to copyright.
... 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.
... In such a game, the political system protects banks in exchange for allocating credit in a way that keeps voters satisfied. Political protection in our setup is the reduction of the bank tax, but this can also be interpreted as a generic form of political favors, such as a delay to resolve a failed bank (Brown and Dinc (2005)), or the provision of deposit insurance (Calomiris and Chen (2022)). Accordingly, banks' contributions to politicians can be interpreted as the cost (or risk) incurred by banks when extending credit to firms and households based on political criteria, rather than financial ones (Khwaja and Mian (2005), Chu and Zhang (2022)). ...
... 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. ...
In a general equilibrium framework, we show that banks may “buy” political influence at a discount: They offer disproportionately small campaign contributions compared to the influence they exert, thus generating abnormal returns. We distinguish between the direct effect of contributions which, as a cost, reduce bank returns, and the indirect effect of contributions which boost returns via inducing bank-favoring policies. Therefore, abnormal returns may or may not increase with the amount of contributions, depending on which effect dominates: Stricter capital requirements decrease contributions and abnormal returns. When politicians attach more weight to households’ welfare, contributions increase and abnormal returns decrease.
To analyze whether the occurrence of elections affects access to credit for firms, we perform an investigation using firm‐level data covering 44 developed and developing countries. The results show that elections impair access to credit. Specifically, firms have lower access to credit in election years and pre‐election years as elections exacerbate political uncertainty. While higher borrower discouragement is a tangible negative effect of elections, their occurrence per se does not seem to affect loan acceptance by banks. We also document that the negative relationship between elections and credit access is shaped by country and election characteristics as well as firm characteristics.
More stable governments should improve banking systems’ financial stability by increasing the predictability of future public decisions. Our study explores the relationship between political stability, as captured by the voting share of governing parties, and banking system stability. Using a sample of 84 countries over the 2004–2017 period, our dynamic panel approach shows that voting power is significantly related to banking default risk only in presidential systems. An increase in the voting share of governing parties probably favors the enforcement of the president’s political agenda, thereby reducing the degree of political uncertainty. This seems to strengthen banking stability.
The overstatement of asset collateral values reduces bank capital requirements. We identify this novel form of regulatory arbitrage by studying housing overappraisals, the difference between housing collateral values computed by appraisers and actual transaction prices. We leverage granular loan-level data from Spain and a kink in the scheme of residential mortgage risk weights to show that tighter regulatory requirements cause larger overappraisals. This bias depends on the relationship between appraisers and banks; appraisers inflate mortgage collateral values only for their major customer banks. On average, overappraisals lower risk-weighted mortgages by 9%. Mortgage overappraisals allow banks to free up regulatory capital to support additional risk-taking in the corporate loan market.
This paper was accepted by Victoria Ivashina, finance.
Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4805 .
We study how banks use “regulatory adjustments” to inflate their regulatory capital ratios and whether this depends on forbearance on the part of national authorities. Using the 2011 EBA capital exercise as a quasi-natural experiment, we find that banks substantially inflated their levels of regulatory capital via a reduction in regulatory adjustments (without a commensurate increase in book equity and without a reduction in bank risk). We document substantial heterogeneity in regulatory capital inflation across countries, suggesting that national authorities forbear their domestic banks to meet supranational requirements, with a focus on short-term economic considerations.
There is an extensive empirical literature on political business cycles, but its theoretical foundations are grounded in pre-rational expectations macroeconomic theory. Here we show that electoral cycle in taxes, government spending and money growth can be modeled as an equilibrium signaling process. The cycle is driven by temporary information asymmetries which can arise if, for example, the government has more current information on its performance in providing for national defense. Incumbents cheat least when their private information is either extremely favorable or extremely unfavorable. An exogenous increase in the incumbent party's popularity does not necessarily imply a damped policy cycle.
This paper investigates private-interest, public-interest, and political-institutional theories of regulatory change to analyze state-level deregulation of bank branching restrictions. Using a hazard model, we find that interest group factors related to the relative strength of potential winners (large banks and small, bank-dependent firms) and losers (small banks and the rival insurance firms) can explain the timing of branching deregulation across states during the last quarter century. The same factors also explain congressional voting on interstate branching deregulation. While we find some support for each theory, the private interest approach provides the most compelling overall explanation of our results.