Compensation Regulation in Banking: Executive Director Behavior and Bank Performance after the EU Bonus Cap
Stefano Colonnello, Michael Koetter, Konstantin Wagner
Journal of Accounting and Economics,
forthcoming
Abstract
The regulation that caps executives’ variable compensation, as part of the Capital Requirements Directive IV of 2013, likely affected executive turnover, compensation design, and risk-taking in EU banking. The current study identifies significantly higher average turnover rates but also finds that they are driven by CEOs at poorly performing banks. Banks indemnified their executives by off-setting the bonus cap with higher fixed compensation. Although our evidence is only suggestive, we do not find any reduction in risk-taking at the bank level, one purported aim of the regulation.
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Supranational Rules, National Discretion: Increasing versus Inflating Regulatory Bank Capital?
Reint E. Gropp, Thomas Mosk, Steven Ongena, Ines Simac, Carlo Wix
Journal of Financial and Quantitative Analysis,
forthcoming
Abstract
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.
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To Securitize or To Price Credit Risk?
Danny McGowan, Huyen Nguyen
Journal of Financial and Quantitative Analysis,
forthcoming
Abstract
Do lenders securitize or price loans in response to credit risk? Exploiting exogenous variation in regional credit risk due to foreclosure law differences along US state borders, we find that lenders securitize mortgages that are eligible for sale to the Government Sponsored Enterprises (GSEs) rather than price regional credit risk. For non-GSE-eligible mortgages with no GSE buyback provision, lenders increase interest rates as they are unable to shift credit risk to loan purchasers. The results inform the debate surrounding the GSEs' buyback provisions, the constant interest rate policy, and show that underpricing regional credit risk increases the GSEs' debt holdings.
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The Disciplining Effect of Supervisory Scrutiny in the EU-wide Stress Test
Christoffer Kok, Carola Müller, Steven Ongena, Cosimo Pancaro
Journal of Financial Intermediation,
January
2023
Abstract
Relying on confidential supervisory data related to the 2016 EU-wide stress test, this paper presents novel empirical evidence that supervisory scrutiny associated to stress testing has a disciplining effect on bank risk. We find that banks that participated in the 2016 EU-wide stress test subsequently reduced their credit risk relative to banks that were not part of this exercise. Relying on new metrics for supervisory scrutiny that measure the quantity, potential impact, and duration of interactions between banks and supervisors during the stress test, we find that the disciplining effect is stronger for banks subject to more intrusive supervisory scrutiny during the exercise. We also find that a strong risk management culture is a prerequisite for the supervisory scrutiny to be effective. Finally, we show that a similar disciplining effect is not exerted neither by higher capital charges nor by more transparency and related market discipline induced by the stress test.
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Correlation Scenarios and Correlation Stress Testing
Natalie Packham, Fabian Wöbbeking
Journal of Economic Behavior and Organization,
January
2023
Abstract
We develop a general approach for stress testing correlations of financial asset portfolios. The correlation matrix of asset returns is specified in a parametric form, where correlations are represented as a function of risk factors, such as country and industry factors. A sparse factor structure linking assets and risk factors is built using Bayesian variable selection methods. Regular calibration yields a joint distribution of economically meaningful stress scenarios of the factors. As such, the method also lends itself as a reverse stress testing framework: using the Mahalanobis distance or Highest Density Regions (HDR) on the joint risk factor distribution allows to infer worst-case correlation scenarios. We give examples of stress tests on a large portfolio of European and North American stocks.
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20.12.2022 • 31/2022
No deep recession despite energy crisis and rise in interest rates
High energy prices and deteriorating financial conditions are weighing on the German economy. However, the period of weakness over the winter is likely to be moderate, partly because the energy price brakes are supporting private incomes. The Halle Institute for Economic Research (IWH) forecasts that due to the recovery from the pandemic in the first three quarters, gross domestic product (GDP) is estimated to have increased by 1.8% in 2022. Due to high energy prices, however, GDP will slightly decline in the winter months and stagnate on average in 2023. Inflation will fall from 7.8% in 2022 to 6.5% in 2023.
Oliver Holtemöller
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Environmental Reputational Risk, Negative Media Attention and Financial Performance
Leonardo Becchetti, Rocco Ciciretti, Iftekhar Hasan, Gabriele La Licata
Financial Markets, Institutions and Instruments,
No. 4,
2022
Abstract
Tracing negative media attention, this paper investigates the effect of reputational risk on firm value. Decomposing reputational damage into environmental, social and corporate-governance dimensions, it reports that environmental reputational risk has the most significant negative effect on price earnings, i.e., firms exposed to environmental risk are likely to be priced at a discount or charged a higher risk premium when discounting future earnings.
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Measuring Market Expectations
Christiane Baumeister
Handbook of Economic Expectations,
November
2022
Abstract
Asset prices are a valuable source of information about financial market participants' expectations about key macroeconomic variables. However, the presence of time-varying risk premia requires an adjustment of market prices to obtain the market's rational assessment of future price and policy developments. This paper reviews empirical approaches for recovering market-based expectations. It starts by laying out the two canonical modeling frameworks that form the backbone for estimating risk premia and highlights the proliferation of risk pricing factors that result in a wide range of different asset-price-based expectation measures. It then describes a key methodological innovation to evaluate the empirical plausibility of risk premium estimates and to identify the most accurate market-based expectation measure. The usefulness of this general approach is illustrated for price expectations in the global oil market. Then, the paper provides an overview of the body of empirical evidence for monetary policy and inflation expectations with a special emphasis on market-specific characteristics that complicate the quest for the best possible market-based expectation measure. Finally, it discusses a number of economic applications where market expectations play a key role for evaluating economic models, guiding policy analysis, and deriving shock measures.
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The Color of Corporate Loan Securitization
Isabella Müller, Huyen Nguyen, Trang Nguyen
IWH Discussion Papers,
No. 22,
2022
Abstract
We examine whether banks manage firms’ climate transition risks via corporate loan securitization. Results show that banks are more likely to securitize loans granted to firms that become more carbon-intensive. The effect is more pronounced if banks have a lower willingness to adjust loan terms. Exploiting the election of Donald Trump as an exogenous shock that lowers transition risk, we show that banks respond by a lower securitization of loans given to firms that become more carbon-intensive. This is mainly driven by banks that have no or low preferences for sustainable lending and domestic lenders.
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Zinsaufschlag oder Übertragung durch Verbriefung? Der Umgang mit Risiken im US-Hypothekenmarkt
Danny McGowan, Huyen Nguyen
Wirtschaft im Wandel,
No. 3,
2022
Abstract
Seit der Finanzkrise der Jahre 2007 und 2008 diskutiert die Wissenschaft darüber, wie Kreditgeber die Verbriefung von Hypotheken nutzen, um das Kreditrisiko an Dritte weiterzugeben, und wie dies zur Finanzkrise beigetragen hat. Eine aktuelle IWH-Studie betrachtet die Entscheidungssituation des Kreditgebers zwischen Risikoaufschlag und Risikoübertragung. Sie nutzt rechtliche Unterschiede in verschiedenen US-Bundesstaaten bei der Zwangsvollstreckung von Hypotheken, um daraus unterschiedliche regionale Kreditrisiken abzuleiten. Ist dieses regionale Risiko erhöht, reagieren Kreditgeber durch vermehrte Verbriefung, wenn Hypotheken zum Verkauf an halbstaatliche Agenturen (Government Sponsored Enterprises, GSE) wie Fannie Mae und Freddie Mac zugelassen sind und so gegen Ausfall versichert werden können. Bei Hypotheken, für die kein Rückkauf durch GSE infrage kommt, erhöhen die Kreditgeber dagegen die Zinsen, da sie das Kreditrisiko nicht an die Kreditkäufer weitergeben können.
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