Sovereign Credit Risk, Banks' Government Support, and Bank Stock Returns around the World: Discussion of Correa, Lee, Sapriza, and Suarez
Reint E. Gropp
Journal of Money, Credit and Banking,
s1
2014
Abstract
In the years leading up to the 2008–09 financial crisis, many banks around the world greatly expanded their balance sheets to take advantage of cheap and abundantly available funding. Access to international funding markets, in particular, made it possible for banks to reach a size that in some cases was a large multiple of their home countries’ gross domestic product (GDP). In Iceland, for example, assets of the banking system reached up to 900% of GDP in 2007. Similarly, by the end of 2008, assets in UK and Swiss banks exceeded 500% of their countries’ GDPs, respectively. Banks may also have grown rapidly because they may have wanted to reach too-big-to-fail status in their country, implying even lower funding cost (Penas and Unal 2004).
The depth and severity of the 2008–09 financial crisis and the subsequent debt crisis in Europe, however, have cast doubts on the ability of governments to bail out banks when they experience severe difficulties, in particular, in financially fragile environments and faced with large budget imbalances. This has resulted in as what some observers have dubbed a “doom loop”: the combination of weak public finances and weak banks results in a vicious cycle, in which the funding cost of banks increases, as the ability of governments to bail out banks is called into question, in turn increasing the funding cost of these banks and making the likelihood that the government will actually have to step in even higher, which in turn increases funding cost to the government and so forth.
Against this background, the paper by Correa et al. (2014) explores the link between sovereign rating changes and bank stock returns. They show large negative reactions of stock returns in response to sovereign ratings downgrades for banks that are expected to receive government support in case of failure. They find the strongest effects in developed economies, where the credibility of government bail outs is higher ex ante, while the effects are smaller in developing and emerging economies. In my view, the paper makes a number of important contributions to the extant literature.
Read article
The Ex Ante versus Ex Post Effect of Public Guarantees
H. Evren Damar, Reint E. Gropp, Adi Mordel
D. Evanoff, C. Holthausen, G. Kaufman and M. Kremer (eds), The Role of Central Banks in Financial Stability: How has it Changed? World Scientific Studies in International Economics 30,
2013
Abstract
In October 2006, Dominion Bond Rating Service (DBRS) introduced new ratings for banks that account for the potential of government support. The rating changes are not a reflection of any changes in the respective banks’ credit fundamentals. We use this natural experiment to evaluate the consequences of bail out expectations for bank behavior using a difference in differences approach. The results suggest a striking difference between the effects of bail out probabilities during calm times (“ex ante”) versus during crisis times (“ex post”). During calm times, higher bail-out probabilities result in higher risk taking, consistent with the moral hazard view and much of the empirical literature. However, in crisis times, we find that banks with higher bail out probabilities tend to increase their risk taking less compared to banks that were ex ante unlikely to be bailed-out. Charter values are one part of the explanation: Supported banks may have a funding advantage relative to non-supported banks during the crisis. However, we cannot rule out that other factors also may be playing a role, including tighter supervision of supported banks in crisis times.
Read article
Foreign Bank Entry, Credit Allocation and Lending Rates in Emerging Markets: Empirical Evidence from Poland
Hans Degryse, Olena Havrylchyk, Emilia Jurzyk, Sylwester Kozak
Journal of Banking and Finance,
No. 11,
2012
Abstract
Earlier studies have documented that foreign banks charge lower lending rates and interest spreads than domestic banks. We hypothesize that this may stem from the superior efficiency of foreign entrants that they decide to pass onto borrowers (“performance hypothesis”), but could also reflect a different loan allocation with respect to borrower transparency, loan maturity and currency (“portfolio composition hypothesis”). We are able to differentiate between the above hypotheses thanks to a novel dataset containing detailed bank-specific information for the Polish banking industry. Our findings demonstrate that banks differ significantly in terms of portfolio composition and we attest to the “portfolio composition hypothesis” by showing that, having controlled for portfolio composition, there are no differences in lending rates between banks.
Read article
Rules versus Discretion in Loan Rate Setting
Geraldo Cerqueiro, Hans Degryse, Steven Ongena
Journal of Financial Intermediation,
No. 4,
2011
Abstract
Loan rates for seemingly identical borrowers often exhibit substantial dispersion. This paper investigates the determinants of the dispersion in interest rates on loans granted by banks to small and medium sized enterprises. We associate this dispersion with the loan officers’ use of “discretion” in the loan rate setting process. We find that “discretion” is most important if: (i) loans are small and unsecured; (ii) firms are small and opaque; (iii) the firm operates in a large and highly concentrated banking market; and (iv) the firm is distantly located from the lender. Consistent with the proliferation of information-technologies in the banking industry, we find a decreasing role for “discretion” over time in the provision of small credits to opaque firms. While widely used in the pricing of loans, “discretion” plays only a minor role in the decisions to grant loans.
Read article
The Importance of Estimation Uncertainty in a Multi-Rating Class Loan Portfolio
Henry Dannenberg
IWH Discussion Papers,
No. 11,
2011
Abstract
This article seeks to make an assessment of estimation uncertainty in a multi-rating class loan portfolio. Relationships are established between estimation uncertainty and parameters such as probability of default, intra- and inter-rating class correlation, degree of inhomogeneity, number of rating classes used, number of debtors and number of historical periods used for parameter estimations. In addition, by using an exemplary portfolio based on Moody’s ratings, it becomes clear that estimation uncertainty does indeed have an effect on interest rates.
Read article
Central and Eastern European Countries in the Global Financial Crisis: A Typical Twin Crisis?
Diemo Dietrich, Tobias Knedlik, Axel Lindner
Post-Communist Economies,
No. 4,
2011
Abstract
This paper shows that during the Great Recession, banking and currency crises occurred simultaneously in Central and Eastern Europe. Events, however, differed widely from what happened during the Asian crisis that usually serves as the model case for the concept of twin crises. We look at three elements that help explaining the nature of events in Central and Eastern Europe: the problem of currency mismatches, the relation between currency and banking crises, and the importance of multinational banks for financial stability. It is shown that theoretical considerations concerning internal capital markets of multinational banks help understand what happened on capital markets and in the financial sector of the region. We discuss opposing effects of multinational banking on financial stability and find that institutional differences are the key to understand differing effects of the global financial crisis. In particular, we argue that it matters if international activities are organized by subsidiaries or by cross-border financial services, how large the share of foreign currency-denominated credit is and whether the exchange rate is fixed or flexible. Based on these three criteria we give an explanation why the pattern of the crisis in the Baltic States differed markedly from that in Poland and the Czech Republic, the two largest countries of the region.
Read article
Is Rated Debt Arm's Length? Evidence from Mergers and Acquisitions
Reint E. Gropp, C. Hirsch, Jan Pieter Krahnen
CFS Working Papers, No. 2011/10,
No. 10,
2011
Abstract
In this paper we challenge the view that corporate bonds are always arm's length debt. We analyze the effect of bond ratings on the stock price return to acquirers in M&A transactions, which tend to have significant effects on creditor wealth. We find acquirers abnormal returns to be higher if they are unrated, controlling for a wide variety of other effects identified in the literature. Tracing the difference in returns to distinct managerial decisions, we find that, everything else constant, rated firms increase their leverage in takeover transactions by less than their unrated counterparts. Consistent with a significant role for rating agencies, we find monitoring effects to be strongest when acquirer bonds are rated at the borderline between investment grade and junk. Finally, we are able to empirically exclude a large number of alternative explanations for the empirical regularities that we uncover.
Read article
Credit Union Membership and Use of Internet Banking Technology
H. Evren Damar, Lynn Hunnicutt
B.E. Journal of Economic Analysis and Policy,
No. 1,
2010
Abstract
What makes households use internet banking? Bank adoption of internet banking technology has been widely considered, but relatively few papers address consumer usage of internet banking. This study looks at the determinants of internet banking usage among credit union members in the Western United States. We use call report data from the National Credit Union Administration to calculate the rate of internet banking usage among a credit union's members, which allows us to examine whether variations in institutional characteristics, local economic conditions and membership criteria have an impact on the internet usage rates among members of different credit unions. We find that members in credit unions that were early internet technology adopters have higher usage rates, and that the contribution to usage rates varies among types of online services offered.
Read article
The Role of Credit Ratings in Banking Regulations. Credit Ratings Are Insufficiently Anticipating the Risk for Currency Crises.
Tobias Knedlik, Johannes Ströbel
Wirtschaft im Wandel,
No. 10,
2007
Abstract
Bonitätsbewertungen durch Rating-Agenturen gewinnen durch die unter dem Stichwort Basel II diskutierten Reformvorschläge zur Bankenregulierung an Bedeutung. Insbesondere hängt das durch die Regulierung geforderte Mindesteigenkapital unter dem standardisierten Ansatz von Basel II von der Bewertung der Kreditrisiken durch externe Rating-Agenturen ab. Bonitätsbewertungen, speziell von souveränen Schuldnern, bestimmen damit wesentlich die Höhe des Mindesteigenkapitals von Banken. In der Vergangenheit haben Rating-Agenturen Währungskrisenrisiken systematisch unterschätzt. Diese sind jedoch für die Bewertung des Kreditausfallrisikos souveräner Schuldner wichtig. Die prozyklischen Effekte von Basel II entstehen vor allem dadurch, daß im Fall von Währungskrisen aufgrund der zu positiven Bewertung im Vorfeld der Krise schlagartig massive Herabstufungen notwendig werden. Diese Effekte können nur minimiert werden, wenn die währungskriseninduzierten Kreditausfallrisiken angemessen berücksichtigt werden. Die Kritik an der Methode der Rating-Agenturen, insbesondere an mangelnder Berücksichtigung neuerer Währungskrisenmodelle infolge der Asienkrisen von 1997/98, führte zu Reaktionen der Agenturen. So sagte z. B. Standard and Poor’s die Berücksichtigung mikroökonomischer Indikatoren zu, die bei aktuellen Krisen als Krisenfaktoren erkannt wurden. In der vorliegenden Arbeit wird anhand eines Beispiels untersucht, inwiefern sich empirische Anzeichen dafür erkennen lassen, daß mikroökonomische Indikatoren in der Praxis der Bonitätsprüfung beachtet werden. Das Ergebnis der empirischen Untersuchungen zeigt, daß traditionelle makroökonomische Indikatoren die Rating-Ergebnisse dominieren. In aktuellen Ratings können keine Anzeichen für eine stärkere Berücksichtigung von Mikro-Indikatoren gefunden werden. Es muß daher geschlußfolgert werden, daß, wie in der Wirtschaft im Wandel 8/2007 ausgeführt, auch weiterhin prozyklische, krisenverstärkende Effekte von Basel II ausgehen. Die Rating-Agenturen erfüllen bislang die Rolle als frühzeitige Antizipatoren für Währungskrisenrisiken unzureichend.
Read article
