Transcript Session 1: Bank Risk and Regulatory Implications I Chair

Session 1: Bank Risk and
Regulatory Implications I
Chair: Clas Wihlborg, CBS
Asia Link Programme Research
Conference on “Safety and
Efficiency of the Financial System”
Manila Aug. 27, 2007
The Papers
• The Determinants of Domestic and Cross
Border Bank Contagion Risk in South East Asia
– Carlos Bautista, Philippe Rous, Amine Tarazi
• The Effects of NPLs on Bank Lending
Behaviour: A Threshhold Model
– David Dickinson, Yixin Hon
• The Use of Accounting and Stock Market Data
to Predict Bank Financial Distress: A Case
Study of Asian Banks
– Isabelle Distinguin, Jocelyn Trinidad, Amine Tarazi
The Theme
• The risk of a bank’s failure is particularly
serious as a result of potential contagion
among banks and repercussions on the real
economy.
– Paper 1: The potential for contagion within and
among S.E. Asian countries’ banking systems
– Paper 2: Real sector repercussions of distress
(non-performing loans above a threshold level)
– Paper 3: Predicting distress in banking (and
thereby possibly prevent systemic effects)
The Determinants of Domestic and
Cross Border Bank Contagion Risk in
South East Asia; Comments
• 1. Defining and Measuring Systemic
Risk and Contagion
• 2. The magnitude of correlations;
Evidence of (lack of) contagion risk?
• 3. The contributions of individual banks
to contagion
Systemic risk and contagion
Events in the financial sector cause substantial real effects
contributing to a recession or depression or, if events originating
in the real sector are amplified by the financial system, then we
have a systemic risk problem.
1. Causality goes from Fin’l system
2. Systemic effect requires either extreme
concentration in the financial sector or
contagion within the financial sector.
Q-marks w.r.t. correlations in the paper:
1.Correlation between two banks’ stock returns
(adjusted for market) need not be evidence of
potential contagion though linkages, but could be
caused by similarity of exposures
2. The causes of correlation in normal times need not
be the main sources of contagion in a crisis
Correlations
• DOMC: yearly mean of correlations between
weekly “abnormal stock returns” of banks
within country (alternatives tested as well,
including correlations for large movements)
• CBMC: yearly mean for one country’s banks’
correlations with banks in other countries
• Sensitivity of country DOMC/CBMC to
individual bank’s DOMC(i)/CBMC(i)
– >1: “overreaction in terms of contagion” ??
• Explaining sensitivity: Dummy for
sensitivity>1 with statistical significance.
– LARGE number of accounting and market
variables describing bank.
Observations on correlations
• High/low DOMC countries seem
unrelated to crisis or not in 97
• Even high ones for DOMC rather low (.2.3) in terms of average probability of
move in the same direction
• Averages for CBMC close to zero
• What does high sensitivity for a bank
really mean?
Correlations and sensitivities
• Regressions explain high sensitivities
• Why not some selectivity among bank
characteristics on theoretical grounds?
– Based on sources of interbank-contagion and
opaqueness instead of only collinearity
• Alternative: Find high correlation banks
(pairwise) in order to find characteristics
explaining correlations (is the procedure used a
substitute for this?--we lack data on pair-wise
relations).
• Interactive terms: Explain
• Interpretations: Stepwise procedure eliminating
variables with collinearity is perhaps more
appropriate for forecasting than for explaining.
The Effects of NPLs on Bank Lending
Behaviour: A Threshhold Model
 Major concern: Banks with large nonperforming loans are unwilling to lend,
presumably because they are constrained by
capital requirements or inability to obtain
funding. Relevance for procyclicality debate.
 BUT: Limited liability and (implicit or
explicit) deposit insurance provides
incentives to “gamble for resurrection”
Questions on NPLs
 Non-performng loans
 Bad data?
 To what extent has capital been reduced
correspondingly? (provisions)
 To what extent are banks required to hold
capital against recognized NPLs
 The general question is to what extent
NPL has an effect on behavior distinct
from effect of capital?
Specification
 Are growth rates defined for each variable or
are loans, deposits, capital defined relative
to some variable?
 Simultaneity?
 Interactions in addition to capital ratio
dummy?
 Threshholdeffect: Interesting but alterntives
can be considered: quadratic variable,
interactions
 Is specification of effective capital ratio also
derived from threshold analysis?
Results
 Surprising differences across countries
 I would like to see alternative
specifications before I’m convinced
The Use of Accounting and Stock
Market Data to Predict Bank Financial
Distress: A Case Study of Asian Banks
» The most “ready to go” of the papers in
the session.
» General question: How can financial
distress be measured? Downgrading?
Why not Accounting measures (NPL and
the like)? Why not Stock market returns?
» One issue is where information about the
shape of the bank appears first: What
predicts what?
» Thus, the issue here is what predicts
ratings.
Comments
» Focus on predictions rather than
explanations. One must go to the
back to see what variables mean.
» However, analysis of size and
structure effects has greater
economic content. Interesting.
» Would it be possible to do out-of
sample tests?
Does the following make
sense?
» Accounting and market indicators
are good predictors of upgrades but
not downgrades for large banks.
Market indicators predict
downgrades but not upgrades for
small banks.