Essays on Bank Risk

This thesis comprises research on banks\u2019 risk. The work is presented in three empirical essays. The first essay investigates the relationship between bank capital and liquidity and the impact of those connections on the market probability of default. Using quarterly balance sheet data of large European banks over the period 2005-2015 and various configurations of capital and liquidity; we first analyse through a simultaneous equation model the connections between capital and liquidity. The results of the model show a bidirectional positive relationship between capital and funding liquidity risk in line with the \u201cfinancial fragility\u201d and the \u201ccrowding out of deposits\u201d hypotheses developed in theoretical papers. The results also indicate the importance of off-balance sheet exposures and the limitation of risk based capital ratios in explaining the relationship. Given the importance of capital and liquidity for financial stability, in the second part of the paper we explore whether those variables provide incremental information on banks\u2019 risk. To do so, we use a factor model to analyse if leverage and funding liquidity risk are reflected in CDS spreads. We find that capital appears to have a large impact on CDS spread changes, while liquidity risk is priced only when it falls below the regulatory threshold. The second essay examines the causal effect of bank credit rating changes on bank capital structure decisions. In this paper, we hypothesize that bank managers\u2019 concern for credit ratings due to the discrete cost and benefits associated with different credit levels. Using a unique data set with quarterly detailed information on rating changes and bank\u2019s balance sheets for 76 banks based in EU and US from 2005Q1 to 2015Q4, we find that rating changes matter for bank capital structure decisions. More precisely, we find that a downgrade event triggers reductions in leverage, long-term funding and lending. While upgrades do not cause capital structure adjustments. In doing our empirical exercise, we also exploit the asymmetric impact of rating changes of banks based in countries that experienced the sovereign debt crisis. This asymmetric effect leads to greater: capital adjustments, reductions in long-term funding and lending of banks from those stressed countries. The third essay examines how bank risks affects the transmission mechanism of unconventional monetary policy measures taken by the Federal Reserve (FED) in response to the financial crisis. Using quarterly balance sheet data and employing a GMM approach, for a sample of 149 US banks over the period 2007 to 2016, I find that bank risk positions are relevant for the transmission mechanism through the bank lending channel during the FED Quantitative easing (QE) programmes. The empirical findings suggest that QE programs helped banks to supply new loans through the reduction of bank risk conditions, as perceived by financial market investors.Ingles

Dynamic Discouraged Borrowers

This paper investigates the intertemporal dynamics of borrower discouragement. Using a cross-country panel of firms that were resurveyed across the waves of the Survey on Access to Finance of Enterprises, we find that the probability of transitioning into discouragement changes over the business cycle and across bank financing products: term loans and credit lines. Past credit experiences and firm-level risk indicators are important factors in explaining the probability of being discouraged over time.We also analyse the transitioning out of discouragement, and show that firm-level improvements in credit history and profit outlook drive the transitioning out of the discouragement state

Reverse Revolving Doors in the Supervision of European Banks

We show that the presence of executive directors with prior experience in the finance industry is pervasive on the boards of European national banking supervisors. Up to one executive out of three has previously held positions in the industry he/she supervises. Appointments of such executives impacts more favorably bank valuations than those of executives without a finance background. The proximity to supervised banks---rather than superior financial expertise or intrinsic skills---appears to drive the positive differential effect of finance-related executives

Greenfield FDI attractiveness index: a machine learning approach

Purpose – This study aims to propose a comprehensive greenfield foreign direct investment (FDI) attractiveness index using exploratory factor analysis and automated machine learning (AML). We offer offer a robust empirical measurement of location-choice factors identified in the FDI literature through a novel method and provide a tool for assessing the countries’ investment potential. Design/methodology/approach – Based on five conceptual key sub-domains of FDI, We collected quantitative indicators in several databases with annual data ranging from 2006 to 2019. This study first run a factor analysis to identify the most important features. It then uses AML to assess the relative importance of each resultant factor and generate a calibrated index. AML computational algorithms minimize predictive errors, explore patterns in the data and make predictions in an empirically robust way. Findings – Openness conditions and economic growth are the most relevant factors to attract FDI identified in the study. Luxembourg, Hong Kong, Singapore, Malta and Ireland are the top five countries with the highest overall greenfield attractiveness index. This study also presents specific indices for the three sectors: energy, financial services, information and communication technology (ICT) and electronics. Originality/value – Existent indexes present deficiencies in conceptualization and measurement, lacking theoretical foundation, arbitrary selection of factors and use of limited linear models. This study’s index is developed in a robust three-stage process. The use of AML configures an advantage compared to traditional linear and additive models, as it selects the best model considering the predictive capacity of many models simultaneously

Large EU banks' capital and liquidity: Relationship and impact on credit default swap spreads

This paper explores the interrelations between bank capital and liquidity and their impact on the market probability of default. We employ an unbalanced panel of large European banks with listed credit default swap (CDS) contracts during the period 2005-2015, which allow us to consider the impact of the recent financial crisis. Our evidence suggests that bank capital and funding liquidity risk as defined in Basel III have an economically meaningful bidirectional relationship. However, the effect on CDS spread is ambiguous. While capital appears to have a relatively large impact on CDS spread changes, liquidity risk is priced only when it falls below the regulatory threshold

Dynamic correlations and volatility linkages between stocks and sukuk: evidence from international markets

An understanding of volatility and co-movements in financial markets is important for portfolio allocation and risk management practices. The current financial crisis caused a shrinkage in values of most assets, an increased volatility and a threat to the survival of several institutional investors. Managing risks and returns within the classic portfolio theory, when correlations across securities soar, is increasingly challenging. In this paper, we investigate the volatility behavior and the co-movements between sukuk and international stock indexes. Symmetric multivariate GARCH models with dynamic conditional correlations (DCC) were estimated under student-t distribution. We provide evidence of high correlations between sukuk and US and EU stock markets, without finding the well-known flight to quality behavior affecting Islamic bonds. We also show that volatility linkages between sukuk and regional market indexes are higher during financial crisis. We argue that investors could obtain diversification benefits including sukuk in a well \u2013diversified equity portfolio, given their lower volatility compared to equity. But higher volatility linkages and dynamic correlations during financial crises show that they are hybrid instruments between bonds and equity. Our findings are relevant for institutional investors and asset managers, that include Islamic bonds in a diversified portfolio

Financial fragmentation and SMEs’ access to finance

This paper focuses on the impact of financial fragmentation on small and medium enterprises (SMEs)’ access to finance. We combine country-level data on financial fragmentation and the ECB’s SAFE (Survey on the Access to Finance of Enterprises) data for 12 European Union (EU) countries over 2009-2016. Our findings indicate that an increase in financial fragmentation not only raises the probability of all firms to be rationed but also to be charged higher loan rates; in addition, it increases the likelihood of borrower discouragement and it impairs firms’ perceptions of the future availability of bank funds. Less creditworthy firms are even more likely to become credit rationed, suggesting a flight to quality effect in lending. However, our study also documents a potential adverse effect of increasing bank market power resulting from greater integration. This suggests that financial integration could impair firms’ financing, if not accompanied by policy initiatives aimed at maintaining an optimal level of competition in the banking sector

Do SMEs benefit from the corporate sector purchase program? evidence from the eurozone

In this paper, we study the impact of the European Central Bank Corporate Sector Purchase Program on small and medium sized firms' financing using restricted data from the Survey of Access to Finance of Enterprises. We find that following the announcement, credit access improved through the reduction of both formal and informal credit constraints. Loans terms also improved as manifested by a reduction on loan application costs. The unconventional monetary policy intervention is also transmitted through trade credit in production networks as unconstrained borrowers extend more trade credit following the announcement of the program

Analysing, Planning and Valuing Private Firms

This book aims to provide a framework for the valuation of private corporations. Starting from the analysis of financial statements to understand where value comes from, to the appli-cation of valuation methods, this book tries to provide a list of tools and techniques to solve practical application drawbacks. Regarding the financial statement analysis, despite the consolidated use of financial ratios and scores, sometimes it is difficult to provide a complete picture of the company’s economic, financial, and strategic dynamics. The process of valuing private companies is not different from the process of valuing public companies. The present value is computed by discounting future cash flows with a proper rate that reflects the riskiness of the cash flows. However, when applying valuation techniques to private companies, there are two standard problems to overcome: the financial statements for private firms are likely to go back fewer years and have less detail; there is no market value for either debt or equity. In this book, we try to over-come these two criticalities by proposing some approaches to (1) forecast revenues, margins, and cash flows; (2) estimate the cost of capital for private corporations. Then we also provide a framework on how to use relative valuation techniques (multiple) that despite their simplicity hide some pitfalls in the application