How does competition affect efficiency and soundness in banking? New empirical evidence

A growing body of literature indicates that competition increases bank soundness. Applying an industrial organization based approach to large data sets for European and U.S. banks, we offer new empirical evidence that efficiency plays a key role in the transmission from competition to soundness. We use a two-pronged approach. First, we employ Granger causality tests to establish the link between competition and measures of profit efficiency in banking, and find that competition indeed increases bank efficiency. Second, building on these results, we examine the relation between the Boone indicator [Boone, J. (2001) Intensity of competition and the incentive to innovate. IJIO, Vol. 19, pp. 705-726], an innovative measure of competition that focuses on the impact of competition on performance of efficient banks, and relate this measure to bank soundness. We find evidence that competition robustly increases bank soundness, via the efficiency channel. JEL Classification: G21, G28, L11Bank competition, Efficiency, market structure, regulation, soundness

Bank liquidity creation and risk taking during distress

Liquidity creation is one of banks' raisons d'être. But what happens to liquidity creation and risk taking when a bank is identified as distressed by regulatory bodies and subjected to regulatory interventions and/or receives capital injections? What are the long-run effects of such interventions? To address these questions, we exploit a unique dataset of German universal banks for the period 1999 - 2008. Our main findings are as follows. First, regulatory interventions and capital injections are followed by lower levels of liquidity creation. The probability of a decline in liquidity creation increases to up to around 50 percent when such actions are taken. Second, bank risk taking decreases in the aftermath of regulatory interventions and capital injections. Third, while banks' liquidity creation market shares decline over the five years following such disciplinary measures, they also reduce their risk exposure over this period to become safer banks. --Liquidity creation,bank distress,regulatory interventions,capital injections

‘Too systemically important to fail’ in banking – Evidence from bank mergers and acquisitions

In this paper, we examine the systemic risk implications of banking institutions that are considered ‘Too-systemically-important-to-fail’ (TSITF). We exploit a sample of bank mergers and acquisitions (M&As) in nine EU economies between 1997 and 2007 to capture safety net subsidy effects and evaluate their ramifications for systemic risk. We find that safety net benefits derived from M&A activity have a significantly positive association with rescue probability, suggesting moral hazard in banking systems. We, however, find no evidence that gaining safety net subsidies leads to TSITF bank's increased interdependency over peer banks

Monitoring matters:debt seniority, market discipline and bank conduct

We examine if junior debtholders monitor banks and if such monitoring constrains risk-taking. Leveraging an unexplored natural experiment in the U.S. that changes the priority structure of claims on failed banks’ assets, we provide novel insights into the debate on market discipline. We document asymmetric effects for monitoring effort depending on whether a creditor class moves up or down the priority ladder. Conferring priority to all depositors causes declines in deposit interest rates but increases interest rates for non-deposit liabilities, suggesting greater incentives for junior debtholders to exert monitoring effort. Consistent with the idea that senior claims require lower risk premiums, banks increasingly rely on deposit funding following changes in priority structure. More intensive monitoring also influences conduct: subordinating non-depositor claims reduces risk taking. Our results inform the debate about bail-ins and highlight that changes in the priority structure are a complementary tool to regulation which has received little attention in prior work

The real effects of banking supervision: evidence from enforcement actions

We present a novel way to examine macro-financial linkages by focusing on the real effects of bank supervisors’ enforcement actions. Exploiting plausibly exogenous variation in supervisory monitoring intensity, we show that enforcement actions in single-market banks trigger temporarily large adverse effects for the macroeconomy by reducing personal income growth, the number of establishments, and increasing unemployment. These effects are related to contractions in bank lending and liquidity creation, and are more pronounced when we consider enforcement actions on both single-market and multi-market banks, and in counties with fewer banks and greater external financial dependence

Debtholder Monitoring Incentives and Bank Earnings Opacity

This is the author accepted manuscript. The final version is available from Cambridge University Press via the DOI in this recordWe exploit exogenous legislative changes that alter the priority structure of different classes of debt to study how debtholder monitoring incentives affect bank earnings opacity. We present novel evidence that exposing nondepositors to greater losses in bankruptcy reduces bank earnings opacity, especially for banks with larger shares of nondeposit funding, listed banks, and independent banks. The reduction in earnings opacity is driven by a lower propensity to overstate earnings and becomes larger during crises, when the incentive to conceal capital shortfalls is stronger. Our findings highlight the importance of creditors’ monitoring incentives in improving the quality of information disclosure

Bank liquidity creation following regulatory interventions and capital support

We study the effects of regulatory interventions and capital support (bailouts) on banks’ liquidity creation. We rely on instrumental variables to deal with possible endogeneity concerns. Our key findings, which are based on a unique supervisory German dataset, are that regulatory interventions robustly trigger decreases in liquidity creation, while capital support does not affect liquidity creation. Additional results include the effects of these actions on different components of liquidity creation, lending, and risk taking. Our findings provide new and important insights into the debates about the design of regulatory interventions and bailouts

Identifying "problem banks" in the German co-operative and savings bank sector: an econometric analysis

This paper provides the first econometric analysis of problem banks in Germany. Drawing on an original dataset of distressed co-operative and savings banks, we develop early warning indicators for banking difficulties using a parametric approach. Taking the idiosyncratic characteristics of the German banking sector into account and controlling for microeconomic variables, we evaluate as to whether bank type and location matter. Findings indicate that banks in West Germany are less risky than credit institutions in the Neue Länder and that co-operatives are more prone to experience financial difficulties than savings banks. We conclude that a model that combines both savings and co-operative banks is sufficient to identify problem institutions up to three years prior to the surfacing of distress