Designing an effective deposit insurance structure: an international perspective

Deposit insurance

Assessing the impact of regulation on bank cost efficiency

The author finds that the bank production process was significantly distorted during a period typically associated with heavy industry regulation. As deregulation occurred, banks fully exploited the cost advantages associated with size and reaped significant gains from technological change. Efficiency significantly improved with deregulation.Banks and banking - Costs ; Bank supervision

Local market consolidation and bank productive efficiency

The recent banking literature has evaluated the impact of mergers on the efficiency of the merging parties [e.g., Rhoades (1993), Shaffer (1993), Fixler and Zieschang (1993)]. Similarly, there has been analysis of the impact of eliminating bank entry restrictions on the average performance of banks [Jayaratne and Strahan (1998)]. The evidence suggests that acquiring banks are typically more efficient than are acquired banks, resulting in the potential for the new combined organization to be more efficient and, therefore, for the merger to be welfare enhancing. The evidence also suggests, however, that these potential gains are often not realized. This has led some to question the benefits resulting from the recent increase in bank merger activity. We take a somewhat more comprehensive and micro-oriented approach and evaluate the impact of actual and potential competition resulting from market-entry mergers and reductions in entry barriers on bank efficiency. In particular, in addition to the efficiency gains realized by the parties involved in a bank merger, economic theory argues that additional efficiency gains should result from the impact of the merger on the degree of local market competition. We therefore examine the impact of increased competition resulting from mergers and acquisitions on the productive efficiency of incumbent banks. Our findings are consistent with economic theory: as competition increases as a result of entry or the creation of a more viable local competitor, the incumbent banks respond by increasing their level of cost efficiency. We find this efficiency increase to be in addition to any efficiency gains resulting from increases in potential competition occurring with the initial elimination of certain entry barriers. Thus, consistent with economic theory, new entrants and reductions in entry barriers lead incumbent firms to increase their productive efficiency to enable them to be viable in the more competitive environment. Studies evaluating the impact of bank mergers on the efficiency of the combining parties alone may be overlooking the most significant welfare enhancing aspect of merger activity. We do not find evidence of profit efficiency gains. In fact, the mergers are associated with decreases in profit efficiency; perhaps indicating that revenues may also be competed away from incumbents as a result of mergers.Bank mergers

The potential role of subordinated debt programs in enhancing market discipline in banking

Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. This finding satisfies a necessary condition for regulatory proposals which would mandate increased reliance on sub-debt in the bank capital structure to discipline banks’ risk taking. Such proposals, however, have not been implemented, partially because there are still concerns about the quality of the signal generated in current debt markets. We argue that previous studies evaluating the potential usefulness of sub-debt proposals have evaluated spreads in an environment that is very different from the one that will characterize a fully implemented sub-debt program. With a fully implemented program, the market will become deeper, issuance will be more frequent, debt will be viewed as a more viable means to raise capital, bond dealers will be less reluctant to publicly disclose more details on debt transactions, and generally, the market will be more closely followed. As a test to see how the quality of the signal may change, we evaluate the risk-spread relationship, accounting for the enhanced market transparency surrounding new debt issues. Our empirical results indicate a superior risk-spread relationship surrounding the period of new debt issuance due, we posit, to greater liquidity and transparency. Our results overall suggest that the degree of market discipline would likely be enhanced by a mandatory sub-debt program requiring banks to regularly approach the market to issue sub-debt.Bank capital

Subordinated debt as bank capital: a proposal for regulatory reform

Industry observes have proposed increasing the role of subordinated debt in bank capital requirements as a means to increase market discipline. A recent Federal Reserve System Task Force evaluated the characteristics of such proposals. Here, the authors take the next step and offer a specific sub-debt proposal. They describe how it would operate and what changes it would require in the regulatory framework.Bank capital ; Debt ; Bank supervision

The mixing of banking and commerce: a conference summary

Acquisitions of industrial loan corporations by commercial firms have renewed the debate over the separation between banking and commerce in the U.S. On May 16–18, 2007, policymakers and academics weighed in on this debate during the Chicago Fed’s 43rd annual Conference on Bank Structure and Competition, titled The Mixing of Banking and Commerce.Banks and banking ; Banks and banking, American

Measures of the riskiness of banking organizations: Subordinated debt yields, risk-based capital, and examination ratings

Recently there have been a number of recommendations to increase the role of subordinated debt (SND) in satisfying bank capital requirements as a preferred means to discipline the risk-taking behavior of systemically important banks. One such proposal recommended using SND yield spreads as the triggers for mandatory supervisory action under prompt corrective action guidelines introduced in U.S. banking legislation in the early 1990s. Currently such action is prompted by bank capital ratios. Evidence from previous research suggests that yield information may be a better predictor of bank problems. This paper empirically analyzes potential costs and benefits of using SND signals to trigger prompt corrective action.Risk ; Debt ; Banks and banking ; Bank supervision ; Bank examination

Subordinated debt and prompt corrective regulatory action

Several recent studies have recommended greater reliance on subordinated debt as a tool to discipline bank risk taking. Some of these proposals recommend using subordinated debt yield spreads as additional triggers for supervisory discipline under prompt corrective action (PCA); action that is currently prompted by capital adequacy measures. This paper provides a theoretical model describing how use of a second market-measure of bank risk, in addition to the supervisors own internalized information, could improve bank discipline. We then empirically evaluate the implications of the model. The evidence suggests that subordinated debt spreads dominate the current capital measures used to trigger PCA and consideration should be given to using spreads to complement supervisory discipline. The evidence also suggests that spreads over corporate bonds may be preferred to using spreads over U.S. Treasuries. *The authors wish to thank Mark Flannery, Xavier Freixas, Ben Gup, Alan Hess, George Kaufman, Joe Haubrich, William Perraudin and Mark Vaughan for constructive comments and suggestions on earlier drafts. The authors also acknowledge the support of Nancy Andrews, Mark Murawski and George Simler in developing the database used in the study, and Andy Meyer, Alton Gilbert, and Mark Vaughan for graciously providing detailed information about their 'early warning model. The opinions expressed, however, are those of the authors and not necessarily those of the people mentioned above, the Federal Reserve Bank of Chicago, Federal Reserve Bank of Atlanta or the Federal Reserve System.Debt ; Bank supervision

Payment systems--getting ready for the 21st century

Payment systems

Subordinated debt and prompt corrective regulatory action

Several recent studies have recommended greater reliance on subordinated debt as a tool to discipline bank risk taking. Some of these proposals recommend using subordinated debt yield spreads as additional triggers for supervisory discipline under prompt corrective action (PCA), action that is currently prompted by capital adequacy measures. This paper provides a theoretical model describing how use of a second market-measure of bank risk, in addition to the supervisors’ own internalized information, could improve bank discipline. The authors then empirically evaluate the implications of the model. The evidence suggests that subordinated debt spreads dominate the current capital measures used to trigger PCA and consideration should be given to using spreads to complement supervisory discipline. The evidence also suggests that spreads over corporate bonds may be preferred to using spreads over U.S. Treasuries.Bank supervision ; Debt