Journal Sciences News
Transactions of the Royal Society of Tropical Medicine and Hygiene
February 2018
Measuring systemic risk across financial market infrastructures
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): Fuchun Li, Hector Perez-Saiz We measure systemic risk in the network of financial market infrastructures (FMIs) as the probability that two or more FMIs have a large credit risk exposure to a common FMI participant. We construct indicators of credit risk exposures in three main Canadian FMIs and use multivariate extreme value methods to estimate this probability. We find large differences in the levels of systemic risk across participants. Conditional on the participant being distressed, we re-estimate these probabilities and find that some participants create large exposures to FMIs, resulting in a larger level of systemic risk than the rest of the participants. Our results suggest that an appropriate oversight of FMIs may benefit from an in-depth system-wide analysis, which may have useful implications for the macroprudential regulation of the financial system.
February 2018
A contemporary survey of islamic banking literature
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): M. Kabir Hassan, Sirajo Aliyu This article reviews empirical studies on Islamic banking and concentrates on their main findings while highlighting future research directions. The earlier literature on Islamic banking built a foundation using normative judgment, descriptive analysis, theoretical development, and appraisal of country experiences. The paper discusses scholars’ concerns that have led to a paradigm shift in the system and highlight practitioners’ disquiet about recent practices. Subsequent research focuses on empirical investigations without extensive analytical and theoretical exploration in the area. Recent studies focus on the financial crisis, solvency, maqasid, disclosure and financial inclusion, and regulations. Even with the spillover effect on the Islamic banks after the crisis, a few pieces of evidence show that the system performs below its conventional counterpart. The paper discusses issues that are relevant to Islamic banking and identifies other avenues for future research.
February 2018
Reputational shocks and the information content of credit ratings
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): Mascia Bedendo, Lara Cathcart, Lina El-Jahel We investigate how shocks to the reputation of credit rating agencies and the subsequent introduction of stricter regulation affect investors’ reaction to rating signals. We focus on three major episodes of reputational distress: the Enron/WorldCom scandals, the subprime crisis and the lawsuit against Standard & Poor's. We document a stronger response of stock investors to downgrades in the aftermath of reputational shocks, which is not, however, accompanied by an improvement in rating quality. Our results are consistent with a scenario where, following evidence of misrating, market investors conclude that ratings are generally overstated and infer greater negative information from downgrades. The effect is stronger for the investment-grade segment, where rating errors have a wider reputational impact. The introduction of new regulatory measures such the SOX Act, the CRA Reform Act and the Dodd-Frank Act, seems instead to improve rating quality and soften investors’ response.
February 2018
Flexible and mandatory banking supervision
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): Alessandro De Chiara, Luca Livio, Jorge Ponce The implementation of tighter regulation and more powerful supervision may impose large social costs due to the strong reliance on supervisory information that requires direct assessment by a supervisor (i.e. Mandatory Supervision). We show that by introducing a Flexible Supervision contract, which is designed to be chosen by those banks that have incentives to capture the supervisor and allows them to bypass Mandatory Supervision, the most efficient regulation under asymmetric information may be implemented. Benevolent regulators should introduce Flexible Supervision regimes for the less risky, more capitalized and transparent banks in addition to the traditional Mandatory Supervision regime.
February 2018
To be bailed out or to be left to fail? A dynamic competing risks hazard analysis
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): Nikolaos I. Papanikolaou During the global financial crisis, a large number of banks worldwide either failed or received financial aid thus inflicting substantial losses on the system. We contribute to the early warning literature by constructing a dynamic competing risks hazard model that explores the joint determination of the probability of a distressed bank to face a licence withdrawal or to be bailed out. The underlying patterns of distress are analysed based on a broad range of bank-level and environmental factors. We find that institutions with inadequate capital, illiquid and risky assets, poor management, low levels of earnings and high sensitivity to market conditions have a higher probability to go bankrupt. Bailed out banks, on the other hand, face both capital and liquidity shortages, experience low earnings, and are highly exposed to market products; however, neither the managerial expertise, nor the quality of assets is relevant to the odds of bailout. We further document that large and complex banks are less likely to fail and more likely to be bailed out and also that authorities are more prone to provide support to a distressed bank, which is well-connected with politicians and political parties and less prone to let it go bankrupt. Importantly, our model outperforms the commonly used logit model in terms of forecasting power in all the in- and out-of-sample tests we conduct.
February 2018
Syndication, interconnectedness, and systemic risk
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): Jian Cai, Frederik Eidam, Anthony Saunders, Sascha Steffen Syndication increases the overlap of bank loan portfolios and makes them more vulnerable to contagious effects. We develop a novel measure of bank interconnectedness using syndicated corporate loan portfolios, overlap based on industry and region, and different weights such as equal weights, size and relationships. We find that interconnectedness is driven mainly by bank diversification, less by bank size or overall loan market size. Interconnectedness is positively correlated with different bank-level systemic risk measures including SRISK, DIP and CoVaR, and such a positive correlation mainly arises from an elevated effect of interconnectedness on systemic risk during recessions. Overall, our results highlight that institution-level risk reduction through diversification ignores the negative externalities of an interconnected financial system.
Available online 9 January 2018
The performance of European equity carve-outs
Publication date: February 2018
Source:Journal of Financial Stability, Volume 34 Author(s): Apostolos Dasilas, Stergios Leventis In this paper we examine the valuation effects of equity carve-outs in Europe. We demonstrate that equity carve-out announcements yield significant abnormal returns for the shareholders of parent firms. This positive market reaction is stronger in countries that better protect minority shareholder rights. However, a remarkable price reversal is detected in the aftermath of a carve-out transaction that lasts up to two years. In contrast, parent-firm operating performance improves as long as the disposal of subsidiary assets is proven to be an optimal corporate decision. Subsidiaries stemming from the restructuring transaction also experience an initial positive market reaction which then reverses to severe price losses within a few months of the first day of listing.
Available online 23 December 2017
Financial Stress and Equilibrium Dynamics in Term Interbank Funding Markets
Publication date: Available online 9 January 2018
Source:Journal of Financial Stability Author(s): Emre Yoldas, Zeynep Senyuz Interbank funding markets are central to the functioning of the financial system and the transmission of monetary policy. Libor-OIS spreads have been widely-used indicators of conditions in these markets. We construct models that incorporate the long-run equilibrium relationship between term Libor and OIS rates and their regime-dependent dynamics. We find strong evidence for three regimes in the interbank funding market that resemble different pricing of risk and equilibrium outcomes. We provide point and interval estimates for stress thresholds that may serve as benchmarks for policy makers and market participants in assessing funding conditions. We provide evidence of asymmetric adjustment of rates toward long-run equilibrium, and shed light on the role of different policy measures in the adjustment process.
Available online 11 December 2017
Measuring Sovereign Contagion in Europe
Publication date: Available online 23 December 2017
Source:Journal of Financial Stability Author(s): Massimiliano Caporin, Loriana Pelizzon, Francesco Ravazzolo, Roberto Rigobon This paper analyzes sovereign risk shift-contagion, i.e. positive and significant changes in the propagation mechanisms, using bond yield spreads for the major eurozone countries. By emphasizing the use of two econometric approaches based on quantile regressions (standard quantile regression and Bayesian quantile regression with heteroskedasticity) we find that the propagation of shocks in euro's bond yield spreads shows almost no presence of shift-contagion in the sample periods considered (2003-2006, Nov. 2008-Nov. 2011, Dec. 2011-Apr. 2013). Shock transmission is no different on days with big spread changes and small changes. This is the case even though a significant number of the countries in our sample have been extremely affected by their sovereign debt and fiscal situations. The risk spillover among these countries is not affected by the size or sign of the shock, implying that so far contagion has remained subdued. However, the US crisis, does generate a change in the intensity of the propagation of shocks in the eurozone between the 2003-2006 pre-crisis period and the Nov. 2008-Nov. 2011 post-Lehman one, but the coefficients actually go down, not up! All the increases in correlation we have witnessed over the last years come from larger shocks and the heteroskedasticity in the data, not from similar shocks propagated with higher intensity across Europe. These surprising, but robust, results emerge because this is the first paper, to our knowledge, in which a Bayesian quantile regression approach allowing for heteroskedasticity is used to measure contagion. This methodology is particularly well-suited to deal with nonlinear and unstable transmission mechanisms especially when asymmetric responses to sign and size are suspected.
December 2017
The systemic implications of bail-in: A multi-layered network approach
Publication date: Available online 11 December 2017
Source:Journal of Financial Stability Author(s): Anne-Caroline H
December 2017
Inside Front Cover - Editorial Board - Bottom Half
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33

December 2017
The effect of foreclosure laws on securitization: Evidence from U.S. states
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Kristoffer Milonas A mortgage that defaults is more likely to enter foreclosure rather than renegotiation if it has been securitized in the private non-agency market, according to previous research. We study whether this foreclosure-propensity affects lenders’ securitization decision ex-ante. Due to the higher foreclosure probability, the value of a mortgage should be more sensitive to foreclosure costs if it is securitized. Comparing loans made in the same metropolitan area but under different foreclosure laws, we find that lenders are less likely to securitize mortgages in states with higher foreclosure costs, as measured by laws requiring judicial foreclosure. Two additional results are consistent with the proposed channel. First, the effect increases for loans with higher expected default rates and disappears for mortgage-like loans not subject to these laws. Second, the effect of judicial requirements increases for loans with higher expected default rates, consistent with differences in loss given default driving the results. Borrowers in states without judicial requirements also get riskier loans.
December 2017
The value of bank capital buffers in maintaining financial system resilience
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Christina Bui, Harald Scheule, Eliza Wu There is a current controversy concerning the appropriate size of banks’ capital requirements, and the trade-off between the costs and benefits of implementing higher capital requirements. We quantify the size of capital buffers required to reduce system-wide losses using confidential regulatory data for Australian banks from 2002 to 2014 and annual public accounts from 1978 to 2014. We find that a moderate increase in bank capital buffers is sufficient to maintain financial system resilience, even after taking economic downturns into consideration. Furthermore, while banks benefit from paying a lower cost of debt when they have a higher capital buffer, lending volumes are lower indicating that credit supply may be hampered if bank capital levels are too high within a financial system.
December 2017
How does long-term finance affect economic volatility?
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Asli Demirg
December 2017
An international forensic perspective of the determinants of bank CDS spreads11We are grateful to participants at the 14th Finance Meeting of the Brazilian Finance Association, the 2014 Annual Meeting of the Association of Southern European Economic Theorists (ASSET) and the 2nd International Workshop on "Financial Markets and Nonlinear Dynamics" (FMND), seminars at the Ca' Foscari University of Venice and the IPAG Business School, the Editor, Iftekhar Hasan, and two anonymous reviewers for their constructive comments and suggestions that considerably improved this paper. Sousa acknowledges that this work was carried out within the funding with COMPETE reference n° POCI-01-0145-FEDER-006683, with the FCT/MEC's (Funda
December 2017
An overlapping generations model of taxpayer bailouts of banks
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Oz Shy, Rune Stenbacka The paper constructs an overlapping generations model to evaluate how different bank rescue plans affect banks’ risk-taking incentives. For a non-competitive banking industry, we find bailout with tax imposed on the old generation or equity bail-in to be efficient policies in the sense that they implement socially optimal risk-taking. In a competitive banking sector, no-bailout implements the socially-optimal risk-taking. Bailout policies financed by a tax imposed on the young generation always induce excessive risk-taking.
December 2017
Bank opacity and risk-taking: Evidence from analysts’ forecasts
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Samuel Fosu, Collins G. Ntim, William Coffie, Victor Murinde We depart from existing literature by invoking analysts’ forecasts to measure banking system opacity and then investigate the impact of such opacity on bank risk-taking, using a large panel of US bank holding companies, over the 1995–2013 period. We uncover three new results. Firstly, we find that opacity increases insolvency risks among banks. Secondly, we establish that the relationship between opacity and bank risk-taking is accentuated by the degree of banking market competition. Thirdly, we show that the bank business model moderates the risk-taking incentives of opaque banks, albeit only marginally. Overall, these findings suggest that the analysts forecast measure of bank opacity is useful for understanding risk-taking by publicly-traded banks, with important implications for bank stability.
December 2017
Heterogeneous market structure and systemic risk: Evidence from dual banking systems
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Pejman Abedifar, Paolo Giudici, Shatha Qamhieh Hashem This paper investigates how banking system stability is affected when we combine Islamic and conventional finance under the same roof. We compare systemic resilience of three types of banks in six GCC member countries with dual banking systems: fully-fledged Islamic banks (IB), purely conventional banks (CB) and conventional banks with Islamic windows (CBw). We employ market-based systemic risk measures such as MES, SRISK and CoVaR to identify which sector is more vulnerable to a systemic event. We also compute weighted average GES to determine which sector is most synchronised with the market. Moreover, we use graphical network models to determine the most interconnected banking sector that can more easily spread a systemic shock to the whole system. Using a sample of observations on 79 publicly traded banks operating over the 2005–2014 period, we find that CBw is the least resilient sector to a systemic event, it has the highest synchronicity with the market, and it is the most interconnected banking sector during crisis times.
December 2017
How vulnerable are international financial markets to terrorism? An empirical study based on terrorist incidents worldwide
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Sanjay Goel, Seth Cagle, Hany Shawky Each year, millions of dollars are reported lost due to terrorist attacks around the world. In this paper, we conduct a systematic examination of the impact of terrorist attacks on financial markets. We specifically explore the relationship between world stock market indices and large-scale terrorist incidents. We consider sixteen incidents outside the U.S. and thirty-three incidents in the U.S. We use several indices in our analysis, including the S&P 500, the 10-year US Treasury bond yield, gold prices, and several other domestic and international stock market indices. Given the physical asset losses and the psychological impact on citizens, our expectation was to see a strong correlation between terrorist incidents and financial market valuations. However, to our surprise, with the exception of the September 11, 2001 terrorist attacks, our results show that acts of terrorism do not have a significant or lasting economic effect on stock and bond market returns. Contrary to our starting hypothesis, we find no evidence of ‘flight to safety’ behavior in any of the markets.
December 2017
Interbank market failure and macro-prudential policies
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Luisa Corrado, Tobias Schuler This paper analyses the effects of several macro-prudential policy measures on the banking sector and its linkages to the macroeconomy. We employ a dynamic general equilibrium model with sticky prices, in which banks trade excess funds in the interbank lending market. We find that an increase in the liquidity requirement effectively reduces the impact of an interbank shock on the real and financial sector, while an increased capital requirement propagates only through nominal variables as inflation and interest rates. We conclude that stricter liquidity measures which limit inside money creation, dampen the severity of a breakdown in interbank lending. Targeting interbank financing directly through liquidity measures along with a moderate capital requirement generates lower welfare losses. We thereby provide a comprehensive rationale in favor of the regulatory measures in Basel III.
December 2017
International stock market leadership and its determinants
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Charlie X. Cai, Asma Mobarek, Qi Zhang We study time-varying price leadership between international stock markets using a Markov switching causality model. We demonstrate variations in the causality pattern over time, with the US being the dominant country in causing other markets. We examine the factors which determine a country’s role in the causal relationship. For country-specific factors, we show that trades openness increases price leadership. We also find that the lead–lag relationship between the stock markets is weaker during crisis periods, confirming the “wake-up call” hypothesis, with markets and investors focusing substantially more on idiosyncratic, country-specific characteristics during the crisis.
December 2017
Not all emerging markets are the same: A classification approach with correlation based networks
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Ahmet Sensoy, Kevser Ozturk, Erk Hacihasanoglu, Benjamin M. Tabak Using dynamic conditional correlations and network theory, this study brings a novel interdisciplinary framework to define the integration and segmentation of emerging countries. The individual EMBI+ spreads of 13 emerging countries from January 2003 to December 2013 are used to compare their interaction structure before (phase 1) and after (phase 2) the global financial crisis. Accordingly, the unweighted average of dynamic conditional correlations between cross country bond returns significantly increases in phase 2. At first glance, the increased co-movement degree suggests an integration of the sample countries after the crisis. However, using correlation based stable networks, we show that this is not enough to make such a strong conclusion. In particular, we reveal that the increased average correlation is more likely to be caused by clusters of countries that exhibit high within-cluster co-movement but not between-cluster co-movement. Potential reasons for the post-crisis segmentation and important implications for international investors and policymakers are discussed.
December 2017
Sovereign debt spreads in EMU: The time-varying role of fundamentals and market distrust
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Jordi Paniagua, Juan Sapena, Cecilio Tamarit This paper provides further analysis on the determinants of sovereign debt spreads for peripheral Eurozone countries since the start of EMU, paying special attention to episodes that characterized the global financial crisis aftermath starting in 2007. More specifically, the purpose of our research is to disentangle the role of fundamental variables and market perception about variations on risk in order to explain the evolution of sovereign spreads in EMU during the recent crisis. Our results, in line with previous literature, show the importance of three groups of observable variables, namely, changes in risk-aversion of creditors, fiscal indebtedness and liquidity variables. In addition, our model includes unobserved components that are estimated through the Kalman filter as time-varying deviation from fixed-mean parameters of spread determinants. This shows the importance of expectations (market sentiments), amplifying (or reducing) the relative importance of the spread determinants over time through the time-varying behavior of the parameters around their steady-state estimates.
December 2017
Evaluating the effectiveness of the new EU bank regulatory framework: A farewell to bail-out?
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Peter Benczur, Giuseppina Cannas, Jessica Cariboni, Francesca Di Girolamo, Sara Maccaferri, Marco Petracco Giudici In response to the economic and financial crisis, the EU has adopted a new regulatory framework of the banking sector. Its central elements consist of new capital requirements, the single rulebook, and rules for bank recovery and resolution. These legislations have been adopted to reduce the call for government bail-out of distressed banks in future crises. The present study performs a detailed quantitative assessment of the reduction in public finance costs brought about by the introduction of these rules. We use a microsimulation portfolio model, which implements the Basel risk assessment framework, to estimate the joint distribution of bank losses at EU level. The approach incorporates the complete safety-net set up in EU legislation to absorb these losses, explicitly modelling enhanced Basel III capital rules, the bail-in tool and the resolution funds. Using a near-full sample of commercial, cooperative and savings banks in the EU, we quantify the cumulative effects of this safety-net and the contribution of each individual tool to the total effect. Considering a crisis of a similar magnitude as the recent one, our results show that potential costs for public finances decrease from roughly 3.7% of EU GDP (before the introduction of any new tool) to 1.4% with bail-in, and finally to 0.5% when all the elements we model are in place. This latter amount is very close to our estimate of leftover resolution funds and the size of the Deposit Guarantee Scheme. This exercise extends the quantitative analyses performed by the European Commission in its Economic Review of the Financial Regulation Agenda by developing additional scenarios, crucial robustness checks, simulations for different annual data vintages, and by implementing some methodological improvements.
December 2017
Banking, financial markets, risk and financial vulnerability
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Emilios Galariotis, Giacomo Nocera, Fotios Pasiouras, Constantin Zopounidis
December 2017
Collateralization, leverage, and stressed expected loss
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Eric Jondeau, Amir Khalilzadeh We describe a general equilibrium model with a banking system in which the deposit bank collects deposits from households and the merchant bank provides funds to firms. The merchant bank borrows collateralized short-term funds from the deposit bank. In an economic downturn, as the value of collateral decreases, the merchant bank must sell assets on short notice, reinforcing the crisis, and defaults if its cash buffer is insufficient. The deposit bank suffers from losses because of the depreciated assets. If the value of the deposit bank's assets is insufficient to cover deposits, it also defaults. Deposits are insured by the government, with a premium paid by the deposit bank equal to its expected loss on the deposits. We define the bank's capital shortfall in the crisis as the expected loss on deposits under stress. We calibrate the model on the U.S. economy and show how this measure of stressed expected loss behaves for different calibrations of the model. A 40% decline of the securities market would induce a loss of 12.5% in the ex-ante value of deposits.
December 2017
The fall of Spanish cajas: Lessons of ownership and governance for banks
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Alfredo Mart
December 2017
Interest rate liberalization and capital adequacy in models of financial crises
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Ray Barrell, Dilruba Karim, Alexia Ventouri We characterize the effects of interest rate liberalization on OECD banking crises, controlling for the standard macro prudential variables that prevail in the current literature. We use the Fraser Institute’s Economic Freedom of the World database. We test for the direct impacts of interest rate liberalization on crisis probabilities and their indirect effects via capital adequacy. Over the period 1980–2012, we find that interest rate liberalization has a crises reducing effect, and it appears that the beneficial effects work by strengthening capital buffers. We also show that when controlling for liberalization, capital adequacy and liquidity, the main driver of financial crises is property price growth. Our results are invariant when we control for alternative sensitivity tests for robustness purposes.
December 2017
The concentration–stability controversy in banking: New evidence from the EU-25
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Pieter IJtsma, Laura Spierdijk, Sherrill Shaffer This study explores whether the concentration–stability relation is affected by the level of analysis; i.e., bank-level versus country-level stability. The diverging results in the literature suggest that we may indeed expect differences between the two levels. With the z-score as the measure of financial stability, our theoretical analysis confirms that we may find such differences. Yet our empirical analysis for the EU-25 during the 1998–2014 period finds no economically significant effect of concentration on either the bank-level or the country-level z-score. The finding that concentration hardly affects stability at both levels of analysis is an indication of robustness in the empirical concentration–stability relation not previously established in the literature. This finding further suggests that neither supervisory restructuring, nor normal market-driven mergers, are likely to be substantially harmful to financial stability.
December 2017
Determinants of risk in the banking sector during the European Financial Crisis
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Kyriaki Kosmidou, Dimitrios Kousenidis, Anestis Ladas, Christos Negkakis Risk assessment in the banking sector has been a prominent topic in the banking literature and has gained attention especially since the recent financial crises. In particular, the European crisis, which was the first since the formation of the Eurozone, underlined a number of significant problems and increased concerns on the tail or crash risk of banks. In the present study, we seek to examine whether information asymmetry, the importance of banks in the financial system and systemic risk play significant roles in the evolution of stock crashes in the banking sector. Information asymmetry is proxied by opacity, the importance of a bank in a financial network is proxied by network centrality, and systemic risk is proxied by clustering. The research framework considers a number of regulatory, reporting and financial market factors that have also been determined to relate to stock crashes and shows that all of the above factors are related to (idiosyncratic) stock crash risk under specific conditions.
December 2017
What drives the liquidity of sovereign bonds when markets are under stress? An assessment of the new Basel 3 rules on bank liquid assets
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Giovanni Petrella, Andrea Resti The new rules on bank liquidity set by the Basel Committee require banks to hold high-quality liquid assets (HQLAs) against future cash outflows in periods of market stress. Domestic government bonds are considered to be HQLAs. To assess the appropriateness of this rule, we investigate the liquidity of European government bonds in ordinary times and in periods of market turmoil. We find that the effect of adverse market conditions on liquidity strongly depends on individual bond’s characteristics. Our evidence argues for rules on HQLAs that should constrain the eligibility of government bonds depending on their characteristics (primarily, duration and rating).
December 2017
Sovereign collateral as a Trojan Horse: Why do we need an LCR+
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Christian Buschmann, Christian Schmaltz Sovereign bonds are widely used as collateral in banks’ funding and trading operations. If a sovereign becomes distressed, the collateral mechanism impairs and banks are suddenly facing significant liquidity calls. Basel III's Liquidity Coverage Ratio (LCR) protects banks against unexpected liquidity calls, but currently excludes sovereign distress. Thus, all banks fulfilling the LCR are still exposed to a liquidity risk stemming from distressed sovereign debt and materializing through the collateral channel. Our paper shows that this unaddressed risk can translate into a system-wide liquidity shock. To gauge the potential damage caused by such a shock, we develop a model based on banks’ home sovereign exposures and a bundle of simplifying assumptions in which sovereign distress triggers bank distress. Our model describes how deteriorating sovereign collateral can lead to an overall liquidity squeeze and non-compliance with Basel III liquidity standards. As this risk is too material to be neglected, we propose an alternative version of the LCR, LCR+, which includes the liquidity impact of sovereign distress.
December 2017
Bank regulatory arbitrage via risk weighted assets dispersion
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Giovanni Ferri, Valerio Pesic Increased dispersion of Risk Weighted Assets (RWA) troubles regulators as potentially undermining prudential supervision. We study the determinants of RWA/EAD (Exposure-At-Default) on data painstakingly compiled from Basel Pillar-Three for 239 European banks over 2007–2013. We improve on most previous studies, which consider instead RWA/TA (Total Assets). Indeed, Internal-Rating-Based (IRB) models allow lawful capital-saving Roll-Out effects which RWA/TA analyses disregard and likely misidentify as regulatory arbitrage. Instead, encapsulating Roll-Out effects, RWA/EAD avoids false positive identification. We find that regulatory arbitrage: (i) was present; (ii) likely materialized via risk weights manipulation with IRB models; (iii) was stronger at Advanced-IRB vs Foundation-IRB banks.
December 2017
Network centrality and funding rates in the e-MID interbank market
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Asena Temizsoy, Giulia Iori, Gabriel Montes-Rojas This paper empirically investigates the role of banks’ network centrality in the interbank market on their funding rates. Specifically we analyze transaction data from the e-MID market, the only electronic interbank market in the Euro Area and US, over the period 2006–2009 that encompasses the global financial crisis. We show that interbank spreads are significantly affected by both local and global measures of connectedness. The effects of network centrality increased as the financial crisis evolved. Local measures show that having more links increases borrowing costs for borrowers and reduces premia for lenders. For global network centrality, borrowers receive a significant discount if they increase their intermediation activity and become more central, while lenders pay in general a premium (i.e. receive lower rates) for centrality. This provides evidence of the ‘too-interconnected-to-fail’ hypothesis.
Available online 10 November 2017
Wealth and risk implications of the Dodd-Frank Act on the U.S. financial intermediaries
Publication date: December 2017
Source:Journal of Financial Stability, Volume 33 Author(s): Kostas Andriosopoulos, Ka Kei Chan, Panagiotis Dontis-Charitos, Sotiris K. Staikouras We contribute to the current regulatory debate by examining the wealth and risk effects of the Dodd-Frank Act on U.S. financial institutions. We measure the effects of key legislative events of the Act by means of a multivariate regression model using the seemingly unrelated regression (SUR) framework. Our results indicate a mixed reaction by financial institutions during the various stages of the Act’s legislative process. Further tests reveal that any positive reactions are driven by small and/or low risk institutions, while negative ones are consistent across subsets; except for investment banks. We also find market risk increases for most financial institutions that are dominated by small and/or low risk firms. The cross-section results reveal that large institutions fare better than their smaller counterparts and that large investment banks gain value at the expense of others. Overall, the Dodd-Frank Act may have redistributed value among financial institutions, while not necessarily reducing the industry’s riskiness.
Available online 4 November 2017
Network Models, Stress Testing, and other tools for Financial Stability Monitoring and Macroprudential Policy Design and Implementation
Publication date: Available online 10 November 2017
Source:Journal of Financial Stability Author(s): Manuel Ramos-Francia
Available online 3 November 2017
Fiscal policy with banks and financial frictions
Publication date: Available online 4 November 2017
Source:Journal of Financial Stability Author(s): Panagiotis Asimakopoulos, Stylianos Asimakopoulos We assess the role of banks to the transmission of optimal and exogenous changes in fiscal policy to the economy. We built-up a dynamic stochastic general equilibrium model with patient and impatient agents, banks and a government to find that banks and their associated capital-adequacy constraint mitigate the negative spill-over effects to the economy from higher taxes. Specifically, we confirm that labour income tax is the most distortionary fiscal instrument. The optimal choice of a housing tax is the most favorable funding source to a temporary increase in public spending. The combination of housing and labour taxes is the most preferred tax bundle to be optimally chosen under negative output shocks. Moreover, a permanent increase in housing tax is beneficial if it is welfare enhancing and the existence of banks benefits mainly impatient households under permanently higher consumption taxes. Finally, these results remain robust to various robustness checks.
Available online 31 October 2017
Central banks’ preferences and banking sector vulnerability
Publication date: Available online 3 November 2017
Source:Journal of Financial Stability Author(s): G. Levieuge, Y. Lucotte, F. Pradines-Jobet According to “Schwartz's conventional wisdom” and what has been called “divine coincidence”, price stability should imply macroeconomic and financial stability. However, in light of the global financial crisis, with monetary policy focused on price stability, scholars have held that banking and financial risks were largely unaddressed. According to this alternative view, the belief in divine coincidence turns out to be benign neglect. The objective of this paper is to test Schwartz's hypothesis against the benign neglect hypothesis. The priority assigned to the inflation goal is proxied by the central banks’ conservatism (CBC) index proposed by Levieuge and Lucotte (2014), here extended to a large sample of 73 countries from 1980 to 2012. Banking sector vulnerability is measured by six alternative indicators that are frequently employed in the literature on early warning systems. Our results indicate that differences in monetary policy preferences robustly explain cross-country differences in banking vulnerability and validate the benign neglect hypothesis, in that a higher level of CBC implies a more vulnerable banking sector.
Available online 16 October 2017
How sensitive is corporate debt to swings in commodity prices?
Publication date: Available online 31 October 2017
Source:Journal of Financial Stability Author(s): Pablo Donders, Mauricio Jara, Rodrigo Wagner Commodity producing corporations have trillions of dollars in outstanding debt. Thus, the recent fall in commodity prices raised concerns about sustainability and systemic risks. Using a global sample (2003- 2015) we measure how corporate bonds react to the underlying commodity price. On average a 10% change in the commodity moves yields-to-maturity by only 15 basis points. This is just a tenth of the sensitivity of stocks returns. Nonetheless, bond sensitivity to commodities is significantly stronger for smaller, leveraged and less profitable firms. Also for short maturity bonds. The type of commodity price change matters too. Sensitivity to price drops is at least five times stronger than to increases. Transitory price changes matter for shorter maturities and leveraged firms. In contrast, longer maturities react more to permanent commodity variations. When firms use hedging derivatives, bonds are less sensitive to all price variations. Hedging mitigates the amplification of commodity shocks, as in Shiller (2008). In conclusion, while debt finance deteriorated with the commodity bust, it hardly dried-up.
October 2017
Creditor rights and the market power-stability relationship in banking
Publication date: Available online 16 October 2017
Source:Journal of Financial Stability Author(s): Swarnava (Sonny) Biswas I use the staggered passage of creditor rights reforms in 13 countries to examine how changes in creditor rights affect (a) bank stability and (b) the bank market power-stability relationship. (a) There is statistically weak evidence that stronger creditor rights enhance bank stability; the result is not robust across specifications. (b) Market power positively affects stability. However, there is asymmetry in the effect of market power on stability, depending on whether there is an increase or a decrease in creditor rights. The market power-stability relationship is stronger when a country weakens its creditor rights vis-
October 2017
Inside Front Cover - Editorial Board - Bottom Half
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32

October 2017
Monetary policy and macroprudential policy: Rivals or teammates?
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Simona Malovan
October 2017
Style investing and firm innovation
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Koray Sayili, Gokhan Yilmaz, Douglas Dyer, A. Melih K
October 2017
Dating systemic financial stress episodes in the EU countries
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Thibaut Duprey, Benjamin Klaus, Tuomas Peltonen This paper introduces a new methodology to date systemic financial stress events in a transparent, objective and reproducible way. The financial cycle is captured by a monthly Country-Level Index of Financial Stress (CLIFS). Based on two Markov-switching and one threshold vector autoregressive model, information from the CLIFS and industrial production are combined to identify those episodes of financial market stress that are associated with a substantial negative impact on the real economy. By applying this framework to 27 European Union countries, the paper is a first attempt to provide a chronology of systemic financial stress episodes as a complement to the expert-detected events that are currently available.
October 2017
Bank political connections and performance in China
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Chi-Hsiou D. Hung, Yuxiang Jiang, Frank Hong Liu, Hong Tu, Senyu Wang We examine the effects of bank’s political connection on bank performance and risk in China. We use hand-collected information on CEOs’ professional background to identify their political affiliations, and find that banks whose CEOs have former government experiences have higher return on assets, lower default risk, and lower credit risk. Additionally, politically connected banks have disproportionally higher performance when the CEOs previous worked in the same city where the current bank’s headquarter locates, had past banking experiences, spend more on entertainment and travel costs, and have higher previous administrative rankings (e.g., at the provincial or state level). These results suggest that politically connected banks have better access to lending to politically connected firms, which are high yield assets and more likely to be bailed out when in distress. Our results offer a mechanism of political rent seeking, consistent with the institutional environment of China’s banking and political system.
October 2017
Systemic risk: A new trade-off for monetary policy?
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Stefan Las
October 2017
Stress tests and asset quality reviews of banks: A policy announcement tool
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Valter Lazzari, Luigi Vena, Andrea Venegoni It is common in the supervision of banks to perform and disclose a simultaneous standardized assessment of their asset quality, organizational effectiveness, strategic viability and resilience to financial turmoil. By investigating the European Central Bank 2014 Comprehensive Assessment and the stock reactions of the banks to its findings, we find that this process provides limited assistance to the market in sorting good from troubled banks. Notwithstanding, the market adjusts to these findings, since it understands that they signal the stance of supervisory policy toward banking activities, which begets the level of regulatory risk and cost for the supervised banks.
October 2017
Social capital and bank stability
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Justin Yiqiang Jin, Kiridaran Kanagaretnam, Gerald J. Lobo, Robert Mathieu Using a sample of public and private banks, we study how social capital relates to bank stability. Social capital, which reflects the level of cooperative norms in society, is likely to reduce opportunistic behavior (Jha and Chen 2015; Hasan et al., 2017) and, therefore, act as an informal monitoring mechanism. Consistent with our expectations, we find that banks in high social capital regions experienced fewer failures and less financial trouble during the 2007–2010 financial crisis than banks in low social capital regions. In addition, we find that social capital was negatively associated with abnormal risk-taking and positively associated with accounting transparency and accounting conservatism in the pre-crisis period of 2000–2006, indicating that risk-taking, accounting transparency, and accounting conservatism are possible channels through which social capital affected bank stability during the crisis.
October 2017
Did the financial crisis affect the market valuation of large systemic U.S. banks?
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Georgios Bertsatos, Plutarchos Sakellaris, Mike G. Tsionas We examine the impact of the financial crisis on the stock market valuation of large and systemic U.S. bank holding companies (BHCs). Using the Bertsatos and Sakellaris (2016) model of fundamental valuation of bank equity, we provide evidence that the financial crisis has not altered investors’ attitudes towards bank characteristics. In particular, before, during, and after the crisis, investors in large and systemic U.S. BHCs seemed to penalize leverage, albeit temporarily. Both before and after the crisis, they reward size in the short run. This pattern is appearing only briefly during the crisis. We also show that bank opacity plays no role in market valuation either in the short run or in the long run. Last but not least, we find evidence that stress testing has been informative to the market and that those BHCs that failed at the post-crisis stress tests were not subsequently valued differently by the market.

The macroeconomic relevance of bank and nonbank credit: An exploration of U.S. data
Publication date: October 2017
Source:Journal of Financial Stability, Volume 32 Author(s): Alexander Herman, Deniz Igan, Juan Sol
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