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Efficiency of Market Discipline in the Interbank Market: The Case of Russia

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Efficiencyof Market Discipline in the Interbank Market: The Case of Russia

Irina Andrievskaya (Università degli Studi di Verona)

Maria Semenova (NRU HSE, Moscow)

April, 12th 2013

- Introduction and motivation
- Literature
- Model
- Data
- Results

The interbank loan market plays an important role in the efficient functioning of the whole financial system

- Distribution of liquidity among banks
- Increased linkages among banks
- Contagion effect
Loans provided in this market are uninsured

- Financial institutions should have incentives to monitor those they are lending to and punish them for excessive risk-taking
- Market discipline should reduce the threat of contagious closure of credit limits

- Contagion effect

Market discipline:

- A phenomenon when “financial markets provide signals that lead borrowers to behave in a manner consistent with their solvency” (Lane, 1993)
- Its significance is recognized in several policy initiatives (e.g. Basel II, Pillar 3) and is necessary for supporting macroprudential supervision
- Rochet and Tirole (1996) stress that the efficiency of peer monitoring (market discipline) substantially decreases if there is some government intervention such as state insurance of interbank claims or a too-big-to fail policy

Russian market for interbank loans is…

- …an important source of funds
- Average share of bank loans in total liabilities 9-10%
- May amount to 70%

- 1995, 1998, 2004, 2008
- Including credibility gap (“crisis of trust”)

According to the strategy of the banking sector development until 2015, the regulatory standards Basel II and Basel III are going to be fully adopted starting from 2019

Research questions:

- Is there market discipline in the Russian market for interbank loans?
- Is market discipline efficient in constraining the excessive risk-taking behavior of banks?

Existence of market discipline:

- Market of retail and corporate deposits: price discipline (Hannan, Hanweck, 1988), (Ellis, Flannery, 1992); quantity discipline (Jordan, 2000), (Goldberg, Hudgins, 1996); maturity shifts mechanism (Murata, Hori, 2006), (Semenova, 2007)
- Securities market: stock prices (Brewer, Lee, 1986), (Distinguin et al., 2006); debt prices (Ashcraft, 2008), (Goyal, 2005)
- Interbank market: (Furfine, 2001), (King, 2008), (Cocco et al., 2009), (Angelini et al., 2009)

Efficiency of market discipline (extent to which market discipline affects the risk-taking behaviour of banks)

- Market of retail and corporate deposits: efficiency is lower the more the government intervention is (Demirgüç-Kunt, Huizinga, 1999), (Billett et al., 1998), (Demirgüç-Kunt, Huizinga, 2004)
- Interbank market:
- Still limited research, controversial conclusions
- Major contributors: (Nier, Baumann, 2006) for 729 banks from 32 countries, (Dinger, von Hagen, 2009) for Central and Eastern Europe, (Liedorp et al., 2010) for Netherlands

Model 1: Existence of market discipline

- MDi,t (ld_mbkb) - market discipline variable - growth rate of loans received by a bank i from other banks in quarter t
- Heckman estimation procedure
- Not all banks participate in the market
- The growth rate of interbank borrowings is observed only for those that take part in this market (when borrowings are greater than zero)
- Zero values of the growth rate for banks, which do not enter the market, do not represent their corner solution
- The data are not censored at zero

Model 1: Existence of market discipline

- Sample selection problem and we have to account for the non-random nature of the sample. In this case OLS regression will produce inconsistent estimates of the coefficients Heckman sample selection model
- Main equation + participation equation
- Participation equation:
- Dependent variable: indicator of bank’s involvement in the interbank market (it is equal to 0 when a bank has no interbank borrowings, and to 1 when interbank borrowings are greater than 0)
- Independent variables: N1, the ratio of total loans over total assets, logarithm of total assets and interbank borrowings over total assets

Model 1: Existence of market discipline

- BFi,t-1 - vector of bank fundamentals with one quarter lag
- CAMEL
- C (h1) – regulatory bank capital over risk-weighted assets ratio - “N1”
- A (bl_loan) – NPL over total loans
- M (pe_profit) - personnel expenses over total revenues
- E (roa) – ROA
- L (h3) - short-term (liquid) assets over short-term liabilities ratio - “N3”

- Size (lnas) – logarithm of total assets

- CAMEL
- Ii, t-1 (mbkb_as)- share of loans received from other credit institutions in total liabilities of a bank i with one quarter lag
- Tt – dummy variables for each quarter

Model 2: Efficiency of market discipline

- Panel data model
- A choice among pooled OLS, fixed effect and random effect models is done based on a set of appropriate tests (the Hausman test, the Breusch-Pagan test and the test for differing group intercepts)

- yi,t includes indicators of bank’s capital level, credit, liquidity and overall bank risk in quarter t
- Capital level - capital adequacy ratio N1 (h1)
- Credit risk - ratio of NPL over total loans (bl_loan) and ratio of reserves over total assets (res_as)
- Liquidity risk - ratio of instant liquidity N2 (h2), ratio of current liquidity N3 (h3), ratio of long-term liquidity N4 (h4)
- Overall risk – ratio of risk-weighted assets over total assets (rwa_as)

Model 2: Efficiency of market discipline

- xit-1 – interbank variables with one quarter lag
- Ratio of total interbank borrowings over total assets (mbkb_as)
- Ratio of interbank foreign borrowings over total assets (fmbkb_as)

- zit-1 - bank-level control variables with one quarter lag
- Share of interest income in total revenues (in_rev)
- Share of total loans in total assets (tl_as)
- ROA (roa)
- Size (lnas)
- Growth rate of total assets (ld_lnas)

Data

- Mobile database (“Banks and Finance” Analytical System)
- Banks’ financial statements (CBR website)
- 665 banks (86% of total assets of the system)
- 1Q2004-2Q2011
- Panel is unbalanced
- Estimations are done for the period before the crisis (1Q2004-1Q2008), for the period afterwards (2Q2008-2Q2011) as well as for 1Q2010-2Q2011
- Is there any effect of the government intervention on market discipline?

Results: Existence of market discipline

Results: Existence of market discipline

- Whole period: market discipline exists
- Bank fundamentals are jointly significant at 1% confidence level
- Higher capital levels correspond to quicker growth of interbank borrowings
- Share of interbank borrowings in total assets is significant and has a negative sign
- Size of a bank - significant at 1% confidence level – positively influences the interbank borrowings’ growth rate
- too-big-to-fail policy?

Results: Existence of market discipline

- Before 1Q2008
- All bank fundamentals are significant at 1% confidence level
- The level of short-term liquidity and the size of a bank have a statistically significant positive effect on the growth rate of interbank borrowings
- The level of personnel expenses and the level of interbank borrowings have a statistically significant negative effect on the growth rate of interbank borrowings

- After 1Q2008
- The level of banks’ bad loans and the level of interbank borrowings have a statistically significant negative sign
- The level of short-term liquidity and the size of a bank have a statistically significant positive effect on the growth rate of interbank borrowings

- 1Q2010-2Q2011
- No evidence of the existence of market discipline

Results: Efficiency of market discipline

Results: Efficiency of market discipline

- Most efficient discipliners - foreign lenders
- Foreign interbank borrowings have a statistically significant effect on the level of banks’ capital (N1)
- Efficiency of market discipline decreases after 1Q2008
- Market discipline is inefficient during 1Q2010-2Q2011

- No effect on liquidity levels, credit and overall bank risk
- Results are robust if we consider top-30 banks and banks with positive interbank borrowings

Thank you for your attention!