THE RESOLUTION OF BANKING CRISES AND MARKET DISCIPLINE: INTERNATIONAL EVIDENCE

1. THE RESOLUTION OF BANKING CRISES AND MARKET DISCIPLINE: INTERNATIONAL EVIDENCE Elena Cubillas Martín Ana Rosa Fonseca Francisco González University of Oviedo

2. OBJECTIVE BANKING CRISES MARKET DISCIPLINE BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES INSTITUTIONAL QUALITY

3. MOTIVATION AND CONTRIBUTION • MARKET DISCIPLINE • Basel II (Pillar 3)  a tooltoincreasebankstability • Literature  Solidevidenceonthepresence of market discipline • Market discipline acrosscountries: • Sironi, 2003 (JMCB) • Demirgüç-Kunt and Huizinga, 2004 (JME) • Nier and Baumann, 2006 (JFI) • Fonseca and González, 2010 (JBF) • DO NOT analyzewhether… • MARKET DISCIPLINE changes AFTER A BANKING CRISIS

4. MOTIVATION AND CONTRIBUTION • MARKET DISCIPLINE AFTER BANKING CRISES ?? • Especially interesting because of the recent financial crisis • Two possible effects: • crisis  depositors more aware of the risk of losing deposits  moreMD • crisis  depositors protected by cause of government interventions  lessMD • Martinez Peria and Schmukler, 2001 (JF) Argentina Chile Mexico CRISES  MARKET DISCIPLINE

5. MOTIVATION AND CONTRIBUTION • International empirical evidence • Bank-level data • Regulation, Supervision and Institutions • Crises Management Policies more banking crises (101) more countries (87) Control unobservedbank, country and timespecificeffects • CountrieswhereRegulation, Supervision, Institutions: • favor MD  largerimpact of BC on MD • not favor MD  no significantimpact of BC on MD Intensifythenegativeeffect of BC on MD Weakenthepositiveeffect of BC on MD

6. Pre-crisis [t1, t-1] 0 Crisis [t, t+2] Post-crisis [t+3, T] 1 Pre-crisis [t1, ta-1] 0 Crisis [ta, tb+2] Post-crisis [tb+3, T] 1 [Kroszner et al., 2007 (JFE)] [Dell’Ariccia et al., 2008 (JFI)] DATA AND METHODOLOGY Costdep (Depgrowth) i, j, t = β0 +β1Risk i, j, t -1 +β2 (Riski, j, t -1 x Crisis j, T ) + + β3 Bank i, j, t –1 + β4 Macro j, t + β5 ∑ Country j + β6 ∑ Time t + ѵ i + εi, j, t 87 2007 j=1 t=1989 • Dependent Variables: • COSTDEP and DEPGROWTH[Demirgüç-Kunt and Huizinga, 2004 (JME)] • Bank Risk: • EQUITY, LIQUIDITY and PROFIT [Demirgüç-Kunt and Huizinga, 2004 (JME)] • Crisis: ONE CRISIS MULTIPLE CRISES • Bank-level controls: • ASSET SIZE and OVERHEAD[Demirgüç-Kunt and Huizinga, 2004 (JME)] 101 banking crises 1989 – 2007 3,254 banks 87 countries • Macro controls: • INFLATION, real GDPpc growth and real GNPpc[Demirgüç-Kunt and Huizinga, 2004 (JME)]

7. DATA AND METHODOLOGY • Standard panel data approach (fixed and random effects) • Bank-specific effects • Country-specific effects • - Time-specific effects • Bank variables included with a lag (t -1) [Martinez Peria and Schmukler, 2001 (JF)] [Demirgüç-Kunt and Huizinga, 2004 (JME)]

8. RESULTS

9. RESULTS

10. DATA AND METHODOLOGY Costdep (Depgrowth) i, j, t = β0 + β1Risk i, j, t -1 +β2 (Riski, j, t -1 x Crisis j, T ) + + β3 (Riski, j, t -1 x Crisis j, T x Regintj, t ) + + β4 Bank i, j, t -1 + β5 Macro j, t + β6 ∑ Country j + β7 ∑ Time t + ѵ i + εi, j, t ENTRY and FOREIGN ENTRY OFFICIAL and MONITOR STATE and PRIVATE [Barth et al., 2004 (JFI)] TOTAL INTERVENTIONS = Blanket Guarantee + Liquidity Support + Forbearance + Recapitalization + Nationalization RESOLUTION INTERVENTIONS = Forbearance + Recapitalization + Nationalization FORBEARANCE RECAPITALIZATION NATIONALIZATION [Laeven and Valencia, 2008] 87 2007 j=1 t=1989 • Bank Regulation and Supervision: • Institutional quality: • FREEDOM (“Index of Economic Freedom” from the Heritage Foundation) • LAW (“Rule of law” indicator from the International Country Risk Guide) • The crisis management policies: Control ENDOGENEITY usingtheinstrumentsdefinedby[Barth et al., 2004]: - Legal origin - Latitude - Religion Containment Resolution

11. RESULTS

12. RESULTS

13. RESULTS

14. RESULTS

15. CONCLUSIONS BANKING CRISES MARKET DISCIPLINE BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES INSTITUTIONAL QUALITY

16. CONCLUSIONS BANKING CRISES MARKET DISCIPLINE • Banking crises WEAKEN market discipline BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES INSTITUTIONAL QUALITY

17. CONCLUSIONS BANKING CRISES MARKET DISCIPLINE • Banking crises WEAKEN market discipline • The REDUCTION VARIES across countries: • LARGER in environments in which regulation and institutionsenhanced MD before BC: BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES INSTITUTIONAL QUALITY LESS STRINGENT FOREIGN ENTRY RESTRICTIONS LOWER OFFICIAL SUPERVISORY POWER MORE ACCOUNTANT AND AUDIT REQUIREMENTS MORE PRIVATE OWNERSHIP OF BANKS BETTER-QUALITY INSTITUTIONS

18. CONCLUSIONS BANKING CRISES MARKET DISCIPLINE • Banking crises WEAKEN market discipline • The REDUCTION VARIES across countries: • LARGER in environments in which regulation and institutionsenhanced MD before BC: • POSITIVELY related to the policies applied to resolve the crisis BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES INSTITUTIONAL QUALITY LESS STRINGENT FOREIGN ENTRY RESTRICTIONS LOWER OFFICIAL SUPERVISORY POWER MORE ACCOUNTANT AND AUDIT REQUIREMENTS MORE PRIVATE OWNERSHIP OF BANKS BETTER-QUALITY INSTITUTIONS FORBEARANCE RECAPITALIZATIONS

19. CONCLUSIONS BANKING CRISES MARKET DISCIPLINE • Banking crises WEAKEN market discipline • The REDUCTION VARIES across countries: • LARGER in environments in which regulation and institutionsenhanced MD before BC: • POSITIVELY related to the policies applied to resolve the crisis • POLICY IMPLICATIONS BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES INSTITUTIONAL QUALITY LESS STRINGENT FOREIGN ENTRY RESTRICTIONS LOWER OFFICIAL SUPERVISORY POWER MORE ACCOUNTANT AND AUDIT REQUIREMENTS MORE PRIVATE OWNERSHIP OF BANKS BETTER-QUALITY INSTITUTIONS FORBEARANCE RECAPITALIZATIONS MARKET DISCIPLINE… effective after financial crises???

20. THE RESOLUTION OF BANKING CRISES AND MARKET DISCIPLINE: INTERNATIONAL EVIDENCE Elena Cubillas Martín Ana Rosa Fonseca Francisco González University of Oviedo