Banks and the Global Credit Crisis

The following post comes to us from Andrea Beltratti, Professor of Finance at the Università Bocconi, and René Stulz, Professor of Finance at Ohio State University.

In our paper, The Credit Crisis Around the Globe: Why Did Some Banks Perform Better?, forthcoming in the Journal of Financial Economics, we investigate the determinants of the relative stock return performance of large banks across the world during the period from the beginning of July 2007 to the end of December 2008. Our study does not focus on why the crisis happened. Rather, it is an investigation of the validity of various hypotheses advanced in the literature and the press as to why banks performed so poorly during the crisis.

Analyses of the crisis that emphasize the fragility of banks financed with short-term funds raised in the money markets are strongly supported by our empirical work, as are analyses that emphasize the role of bank capital. We find that large banks with more Tier 1 capital, more deposits, and less funding fragility performed better. Banks from countries with current account surpluses fared significantly better during the crisis, while banks from countries with banking systems more exposed to the U.S. fared worse. These latter results show that macroeconomic imbalances and the traditional asset contagion channel are related to bank performance during the crisis.

We find no support for analyses that attribute an important role to governance in the crisis since banks with more shareholder-friendly boards, which are banks that conventional wisdom would have considered to be better governed, generally fared worse during the crisis. Either conventional wisdom is wrong or this evidence is consistent with the view that banks that took more risks rewarded by the market before the crisis suffered more during the crisis when these risks led to unexpectedly large losses. Evidence supportive of the latter interpretation is that the performance of large banks during the crisis is negatively related to their performance in 2006. In other words, the banks that the market rewarded with large stock returns in 2006 are the banks whose stock suffered the largest losses during the crisis.

There is no systematic evidence that stronger regulation led to better performance of banks during the crisis. However, we do find evidence that banks from countries that imposed more restrictions on banks in 2006 fared better during the crisis. Since there is no evidence that these banks had less risk ex ante, it is possible that banks with more restrictions on their activities had higher returns because they did not have the opportunity to diversify into activities that unexpectedly performed poorly during the crisis. Though the existence of a formal deposit insurance scheme is associated with more idiosyncratic risk before the crisis, banks benefitting from such a scheme did not perform worse during the crisis. The regulatory indices are measures of formal rights and duties of regulators and banks, but activist regulators may have affected risk-taking by banks quite differently from passive regulators even when these different regulators had the same rights. Further research should attempt to construct indices that reflect the stance of the regulators.

The full paper is available for download here.

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