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

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

MOTIVATION AND CONTRIBUTION  MARKET DISCIPLINE Basel II (Pillar 3)  a tool to increase bank stability Literature  Solid evidence on the presence of market discipline Market discipline across countries: - Sironi, 2003 (JMCB) - Demirgüç-Kunt and Huizinga, 2004 (JME) - Nier and Baumann, 2006 (JFI) - Fonseca and González, 2010 (JBF) DO NOT analyze whether… MARKET DISCIPLINE changes AFTER A BANKING CRISIS

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  more MD crisis  depositors protected by cause of government interventions  less MD Martinez Peria and Schmukler, 2001 (JF) CRISES  MARKET DISCIPLINE Argentina Chile Mexico

MOTIVATION AND CONTRIBUTION International empirical evidence Bank-level data Regulation, Supervision and Institutions Crises Management Policies Countries where Regulation, Supervision, Institutions: - favor MD  larger impact of BC on MD - not favor MD  no significant impact of BC on MD Countries where Regulation, Supervision, Institutions: - favor MD  larger impact of BC on MD - not favor MD  no significant impact of BC on MD Control unobserved bank, country and time specific effects more banking crises (101) more countries (87) more banking crises (101) more countries (87) Intensify the negative effect of BC on MD Weaken the positive effect of BC on MD Intensify the negative effect of BC on MD Weaken the positive effect of BC on MD

DATA AND METHODOLOGY  Dependent Variables: COSTDEP and DEPGROWTH [Demirgüç-Kunt and Huizinga, 2004 (JME)]  Bank Risk: EQUITY, LIQUIDITY and PROFIT [Demirgüç-Kunt and Huizinga, 2004 (JME)]  Crisis: Costdep (Depgrowth) i, j, t = β 0 + β 1 Risk i, j, t -1 + β 2 (Risk i, j, t -1 x Crisis j, T ) + + β 3 Bank i, j, t –1 + β 4 Macro j, t + β 5 ∑ Country j + β 6 ∑ Time t + ѵ i + ε i, j, t Costdep (Depgrowth) i, j, t = β 0 + β 1 Risk i, j, t -1 + β 2 (Risk i, j, t -1 x Crisis j, T ) + + β 3 Bank i, j, t –1 + β 4 Macro j, t + β 5 ∑ Country j + β 6 ∑ Time t + ѵ i + ε i, j, t 87 j=1t= Pre-crisis [t 1, t-1]  0 Crisis [t, t+2] Post-crisis [t+3, T]  1 Pre-crisis [t 1, t a -1]  0 Crisis [t a, t b +2] Post-crisis [t b +3, T]  1 [Kroszner et al., 2007 (JFE)] [Dell’Ariccia et al., 2008 (JFI)] ONE CRISIS MULTIPLE CRISES  Bank-level controls: ASSET SIZE and OVERHEAD [Demirgüç-Kunt and Huizinga, 2004 (JME)]  Macro controls: INFLATION, real GDPpc growth and real GNPpc [Demirgüç-Kunt and Huizinga, 2004 (JME)] 101 banking crises 1989 – ,254 banks 87 countries 101 banking crises 1989 – ,254 banks 87 countries

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)]

RESULTS

RESULTS

DATA AND METHODOLOGY  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: 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] Costdep (Depgrowth) i, j, t = β 0 + β 1 Risk i, j, t -1 + β 2 (Risk i, j, t -1 x Crisis j, T ) + + β 3 (Risk i, j, t -1 x Crisis j, T x Regint j, t ) + + β 4 Bank i, j, t -1 + β 5 Macro j, t + β 6 ∑ Country j + β 7 ∑ Time t + ѵ i + ε i, j, t Costdep (Depgrowth) i, j, t = β 0 + β 1 Risk i, j, t -1 + β 2 (Risk i, j, t -1 x Crisis j, T ) + + β 3 (Risk i, j, t -1 x Crisis j, T x Regint j, t ) + + β 4 Bank i, j, t -1 + β 5 Macro j, t + β 6 ∑ Country j + β 7 ∑ Time t + ѵ i + ε i, j, t 87 j= t=1989 Control ENDOGENEITY using the instruments defined by [Barth et al., 2004]: - Legal origin - Latitude - Religion ContainmentResolution

RESULTS

RESULTS

RESULTS

RESULTS

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

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

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

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

CONCLUSIONS Banking crises WEAKEN market discipline The REDUCTION VARIES across countries: - LARGER in environments in which regulation and institutions enhanced MD before BC: - POSITIVELY related to the policies applied to resolve the crisis POLICY IMPLICATIONS BANKING CRISES MARKET DISCIPLINE INSTITUTIONAL QUALITY BANK REGULATION AND SUPERVISION BANK REGULATION AND SUPERVISION CRISIS MANAGEMENT POLICIES 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??? MARKET DISCIPLINE… effective after financial crises???

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