Discussion: International Evidence on Bank Funding Profiles and - - PowerPoint PPT Presentation

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Discussion: International Evidence on Bank Funding Profiles and Performance: Are Banks ”Overbanked”? Jose A. Lopez and Mark M. Spiegel Carolina Villegas-Sanchez

ESADE Business School

Amsterdam, June 2014

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Research Question: Is there a point beyond which individual banks rely too heavily on deposit funding? If so ... could greater reliance on longer-term funding be beneficial? Trade-off:

Deposits: stable source of funding but difficult to increase immediately. “Wholesale Funding”: Large amounts of funds are easier and faster to attract but at a higher risk (increased exposure to shocks originating in that market).

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Findings

Banks are less profitable the more they rely on standard bank funding sources (deposits). Negative spillovers from excess reliance on deposit funding in national systems. Bank profits increase when they hold a more liquid asset portfolio (cash). Therefore, measures of bank balance sheet liquidity risk (NSFR score) are not significant determinants of bank profitability (weighted average of liabilities to assets).

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Findings

Results are robust to:

Focusing on a sample of 100 largest banks in each country. Controlling for other bank and country level characteristics.

Interesting differences arise between:

Domestic and Foreign banks Over time relationship

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

What is the Relevant Explanatory Variable?

In the paper the key measure is the ratio of Deposits to Total Assets. The research question asks for some measure of the relation between deposits and “wholesale funding”:

Alternative measure I: ratio of Deposits to Total Liabilities (controlling for Total Liabilities) Alternative measure II: Loan-to-Deposit funding gap (indication of the need for wholesale funding)

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Are Profits the Only Relevant Outcome Variable?

Alternatively to deposits banks could fund operations with “wholesale funding” Recent research by the IMF (Global Financial Stability Report: Transition Challenges to Stability (2013)) shows that higher reliance on wholesale funding (a higher loan-to-deposit ratio) is linked to higher bank distress. Non-distress banks improved:

Funding structures

Increasing their capitalization ratios (equity-to-asset ratios) Lowering their debt ratios

Funding diversification:

Decreasing reliance on short-term debt (relative to total borrowing)

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Are Profits the Only Relevant Outcome Variable?

Measure of distress: The z-score which is a measure of the risk-adjusted ROA Defined as the equity-to-asset ratio plus return on assets (ROA), divided by the standard deviation of ROA. The higher the z-score, the more resilient the bank.

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

High Volatility of Loans

Dinger and Craig (2013) show evidence that US commercial banks facing more volatile loan demand tend to employ more wholesale liabilities rather than retail deposits. They argue that in environments with high volatile loan demand banks prefer to fund its assets by wholesale liabilities

wholesale liabilities typically have short-term maturities and are flexible to adjust deposits are an inflexible source of funding: retail customers’ inertia, switching costs, etc.

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Differences across countries

Differences for emerging and advanced economies. IMF research shows that larger banks in advanced economies rely more of wholesale funding. Japan and emerging markets rely more of deposits. Banks that face higher currency volatility, stronger regulatory framework and stricter disclosure requirements have less wholesale funding (these variables might correlate with profits as well)

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

The main finding is that higher deposits lead to lower profits but it might well be that low profit banks find it more difficult to access secondary markets.

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Access to “Wholesale Funding”

When banks are shut down from bond markets → increase competition for a limited pool of deposits → adjustment via prices (interest rate) which would explain the negative spillovers from other banks relying on deposits. Relevant for Euro area countries during the financial crisis when bank fundamentals played little role in access to “wholesale funding”.

Sovereign downgrades spill over to banks, worsening both their cost of and access to funding.

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Why is the Question Relevant?

A major issue during the crisis was caused by banks being unable to roll over short-term financing. The Basel Committee has introduced two new liquidity ratios for banks:

Liquidity Coverage Ratio (LCR): designed to strengthen the ability of banks to withstand adverse shocks. Requires banks to hold sufficient high quality liquid assets to meet a severe cash outflow for at least 30 days. Net Stable Funding Ratio (NSFR): structural measure intended to ensure that banks hold sufficient stable funding (capital and long-term debt instruments, retail deposits and more than one year maturity wholesale funding) to match their medium and long-term lending.

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Aim

Strengthen banks against adverse shocks Eliminate structural mismatches between assets and liabilities Encourage more stable sources of funding - medium and long-term rather than short-term options.

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Key issues for Banks

It will be costly for banks (probably reduced profitability) to adjust their balance sheets by:

holding more (relatively low yield) high quality liquid assets; raising more expensive retail deposits; raising additional medium and long-term wholesale funding; and reducing long-term lending

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding

Summary Comment I: Variables of Interest Comment II: Alternative Explanations Comment III: Main Policy Implication

Minor issues

Why not a panel? Data on short-term and long-term wholesale funding? Splitting samples (foreign-domestic) and not interacting. Before and after the crisis analysis

Carolina Villegas-Sanchez (ESADE) Discussion: International Evidence Bank Funding