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Regulatory Reluctance and Bank Failures: Too Many to Fail?

This paper analyzes the evidence of regulatory reluctance in bank failures when the banking sector is weak. Using data from 21 emerging economies in the 1990s, the paper shows that governments are less likely to close banks if other banks in the country are also weak. The study uses a Cox proportional hazard model to examine the determinants of bank failures, controlling for bank-level characteristics, macroeconomic factors, and political factors. The paper offers a unique investigation into the factors influencing bank failures but suggests further research can be done to explore the underlying causes.

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Regulatory Reluctance and Bank Failures: Too Many to Fail?

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  1. Too Many to Fail? Evidence of Regulatory Reluctance in Bank Failures When the Banking Sector is WeakCraig Brown and Serdar Dinç Discussion by: Sole Martinez Peria World Bank JFI/World Bank Conference on Bank Regulation and Corporate Finance October 26, 2006

  2. What is this paper about? • Using data on bank failures among the 10 largest banks in 21 emerging economies in the 1990s, paper shows that governments are less likely to close banks (i.e., intervention is delayed) if other banks in the country are also weak (the “too many to fail” effect). • Data comes from Bankscope – focus is on 164 private banks. • Methodology – Cox proportional hazard model, where a positive coefficient indicates increasing likelihood of bank failure. • Results are robust to controlling for certain bank-level characteristics, macroeconomic, and political factors. • Interesting paper that offers a unique investigation of determinants of bank failures using bank-level data, but more can be done.

  3. Comments • Definition and identification of failures • Individual bank-level controls • Measures of systemic weakness • Size of the effect of systemic weakness on the likelihood of failure/intervention • Robustness/Extensions

  4. Definition of failure • Paper only considers government take-overs and license revocations. But, • How are mergers treated in the sample? • Mergers are included among three of the “exit” events: (a) bank is taken over or license revoked, (b) bank is acquired by another bank and balance sheet is not available, (c) bank survives as of December 2000. Is (b) seen as different from (a)? • E.g., what about mergers were a private bank is coerced and/or compensated by the government to acquire a troubled bank? • This was common practice following the Argentine Tequila crisis. • What about privatizations where government sells the bank because bank is in weak condition? • In the paper, banks that were privatized at some point during the sample are considered private throughout the sample. • How would recapitalization schemes enter into this concept of failure?

  5. Controlling for individual bank characteristics • Paper controls for banks’ total assets to GDP, capital ratio and the ratio of operating income to assets. • There are other potential bank-level factors that might affect likelihood of failure: • number of branches/clients? • stock performance? • liquidity mismatches? • bank indebtedness with other banks? • bank ownership? • exposure to exchange risk? government default?

  6. Measures of systemic weakness • Systemic weakness is measured by other banks’ capital and income ratios. • What about: • Liquidity measures • E.g., share of other banks liquid assets to liquid liabilities • Measures of exposure to systemic/macro shocks • E.g. currency mismatches or government debt holdings. • Instead of looking at balance sheet data and profit statements that sometimes do not reflect accurately the condition of a bank, why not control directly for the number of banks that failed in the recent past or that are currently under government control.

  7. Size of systemic weakness effect • Currently, the paper does not discuss the economic significance of the “too many to fail” effect. • Also, the size of this effect might depend on a number of additional factors: • Budget deficit • Coverage/funding of deposit insurance • % of domestic versus foreign-owned remaining banks • Concentration among remaining banks • The impact of these factors can be looked at independently or as interaction terms with the indicators of systemic weakness.

  8. Robustness checks and extensions • Is the “too many to fail” effect robust to using other duration models? • Does the “too many to fail” effect persist if we include more banks and countries? • It seems important to include more banks and countries because of small degrees of freedom. • Finally, as the authors suggest it would be useful to explore what is behind the “too many to fail effect” (e.g., informational spillovers, financial contagion through interbank market, incentive of politicians and regulators, etc.)

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