Which Banks Recover From A Banking Crisis?

1. Which Banks Recover From A Banking Crisis? Discussant: Emre Ergungor Federal Reserve Bank of Cleveland The views stated herein are my own and…

2. What is this Paper About? • The paper is a valuable contribution to our understanding of the process of bank recovery. • What are the key characteristics of banks that recover compared to those that don’t? • Distress and recovery are defined in terms of ROA. The paper is not about survival vs. failure. • How important are the macro and regional (exogenous) factors? • What are the good banking practices that help earnings recovery?

3. Findings • Important factors • The size of the initial profit drop • General business climate after the onset of the distress • The way the bank manages its portfolio while in distress

4. Discussion • Two main concerns • Loans to Firms = f (Recovery, …) • Are bankers who know they will recover treating their customers differently or is the way they treat their customers causing the recovery? • Recovery is endogenous • Why not estimate • Loans to Firms = f (Pr(Recovery), …) • Identification? • Do other lenders fill in the funding gap?

5. Discussion • Two main concerns • Control for bank characteristics • Capital as well as the size of loss relative to capital will affect the recovery probability as well as the lending policies • Size (correlated with the availability of alternative funding sources as well as the probability of TBTF) • Deposits/Total Assets

6. Discussion • Minor issues • Some control for the cause of the distress • Is it a macro-shock or bank-specific event?

7. Discussion • Window dressing and loss recognition Are the non-recovering banks the ones that delay the recognition of losses?

8. Discussion • The paper ignores the exiting banks • Non-recovery means non-recovery of earnings not failure or merger with a healthy institution • How should we interpret this claim? • “In cases where the share of high risk customers is substantial, the recovering banks show more of a propensity to tighten credit.” • Non-recovering banks with a substantial share of high-risk customers should have tightened credit • Most banks, which had a substantial share of high-risk customers and tightened credit, failed. • In other words, few banks tightened credit and survived but those that survived recovered quickly. • But not tightening increases the odd of survival

9. Discussion • “We would expect banks to give (their major clients) higher priority than a typical borrower. Hence, if anything the presumption would be that these customers are insulated from credit reductions. If this is correct, it suggests that any effects that we do find understate what might occur for the smaller more typical bank customers.” • Not necessarily so! • Major bank clients are liquidity borrowers. They want a stable, long-term source of liquidity. • If the lender is distressed, they will go elsewhere. This is not just a bank-cutting-the-loan-supply story. • Lower loan demand from major customers may free up resources for smaller borrowers.

10. Discussion • “On average recovering banks are 14.4 percent more likely to continue extending credit to their clients than the non-recovering banks.” • Is this really the bank’s choice or related to the availability of funds to the bank? • Assuming the market can anticipate which bank will recover soon