Has the banking sector become
more vulnerable over time?
Deniz Anginer
Financial Economist, DECFP
Asli Demirguc-Kunt
Chief Economist FPD, Research Manager DECFP
May 2011
Dubrovnik Economic Conference
Deniz Anginer
Has the banking sector become more vulnerable over time?
Globalization
• The last two decades have seen a tremendous transformation in the
global financial sector driven by:
– Globalization
– Innovations in financial engineering and communications technology
– De-regulation
• These global trends have resulted in:
–
–
–
–
Increased productivity
Increased capital flows
Lower cost of borrowing
Price discovery and more opportunities for risk diversification
• Same trends have also resulted in increased concentration,
complexity, and exposure to common sources of risk
Deniz Anginer
Has the banking sector become more vulnerable over time?
Economic Convergence – KOF Index
Deniz Anginer
Has the banking sector become more vulnerable over time?
Political Convergence – KOF Index
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Has the banking sector become more vulnerable over time?
Social Convergence – KOF Index
Deniz Anginer
Has the banking sector become more vulnerable over time?
What do we do?
• We examine whether these global trends have lead to an
increase in banks’ exposure to common risk factors
• We construct a default risk measure for all publicly traded
banks using the Merton (1974) contingent claim model
– Create a weekly time series of default probabilities for over 2,000
banks in over 70 countries and examine the evolution of the
covariance structure of default risk of banks over time
• We also examine cross-country differences and link them
various measures of financial and economic openness
Deniz Anginer
Has the banking sector become more vulnerable over time?
What do we find?
• Systematic default risk has a significant global component in the
banking sector
• There has been a significant increase in default risk co-dependence
leading up to the 2007/2008 financial crisis
• The increase in co-dependence has been higher for North American
and European banks, as well as banks that are larger
• Developing countries which are more integrated, have liberalized
financial systems and weak banking supervision have higher codependence in their banking sector
Deniz Anginer
Has the banking sector become more vulnerable over time?
Policy Implications
• In the aftermath of the crisis of 2007/08, there has been
renewed interest in macro-prudential regulation
• There has also been a growing consensus to adjust capital
requirements to better reflect an individual bank’s contribution
to the risk of the financial system as a whole
– Acharya et al (2010) Brunnermeier, Crockett, Goodhart,
Persaud, and Shin (2009), Financial Stability Forum (2009)
• Our results support an increase in scope for intra-national
supervisory co-operation, as well as capital charges for tooconnected-to-fail’ institutions that can impose significant
externalities
Deniz Anginer
Has the banking sector become more vulnerable over time?
Literature
• Growing number of papers examine the risk of individual banks to
the banking system
– Acharya et al (2010), Adrian and Brunnermeier (2009), Huang et al. (2009),
Chan-Lau and Gravelle (2005), Avesani et al. (2006), and Elsinger and Lehar
(2008)
• Others have examined the correlation structure of equity returns of a
subsample of banks
– De Nicolo and Kwast (2002), Schuler (2002), Hawkesby, Marsh and Stevens
(2003,2007)
• Larger contagion/convergence literature
– Forbes and Rigobon (2002), Kee-Hong Bae and Stulz (2003), Bekeart and Wang
(2009); Pukthuanthong and Roll (2009)
Deniz Anginer
Has the banking sector become more vulnerable over time?
Merton Model
•
We compute default probabilities implied
from the structural credit risk model of
Merton (1974)
•
Commonly used in default prediction
outperforming accounting-based models
in hazard regressions
–
•
Campbell, Hilscher and Szilagyi 2008;
Hillegeist, Keating, Cram, and Lundstedt,
2004; Bharath and Shumway, 2008)
Merton (1977) points out the applicability
of the contingent claims approach to
pricing deposit insurance in the banking
context.
–
Log Asset Value Distribution
Bongini, Laeven, and Majnoni (2002),
Bartram, Brown and Hundt (2008) and
others have used the Merton model to
measure default probabilities of
commercial banks
Deniz Anginer
Average PD = 4%
Default
-4
-3
-2
MertonDD = -
C
-1
0
1
log (V A / X ) + ( m - ¶ -
2
3
(s A2 / 2 ))T
sA T
Has the banking sector become more vulnerable over time?
4
Data Coverage
1200
1084
# of Publicly traded Banks
with Datastream and
Bankscope coverage
1000
974
800
# of Banks with DtD after
filters
600
347 328
400
219 209
200
66
122
36
164 162
81
105 86
123 103
64 50
0
Africa
•
•
•
Central Asia East Asia
& Eastern and Pacific
Europe
Japan
Latin
Middle East
North
America & & North
America
Caribbean
Africa
South Asia
Western
Europe
Market cap and equity volatility obtained from Datastream; Bank assets and liability information
comes from BankScope
Our results are robust to alternative Distance-to-Default definitions
We impose a number of filters to ensure data integrity
–
Final sample includes 2029 banks from 70 countries starting in 1998
Deniz Anginer
Has the banking sector become more vulnerable over time?
Average Distance to Default
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Has the banking sector become more vulnerable over time?
Average Distance to Default for Different Regions
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Has the banking sector become more vulnerable over time?
Global Component of Changes in Credit Risk
100%
90%
80%
70%
Marginal
60%
•
Principal components of log
changes in Default
probabilities for commercial
banks Jan 1998 – Oct 2010
•
The first component
explains 60% of variation in
changes in default risk of
commercial banks
Cumulative
50%
40%
30%
20%
10%
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Comp10
Comp9
Comp8
Comp7
Comp6
Comp5
Comp4
Comp3
Comp2
Comp1
0%
Has the banking sector become more vulnerable over time?
Clustering in Default Risk
Worst week
25%
20%
15%
10%
5%
•
07/03/10
10/03/09
01/03/09
04/03/08
07/03/07
10/03/06
01/03/06
04/03/05
07/03/04
10/03/03
01/03/03
04/03/02
07/03/01
10/03/00
01/03/00
04/03/99
07/03/98
10/03/97
01/03/97
0%
This chart shows the percentage of banks in a given week that have simultaneous worst change
in default risk over a 12 month time period
Deniz Anginer
Has the banking sector become more vulnerable over time?
Decomposing the Systematic Changes in Default Risk
•
Regions
Number of
Banks
Global
Effect
Region
Effect
Africa
Central Asia & Eastern Europe
East Asia and Pacific
Japan
Latin America & Caribbean
Middle East & North Africa
North America
South Asia
Western Europe
36
81
209
162
86
103
974
50
328
0.2809
0.4335
0.4952
0.1193
0.4007
0.1066
0.7411
0.1928
0.4573
0.7191
0.5665
0.5048
0.8807
0.5993
0.8934
0.2589
0.8072
0.5427
We follow Heston & Rouwenhorst (1994)’s method to decompose the systematic variance of
changes in default risk into global and regional effects:
Deniz Anginer
Has the banking sector become more vulnerable over time?
Increase in Bank Concentration
Deniz Anginer
•
Concentration
measures assets of 3
largest banks as a
share of assets of all
commercial banks
•
There has been a
substantial increase in
concentration in both
developing and
developed countries
Has the banking sector become more vulnerable over time?
Decomposing the Systematic Changes in Default Risk
Developed
Developing
European Union
Assets < 10 bn
10 bn < Assets < 50 bn
Assets > 50 bn
•
•
No Banks
1552
356
286
Global
15.1%
18.3%
14.8%
Country
77.2%
75.5%
76.6%
Size
7.7%
6.2%
8.6%
1464
495
276
54.8%
23.8%
17.2%
36.7%
61.3%
56.9%
8.5%
14.9%
25.9%
Banks Size explains a significant portion of systematic variation in default risk
Co-dependence is significantly higher for larger banks
Deniz Anginer
Has the banking sector become more vulnerable over time?
Variance Ratio
PR(t)
-1.5
•
Variance ratio (Bekaert and Wang
(2009), Ferreira and Gama (2005)):
-2
-2.5
𝑃𝑅𝑡 = 𝑙𝑛( 1
(𝑁
-3
-3.5
-4
𝑣𝑎𝑟(𝑁1
𝑖 ∆𝑥 𝑖,𝑠
)
2
𝑖 𝑆𝑇𝐷(∆𝑥𝑖,𝑠 ))
)
•
Variance ratio calculated for all
banks in the data set Jan 1998 –
Oct 2010 period
•
Starting in 2004 there has been an
upward trend leading up to the
crises
-4.5
-5
Deniz Anginer
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
-5.5
Has the banking sector become more vulnerable over time?
Comovement
ST(t)
12
0.16
10
0.14
2000
0.12
2006
8
2008
0.10
6
0.08
0.06
4
0.04
2
0.02
0.00
•
•
Co-movement (Harmon et al
(2010):
1
𝑈𝑃𝑡 =
𝑁
𝑁
𝐈 ∆𝑥 𝑖,𝑡 >0
𝑖=1
1
𝑆𝑇𝜏 =
𝑇
Deniz Anginer
𝑇
𝑈𝑃𝑡 − 𝑈𝑃
Chart shows the distribution in a
given year of the % of banks that
had a positive increase in default
probability
𝑡=1
Has the banking sector become more vulnerable over time?
80%
75%
63%
60%
58%
55%
53%
50%
48%
45%
43%
40%
38%
35%
33%
30%
28%
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0
Quintile Regression
Beta
QT
2.5
6
2.0
5
4
1.5
3
1.0
2
0.5
1
•
𝛽 (𝜏) = argmin𝛽∈𝑹𝜌 =
𝜌𝜏
𝑡=1
Deniz Anginer
∆𝑥𝑖,𝑡
1
−
𝑁
0.01 0.05 0.1
•
Quintile regression (Boyson, Stahel and Stulz
(2010), Brunnermeier and Pedersen (2009):
𝑇
0
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0.0
0.2 0.25 0.5 0.75 0.8
0.9 0.95 0.99
Co-dependence is higher for higher levels of
default risk changes
𝑁
∆𝑥𝑖,𝑡
𝑖=1
Has the banking sector become more vulnerable over time?
Trends in Co-dependence
•
We formally test to see if there has been a change in co-dependence over time
𝑃𝑅𝑡 = 𝛼1 𝐼 𝑡∈1998.01−2003 .12 + 𝛽1 𝐼 𝑡∈1998.01−2003 .12 ∙ 𝑡 + 𝛼2 𝐼 𝑡∈2004 .01−2007.06
+ 𝛽2 𝐼 𝑡∈2004.01−2007.06 ∙ 𝑡 + 𝛼3 𝐼 𝑡∈2007.06−2009.12 + 𝛽3 𝐼 𝑡∈2007.06−2009.12 ∙ 𝑡 + 𝜀𝑡
Coeff
int
World
Developed
Developing
EU
USA
Japan
ECA
MENA
LAC
1998.01 - 2003.12
-3.424***
-3.434***
-2.273***
-3.044***
-3.378***
-2.078***
-1.800***
-0.724***
-2.237***
slope 1998.01 - 2003.12
-0.002***
-0.001***
-0.003***
0.000
-0.001***
-0.000
-0.001***
-0.002***
-0.002***
int
2004.01 - 2007.06
-6.588***
-6.413***
-2.421***
-7.111***
-5.451***
-2.529***
-3.169***
-0.706
-2.482***
slope 2004.01 - 2007.05
0.004***
0.004***
-0.004***
0.008***
0.002***
0.002***
0.001***
-0.005***
-0.001***
2007.06 - 2010.07
-11.953***
-11.616***
-1.344*** -11.175*** -10.293***
-8.404***
slope 2007.06 - 2010.07
0.015***
0.014***
int
•
•
-12.650*** -11.422*** -10.315***
0.015***
0.015***
0.012***
0.009**
0.014***
0.012***
0.010***
During the crisis there has been an increase in co-dependence for all banks in all
regions
On average we find that starting in 2004 leading up to the crisis, there has been an
upward increase in co-dependence
•
But there is much cross-country variation, which we explore next
Deniz Anginer
Has the banking sector become more vulnerable over time?
Cross-Country Regressions
M1
M2
M3
M4
M5
M6
M7
M9
M10
M11
Stock mkt Cap / GDP
0.127*
0.136*
0.279*
0.104
0.152*
0.228**
0.257**
0.213*
0.246**
0.216**
Bank Deposits / GDP
-0.050
0.000
0.102
-0.002
0.035
0.258
0.199
-0.027
-0.116
-0.034
Bank Crisis Dummy
0.273***
0.299***
0.327***
0.273***
0.294***
0.264***
0.286***
0.202**
0.195*
0.205**
Log # of Banks
-0.691*** -0.807*** -0.882*** -0.829***
-0.807*** -0.729*** -0.696*** -0.704***
-0.721*** -0.714***
Bank Capital / Assets
0.039*
0.019
0.018
0.016
0.022
0.021
0.026
0.012
0.013
0.010
Liquid Assets Ratio
0.029**
0.035**
0.039***
0.036**
0.034**
0.039***
0.036**
0.039***
0.036***
0.039***
log GDP/cap
-0.007
0.025
-0.062
0.041
0.020
-0.049
-0.169
-0.077
0.045
-0.022
GDP/cap growth
-0.033**
-0.039**
-0.048**
-0.037**
-0.040**
-0.049***
-0.039**
-0.058***
Stock mkt turnover
0.130***
Chin-Ito Financial Openness
-0.059*** -0.058***
0.100**
Deposit Insurance Coverage
0.211***
Bank concentration
0.445*
Trade / GDP
-0.001
KOF Social globalization
0.015
KOF Political globalization
0.028**
Stock market liberalization
0.241***
International capital liberalization
0.643***
Banking supervision
-0.129**
Country FE
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
2
0.287
0.253
0.345
0.265
0.256
0.276
0.277
0.285
0.303
0.284
Adj R
Deniz Anginer
Has the banking sector become more vulnerable over time?
Conclusion
•
We create a database of default risk measure for all publicly traded banks
using the Merton (1974) contingent claim model
•
We show that systematic default risk has a significant global component in
the banking sector and that there has been a significant increase in default
risk co-dependence leading up to the 2007/2008 financial crisis
•
There is much cross-sectional variation, and countries which are more
integrated, have liberalized financial systems and weak banking supervision
have higher co-dependence in their banking sector
•
Our results support an increase in scope for intra-national supervisory cooperation, as well as capital charges for too-connected-to-fail’ institutions
that can impose significant externalities
Deniz Anginer
Has the banking sector become more vulnerable over time?
THANK YOU
Deniz Anginer
Has the banking sector become more vulnerable over time?