Deposit Insurance and Bank Regulation: A Partial Equilibrium Exposition

Kareken, John H.; Wallace, Neil

doi:10.21034/sr.16

Cited by 86 publications

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“…Why study the effect of bailouts on bank equity? The anticipation of future bailouts of bondholders and other creditors always benefits shareholders (see Kareken and Wallace ()) ex ante. Furthermore, during a crisis, there may be massive uncertainty about the resolution regime, especially for large financial institutions.…”

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confidence: 99%

Size Anomalies in U.S. Bank Stock Returns

Gandhi¹,

Lustig

2015

The Journal of Finance

245

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The largest commercial bank stocks, ranked by total size of the balance sheet, have significantly lower risk-adjusted returns than small-and medium-sized bank stocks, even though large banks are significantly more levered. We uncover a size factor in the component of bank returns that is orthogonal to the standard risk factors, including small minus big, which has the right covariance with bank returns to explain the average risk-adjusted returns. This factor measures size-dependent exposure to bankspecific tail risk. These findings are consistent with government guarantees that protect shareholders of large banks, but not small banks, in disaster states.BANKS ARE DIFFERENT FROM NONFINANCIAL FIRMS in many ways. One of the most salient distinctions is that banks are subject to bank runs during banking panics and crises, not just by depositors, but also by other creditors (see Gorton and Metrick (2012) and Duffie (2010)). Because financial crises are high marginal utility states for the average investor, the expected return on bank stocks should be especially sensitive to variation in the anticipated financial disaster recovery rates of bank shareholders related to bank size, the regulatory regime, implicit government guarantees, and other characteristics. For example, if a bank is deemed too big to fail, the expected return on its stock is lower in equilibrium than that of smaller banks holding the exact same assets in their portfolio because the government absorbs some of the large bank's tail risk. We find evidence that the pricing of bank-specific tail risk in the stock market depends on all of these bank characteristics.

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confidence: 99%

Size Anomalies in U.S. Bank Stock Returns

Gandhi¹,

Lustig

2015

The Journal of Finance

245

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“…Thousands of banks failed from 1930 to 1933, wiping out the funds of deposi tors, producing a collapse of the money supply, increasing the costs of interm ediation and in ter fering with the clearing of payments.3 Although large banks and many econom ists vigorously op posed deposit insurance, and President Franklin Roosevelt was reluctant to accept it, Congress deemed deposit insurance necessary to protect small, unsophisticated depositors from losses due to bank failures, and the payments system from a wholesale banking collapse like that of 1930-33.4 Until the 1980s, deposit insurance was g en er ally hailed for eliminating the possibility of widespread bank failures. 5 M erton (1977) and Kareken and Wallace (1978) showed, however, that w hen insurance premiums are unrelated to the expected cost of failure to the insurance sys tem, banks have an incentive to take greater risks than they otherw ise would. Because depo sitors are protected in the event of bank failure (to the limit of insurance coverage), they have little or no incentive to m onitor their banks' ac tivities or to demand risk premiums on deposit interest rates.…”

Section: Epo Sit Insurance and Bank Failurementioning

confidence: 99%

“…20See Merton (1977) or Kareken and Wallace (1978). failure rate of insured banks might have been higher simply because risky banks were more likely to join the voluntary insurance system, that is, because of "adverse selection."…”

Section: The Characteristics Of Insured Banksmentioning

confidence: 99%

The P-Star Model in Five Small Economies

Kool¹,

Tatom²

1996

ICPSR Data Holdings

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Helmut SchlesingerIn the last two centuries, only a handful of m onetary unions have been created successfully. Now, Europe has em barked on the creation of one of the most ambitious to date: the European M onetary Union, w hich will encom pass nearly 400 million people and have the highest gross domestic product in the world.In the Eighth Annual Homer Jones Memorial Lecture, Helmut Schlesinger, form er president of the Deutsche Bundesbank, briefly traces the econom ic and political history of the European Community, from its beginning in 1957 with six m em bers to its likely expansion to 16 m em bers in 1995. He also reflects on the cu rren t situation in light of the M aastricht Treaty of 1993, which established the fram ew ork for the m onetary union. Although the actual date of the European M onetary Union is in question, Schlesinger concludes that its birth is imm inent and that one of the most critical elem ents in determ ining its success will be the establishm ent of a single curren cy that is as stable as the best-perform ing national currencies within Europe. T h e P -S tar Model in F iv e Sm all E co n o m ie s Clemens J.M. K ool and John A. TatomA nation's exchange rate regim e affects the link betw een its m onetary ag gregates and its general level of prices, according to Clemens J.M . Kool and John A. Tatom . They explain an em pirical specification of a quantity theory of money called the P-star model, which indicates that a country's price level depends principally on its own money stock. This theory, however, applies only to a closed econom y or one with a flexible ex change rate. In contrast, they argue, a small open econom y which pegs the value of its curren cy to another country's cu rren cy also pegs its prices to that cou ntry's money stock. Kool and Tatom explain how the P-star model can be adapted for use in small open econom ies with fixed exchange rates. The}' test their openeconom y P-star model on five countries bordering Germany: Austria, Bel gium, Denm ark, the Netherlands and Switzerland. These countries have pegged their curren cies to the deutsche m ark to varying degrees since the breakdow n of the Bretton Woods agreem ent. Kool and Tatom 's evi dence supports the theoretical model, especially the principal hypothesis that, to the extent a country pegs the value of its cu rren cy to the Ger man m ark, its own inflationary developments are determ ined by m one tary conditions in German)'. MAY/JUNE 1994 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 31Is th e D isco u n t W in d o w N e ce ssa ry ? A P e n n C en tral P e rs p e c tiv e Charles II . CalomirisPolicym akers generally regard the discount window as an essential tool for preventing the spread of financial crises, but some critics have argued that it is an unnecessary-and costly-policy instrum ent. The argum ents against the discount window emphasize that it may unwisely postpone bank failures or underm ine the Fed's control over the supply of reserves. Fu r therm ore, the critics ...

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“…Substantial concern exists about the potential and/or actual deterioration of the commercial banking sector in the U.S. financial system, and about increases in risk at commercial banks [1, 2, 3, 7]. Fixed‐rate deposit insurance and non‐risk‐based capital standards in a deregulated environment provide theoretical justification for increased bank risk taking [11, 8]. Economic shocks associated with industry‐ or country‐specific events—such as the collapse of the Real Estate Investment Trust industry, the debt crisis involving less developed countries (LDC), the energy and real estate “bust” in the Southwest, and the farm crisis—provide further evidence of increased bank risk, as does the surge in the number of problem and failed banks.…”

Section: Introductionmentioning

confidence: 99%

The Risk Implications of Forecast Errors of Bank Earnings, 1976–1986

Fraser

Srinivasan

1989

J of Financial Research

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The forecast errors arising from security analysts' predictions of commercial bank earnings are investigated here and compared with the earnings forecast errors associated with savings and loans, other financial services organizations, and a random sample of nonfinancial firms from 1976 to 1986. Although bank earnings forecast errors did increase over 1976-1986, analyses suggest that the rise was less than at other industries considered in the study. The increase in forecast errors appears to be centered at multinational banking organizations, with only limited increases in earnings forecast errors at regional banks.The authors are indebted to Lynch, Jones, and Ryan for providing data from the Institutional Brokers Estimate System. All errors in the use of the data are the authors' responsibility. The contributions of two anonymous referees of this journal, and the computer support provided by Ketan Patel are acknowledged and appreciated. 261

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Deposit Insurance and Bank Regulation: A Partial Equilibrium Exposition

Cited by 86 publications

References 0 publications

Size Anomalies in U.S. Bank Stock Returns

Size Anomalies in U.S. Bank Stock Returns

The P-Star Model in Five Small Economies

The Risk Implications of Forecast Errors of Bank Earnings, 1976–1986

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