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The role of relative performance in bank closure decisions

Author

Listed:
  • Kenneth Kasa
  • Mark M. Spiegel
Abstract
This paper studies a competitive banking industry subject to common and idiosyncratic shocks. The induced correlation across bank portfolio returns can be used by a regulator to improve inferences about bank portfolio choices. We compare two types of closure rules: (1) an 'absolute closure rule', which closes banks when their own individual asset/liability ratios fall below a given threshold, and (2) a 'relative closure rule', which closes banks when their asset/liability ratios fall below the industry average by a given amount. ; Two main results emerge from the model. First, a relative closure rule implies forbearance during 'bad times', defined as adverse realizations of the common shock. This forbearance occurs for incentive reasons, not because of irreversibilities or political economy considerations. Second, a relative closure rule is less costly to taxpayers, and the cost savings increase with the relative variance of the common shock. ; To evaluate the model, we estimate a panel-logit regression using a sample of U.S. commercial banks for the period 1992 through 1997. We find strong evidence that U.S. bank closures are based on relative performance. Individual and average asset/liability ratios are both significant predictors of bank closure, and their coefficient estimates are consistent with the theory. We conclude that relative performance is a valuable input to bank closure decisions, and that U.S. bank regulators seem to be aware of this.

Suggested Citation

  • Kenneth Kasa & Mark M. Spiegel, 1999. "The role of relative performance in bank closure decisions," Working Papers in Applied Economic Theory 99-07, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfap:99-07
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    References listed on IDEAS

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    Cited by:

    1. Di Nicolo, G. & Gamba, A. & Lucchetta, M., 2011. "Capital Regulation, Liquidity Requirements and Taxation in a Dynamic Model of Banking," Other publications TiSEM 58ac9f00-92d7-497b-a76f-e, Tilburg University, School of Economics and Management.
    2. Korte, Josef, 2015. "Catharsis—The real effects of bank insolvency and resolution," Journal of Financial Stability, Elsevier, vol. 16(C), pages 213-231.
    3. Acharya, Viral V. & Yorulmazer, Tanju, 2007. "Too many to fail--An analysis of time-inconsistency in bank closure policies," Journal of Financial Intermediation, Elsevier, vol. 16(1), pages 1-31, January.
    4. Mark M. Spiegel, 1999. "Moral hazard under the Japanese \"convoy\" banking system," Economic Review, Federal Reserve Bank of San Francisco, pages 3-13.
    5. Korte, Josef, 2013. "Catharsis - The real effects of bank insolvency and resolution," Discussion Papers 21/2013, Deutsche Bundesbank.
    6. Ignatowski, Magdalena & Korte, Josef, 2014. "Wishful thinking or effective threat? Tightening bank resolution regimes and bank risk-taking," Journal of Financial Stability, Elsevier, vol. 15(C), pages 264-281.
    7. Pavlos Almanidis & Robin C. Sickles, 2016. "Banking Crises, Early Warning Models, and Efficiency," International Series in Operations Research & Management Science, in: Juan Aparicio & C. A. Knox Lovell & Jesus T. Pastor (ed.), Advances in Efficiency and Productivity, chapter 0, pages 331-364, Springer.
    8. Acharya, Viral & Yorulmazer, Tanju, 2005. "Cash-in-the-Market Pricing and Optimal Bank Bailout Policy," CEPR Discussion Papers 5154, C.E.P.R. Discussion Papers.
    9. Yunzhi Hu & Felipe Varas, 2021. "A Theory of Zombie Lending," Journal of Finance, American Finance Association, vol. 76(4), pages 1813-1867, August.
    10. Luc Can & Mohamed Ariff, 2009. "Performance of East Asian banking sectors under IMF-supported programs," Journal of the Asia Pacific Economy, Taylor & Francis Journals, vol. 14(1), pages 5-26.
    11. Spiegel, Mark M., 2000. "Bank Charter Value and the Viability of the Japanese Convoy System," Journal of the Japanese and International Economies, Elsevier, vol. 14(3), pages 149-168, September.
    12. Cai, Jin, 2022. "Bank herding and systemic risk," Economic Systems, Elsevier, vol. 46(4).

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