Eliana Balla

Did the Financial Reforms of the Early 1990s Fail? A Comparison of Bank Failures and FDIC Losses in the 1986-92 and 2007-13 Periods

Two of the most significant banking reforms to come out of the banking problems in the late 1980s and early 1990s were the increase in capital requirements from Basel 1 and the prompt corrective action (PCA) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). The PCA provisions require regulators to shut down banks before book capital becomes negative. We compare failures and FDIC losses on commercial banks in the pre-FDICIA commercial bank crisis of the mid-1980s to early 1990s with that in the recent financial crisis. Using a sample of community and mid-sized banks, we find that almost all the same bank characteristics predict failure and high losses in the two crises. Our results imply that for these classes of banks, the two crises were very similar. We find that the failure rate in the recent period was driven more by severe economic conditions than by the increased concentrations in real estate lending. The analysis suggests that the combination of PCA with higher capital levels helped reduce failure rates in the recent period. In contrast, the analysis suggests that the reforms did not help with FDIC losses. FDIC losses on failed commercial banks were approximately 14% of failed bank assets over the 1986-92 period but increased to approximately 24% over the 2007-13 period. We find that the increased losses are not explained by variations in bank balance sheets or local economic conditions. Finally, we find that a discretionary accounting variable, interest accrued but not yet received, is predictive of both failure and higher FDIC losses.

Tail Dependence in the US Banking Sector and Measures of Systemic Risk

Tail dependence among international stock markets is widely studied using measures of extremal dependence. In this study, we investigate the extremal dependence among stock prices of US bank holding companies. We find they exhibit strong dependence even in their limiting joint extremes. Motivated by this result, we derive extremal dependence-based systemic risk measures. The proposed systemic risk measures capture downturns in US stock markets, and in particular the financial industry, very well. We also develop another set of extremal dependence-based measures to rank financial institutions based on their systemic interconnectedness. By means of regression analysis we show that interconnectedness measures can be used as indicators of vulnerability to financial crisis. Finally, we identify drivers of extremal dependence in the US banking industry. Similarity between banks on key financial variables increases the likelihood of banks being asymptotically dependent, and increases the strength of asymptotic dependence. We believe the proposed measures have the potential to inform the prudential supervision of systemically important firms which is an area of interest to supervisory policy makers.

Loan loss reserves, accounting constraints, and bank ownership structure

This paper examines how the tightening of accounting constraints associated with the SunTrust bank decision in 1998 impacted the loan loss reserve policies of banks differently based on ownership structure. The SunTrust case, the result of an SEC inquiry over possible overstating of loan loss reserves, represented a strengthening of accounting priorities, which stress the importance of the reserve account for financial statement objectivity and comparability, relative to supervisory priorities, which emphasize the role of reserves for bank solvency through changing economic environments. The evidence presented indicates that publicly held banks, which fall directly under the SECs purview, reduced their loan loss reserve and provisions relative to privately held banks. Evidence also indicates that the positive relationship between bank earnings and provisions weakened, consistent with a reduction in either earnings management or early recognition of losses.

Comparison of Small Bank Failures and FDIC Losses in the 1986–92 and 2007–13 Banking Crises

Failure rates of small commercial banks during the banking crisis of the late 1980s were about 7.6%, which is significantly higher than the 5.7% failure rate during the recent crisis. We compare failure rates in the two periods using a statistical model that allows us to decompose the effect of changes in bank characteristics and economic shocks on failure rates. We find that the severe economic shocks of the recent crisis had a larger impact on high bank failure rates than bank characteristics.