George McKenzie

The impact of environmental risk on the UK banking sector

The aim of this paper is to examine the tensions that face the UK banking sector in assessing and managing credit risks associated with actual or potential environmental damage arising from the activities of borrowers. It was found that banks were more concerned with the reputational effects associated with lending to a polluter than with credit risk assessment. Concern exists with the potential legal risks arising from the application of the principle of joint and several liability by courts in cases involving environmental damage caused by borrowers. The paper concludes that further research is required on the role of (a) the supply chain in credit risk assessment and (b) partnership contracts between borrower, lender and environmental agencies.

The globalization of banking and financial markets: The challenge for European regulators

Abstract The objective of this article is to examine recent trends in regulatory philosophy that are occurring as a result of the globalization of banking and financial market activities facilitated by the electronic revolution. By compressing both time and space, this revolution is threatening the supremacy of the nation state as the basis for ordering our economic, political and social lives. In the financial services sector, the result is an increasing transfer of disciplinary functions to the markets themselves. The shift of emphasis is away from the regulation of markets by individual nation states to the provision of sufficient information to enable customers of financial institutions to create the incentives for these institutions to act in a safe and sound manner. This trend is being supported by many regulators recognizing their inability to keep pace with financial innovations and the transient and uncertain nature of market trends. The philosophy underlying the EU Deposit Guarantee Directive is...

Loan-loss provisions and bank buffer-stock capital

In principle, bank capital serves two functions. It represents i) the value of shareholder equity and ii) the value of the buffer stock available to absorb unexpected losses. The calculation of expected loan losses and the provisioning to cover these losses enables a clearer picture of the economic structure of bank balance sheets. In this paper, it is argued that such calculations should take into account i) the implicit subsidy enjoyed by borrowers in the form of limited liability and ii) the expected costs of administering insolvency in the event of borrower default. An expectation represents the most likely outcome. Hence there is a case that expected losses should be treated in exactly the same manner as losses which have already been identified. That is, provisioning against such losses should not be included in capital. However, provisions for unexpected losses should be included in capital. The major policy implication is that the timing of provisioning will be brought forward and the value of bank capital will be less than currently recorded using historical value accounting.

A Comparison of Measures of Earnings Per Share

Abstract This paper explores alternative methods for computing earnings per share (EPS) for a company whose capital structure consists of ordinary shares and warrants. The methods for computing EPS identified by the FASB (1996) are critically evaluated and an alternative measure, the holding period approach,is developed within the framework of contingent claims analysis. Two types of errors are shown to characterize the accounting measures of EPS. One arises from failure of accounting measures to fully recognize the contingent nature of the warrant. The other arises from the practice of not recognizing instances of anti-dilution. A further factor is the treatment of any difference between the proceeds from the issue of the warrants and their fair value at that time. This is ignored in existing measures and yet may have a significant effect on the value of the claims of ordinary shareholders on the company’s earnings. Using a simulation method it is shown that the imputed earnings method of computing EPS is a very close approximation to the holding period method and is considerably more accurate than treasury stock measures favoured by accounting standards bodies.

The econometric modelling of aggregate consumer behaviour

This paper examines several problems involved in modelling the structure of consumer behaviour. A new model of consumer demand is presented which encompasses the indirect translog, the CES and the LES as special cases, enabling nested comparisons to be made. Within this framework we show that acceptance of zero-degree homogeneity and/or symmetry of the Slutsky matrix is heavily dependent upon the structure within which inferential tests are carried out, and that great care must be utilised in formulating nested hypotheses and drawing inferences on the basis of χ2 and F-statistics. We then show that conventional econometric work implies that consumer preferences must be homothetic if symmetry of the Slutsky matrix is imposed. An alternative procedure is suggested and utilised. Finally, we suggest that low Durbin–Watson statistics may arise from misspecification of functional form and may not be due solely to omitted dynamics, as many conjecture.

Regulating the Euro-markets

Abstract This paper examines the implications of the Euro-currency system as a non-monetary financial intermediary. Within the framework of a simple algebraic model, it is shown that changes in reserve ratios or the imposition of quantitative limits on Euro-currency activity will affect both the global level and international pattern of financial flows. Consequently, arguments that the Euro-currency system has very little impact on international credit creation are shown to be wanting. A corollary to this result concerns central bank depositing in the Euro-currency system. It is shown that this quantitatively important activity has (a) led to substantial increases in the level of international credit creation, and (b) produced unrecognized effects on the international payments mechanism.

Speculation, Hedging and Arbitrage

Perhaps the most difficult problem that economists and policy makers face is understanding how the existence of uncertainty affects people’s behaviour and in particular their reaction to various economic policies. In the simple model developed in earlier chapters, we emphasised that the informational requirements for the achievement of equilibrium are quite large. When we realise that people base their decisions not only on current prices and incomes but also on expectations about the future values of these variables, the magnitude of the problem becomes apparent. As a result buyers and sellers gather whatever information is readily available and form expectations about prices, etc. on the basis of this. This means that although they may often be correct, their actions may sometimes lead markets away from their equilibrium positions. The purpose of this chapter is to explain some of the transactions that arise in the foreign exchange market because of uncertainty and to show how the demand and supply of foreign exchange may be affected by changes in expectations, particularly about exchange rates. In Chapters 10 and 11 this theme will be returned to when we examine the implications of alternative exchange rate mechanisms. One conclusion will become quite clear: it is extremely difficult to reach any decision about the most desirable international monetary system without more information about the activities discussed in this chapter.

Earnings announcements by UK companies: Evidence of extreme events?

This paper investigates the abnormal share return dispersion occurring when companies announce their interim or final earnings. Whereas, prior research has focused on abnormal returns, little attention has been given to investigating the dispersion of the abnormal returns. We find strong empirical evidence supporting an abnormal dispersion of share returns on event dates. Moreover, we find that these public announcements are sources of extreme share price movements. Our study provides a step forward in identifying factors underlying the leptokurtosis that is traditionally found in time series stock market returns. Our data sample is comprised of interim and full year results for mid-to-large capitalisation UK companies for the period 1984–2005. Consistent with the extant literature on this subject, we find no evidence of market inefficiency around the event date, or straightforward arbitrage opportunities on the event date. However, we find using Paretian statistics that the abnormal return dispersion on the event date is three times higher than on normal non-event days.

Financial instability and the international debt problem

Acknowledgements - The Fundamentals - Objective Risk Assessment - A Behavioural Approach to Financial Institution Behaviour - International Debt: the Anatomy of a Financial Crisis, 1973-1983 - The Maturing Crisis, 1983-1987 - The Markets Response: Debt Swaps - The Regulators Response: the BIS Capital Adequacy Proposals - Notes - Bibliography - Appendices - Index

Liquidity, credit creation and international banking: An econometric investigation

For the past 18 months the Treasury and Civil Service Select Committee of the British House of Commons has been taking evidence from expert witnesses and interested parties concerning International Monetary Arrangements. An important concern of their work has been the inter-relationship between current problems in international bank lending and macroeconomic policies. Our presentation will review the opinions expressed in the Committees Reports in the light of the econometric evidence we have obtained in our formal paper prepared for this conference. Basically we feel that the current problems facing the international banking system are in no small part due to the increased systematic risk introduced into the system by the macroeconomic policies followed by the industrial countries over the past decade, rather than simply to reckless and imprudent bank management. Further, our econometric evidence suggests that Eurocurrency flows may have a substantial effect on domestic liquidity, in contrast to the accepted view that such flows are unimportant. An underlying major theme of our paper concerns the importance of using modern econometric methods to shed light on current important problems of international financial interdependence.