Jeffery W. Gunther

Separating the likelihood and timing of bank failure

Abstract We use a split-population survival-time model to separate the determinants of bank failure from the factors influencing the survival time of failing banks. Basic indicators of a banks condition, such as capital, troubled assets, and net income, are important in explaining the timing of bank failure. However, many of the other variables typically included in bank failure models, such as measures of bank liquidity, are not associated with the time to failure. The results also suggest that the closure of large banks is not delayed relative to the closure of small banks.

Loss underreporting and the auditing role of bank exams

Abstract Using a unique set of banking data containing both originally-reported and subsequently-revised financial variables, we study accounting restatements. Our results indicate the worse a banks financial condition, the more likely it is for originally-reported data to understate financial losses. Also, we find supervisory exams have an important role in uncovering financial problems and prompting accounting restatements to correct loss underreporting. While revisions are directly related to financial difficulties, exam-based restatements are evident at even the earliest stages of deterioration, indicating substantial accounting misstatements—at both banks and other types of companies—can occur well outside severe business circumstances.

Early warning models in real time

Each quarter, banks file a call report, or Report of Condition and Income, containing hundreds of accounting items pertaining to their financial condition. Because call reports are filed quarterly, whereas banks are typically examined about once every twelve to eighteen months, statistical early warning models using call report data potentially provide a more up-to-date picture of a banks condition than on-site exams alone. Often neglected, however, is the fact that call report data are subject to revision. We find evidence of a strong relationship between on-site exams and call report revisions. In addition, we evaluate a major class of early warning models using both originally published and revised data to assess whether model accuracy in real time is appreciably lower than accuracy measured using revised data. The findings indicate revised data overstate the accuracy of early warning models. The substantial effect of revisions on the accuracy of early warning models, coupled with the finding of a relationship between revisions and exams, points to a substantial auditing role for on-site exams. More generally, our findings point to the need for care in the use of call report data for research in which the real-time flow of financial information is of some concern.

Mexican banks and the 1994 peso crisis: The importance of initial conditions

Abstract We find that portfolio investment flows explain a large proportion of the variance in Mexicos reserve position, exchange rate and macroeconomic performance, while the impact of direct investment is relatively small. Moreover, we argue that the huge portfolio investment outflows associated with the 1994 peso crisis reflected a long sequence of related events, beginning with key features of the bank privatization program that helped institute a policy of government forbearance toward the Mexican banks. As such, the crisis points to the importance of minimizing the distortions associated with the failure to address emerging financial difficulties at institutions with access to government safety nets.

The likelihood and extent of banks' involvement with interest rate derivatives as end users

Based on annual data for medium-sized U.S. commercial banks from 1991 through 1998, we investigate both the decision of whether to participate in interest rate derivatives and, for those banks participating, the extent of their involvement as end users. We find the hedging of balance sheet positions is an important motivation for involvement in derivatives. In addition, the extent of involvement is directly related to a banks capital position. These results pointing to the typical end user as a financially secure bank seeking to hedge unwanted risk argue against the need for any additional restrictions on derivatives activities.

Bank Credit and Economic Activity: Evidence from the Texas Banking Decline

In the latter half of the 1980s, banking difficulties were concentrated in Texas. Because of the magnitude of these financial difficulties, interest has focused on whether an alleged inability or unwillingness of Texas banks to extend loans hampered economic growth in the state. Using various measures of banking-sector activity and economic activity in Texas over the period 1976:I-1990:IV, a structural VAR model of the Texas economy is estimated. Variance decompositions measure the interdependence of the banking and real sectors of the economy. Our results indicate a strong effect from the real sector to the financial sector. We find little evidence, though, that the deterioration observed in the Texas banking sector contributed to reduced economic growth.

Increasing the Efficiency of Pooled Estimation with a Block-Diagonal Covariance Structure

A small number of time-series observations relative to regions precludes estimation of the entire structure of regional dependence in a pooled regression model. The resulting need for parsimonious models of regional dependence can be satisfied through the use of spatial autocorrelation structures. This article explores an alternative methodology that allows the researcher to estimate disturbance covariances for regions that are closely linked, even when the number of time-series observations is relatively low. The approach presented here shares the advantage of spatial autocorrelation structures in being parsimonious, but offers the additional advantage of relying more completely on sample information to provide estimates of dependence between regions within specified regional groups. Monte Carlo experiments suggest that block-covariance models offer substantial efficiency gains over simple heteroskedastic models. The experiments also suggest that when the number of time-series observations is limited and the correlations of disturbances between regions are small, block structures yield efficiency gains over a full-information model.

Universal access, cost recovery, and payment services

We suggest a subtle, yet far-reaching, tension in the objectives specified by the Monetary Control Act of 1980 (MCA) for the Federal Reserve’s role in providing retail payment services, such as check processing. Specifically, we argue that the requirement of an overall cost-revenue match, coupled with the goal of ensuring equitable access on a universal basis, partially shifted the burden of cost recovery from high-cost to low-cost service points during the MCA’s early years, thereby allowing private-sector competitors to enter the low-cost segment of the market and undercut the relatively uniform prices charged by the Fed. To illustrate this conflict, we develop a voter model for what begins as a monopoly setting in which a regulatory regime that establishes a uniform price irrespective of cost differences, and restricts total profits to zero, initially dominates through majority rule both deregulation and regulation that sets price equal to cost on a bank-by-bank basis. Uniform pricing is dropped in this model once cream skimming has subsumed half the market. These results help illumine the Federal Reserve’s experience in retail payments under the MCA, particularly the movement over time to a less uniform fee structure for check processing.