Jörg Prokop

The value relevance of “too-big-to-fail” guarantees

Purpose - – This paper aims to analyze the impact of conjectural “too-big-to-fail” (TBTF) guarantees on big and small US financial institutions’ stock prices during the 2008-2009 banking crisis. Design/methodology/approach - – The paper analyzes shocks to stock market investors’ expectations of government aid to banks in distress and respective spillover effects using an event study approach. We focus on three major events in late 2008, namely, the Lehman bankruptcy, the Citigroup bailout and the first announcement of the Capital Purchase Program (CPP) by the US Government. Findings - – The authors found significant differences in market reactions to the respective events between small and large banks. For both the Lehman and the CPP event, abnormal returns on big banks’ stocks are negative, while small banks’ stocks tend to generate positive abnormal returns. In contrast, large banks strongly outperform small banks in the case of the Citigroup bailout. Results for a control group of non-financial firms indicate that this behavior may be specific to the banking industry. The authors observed significant spillover effects to both competitors and non-competitors of Lehman and Citigroup, and concluded that while the Lehman event shook the widely held belief in an implicit TBTF subsidy to large banks, the TBTF doctrine was reinstated shortly thereafter. Originality/value - – This paper shows that conjectural TBTF guarantees are priced in by equity investors. While government aid to large banks in distress may prevent negative effects on the stability of the financial system, it may also create negative externalities by putting small banks at a competitive disadvantage. The findings suggest that US and European regulators’ recent policy measures directed at establishing reliable bank resolution schemes should be a step in the right direction to level the playing field for small and large financial institutions.

Financial regulation, collective cognition, and nation state crisis management

Purpose - – The purpose of this cross-national study is to evaluate the communality and differences in experiences and policy responses in the run up to the 2007-2009 credit crisis and during its critical early stages in Germany, Ireland and the UK. The importance of shared cognitive illusions regarding the power and stability of financial markets is emphasised. Design/methodology/approach - – A multiple case study approach is used which draws on publicly available information to trace developments leading up to bank failures (or near failures) and the evolution of government responses drawing upon alternative paradigms used to justify State intervention. Findings - – Findings emphasise the role of state regulatory bodies and their response to the crisis as a primary source of the “rules of the game” in financial markets, here it is the “game of bank bargains” and a potential source of repair. Given the degree of interconnectedness, opacity and complexity of financial markets investors/politicians/regulators will fall victim to cognitive biases which affect their decisions. Research limitations/implications - – This case study method allows identification of patterns in decision-makers’ behaviour and yields richer insights than a quantitative approach but is limited in its generalisability. Practical implications - – This paper offers practical implications in suggesting that a pivotal step in effective crisis management requires directly addressing sources of uncertainty, namely, time pressure, complexity and opacity of underlying cause–effect relationships, empowering decision-makers to act responsibly. Originality/value - – This paper is novel in its illustration of the collective cognitive paradigm for justifying regulatory action across three countries using six case studies.

Drivers of Bank Solvency, Risk Provisioning and Profitability in the Armenian Banking System:

The aim of this study is to examine the effects of bank-specific, regulatory and macroeconomic determinants on solvency, risk provisioning, and profitability in the Armenian banking sector. We show that abnormal loan growth is associated with a decrease in regulatory capital ratios, an increase in loan loss provisions, and a reduction in loan portfolio profitability. In addition, we observe an inverse relationship between GDP growth and bank solvency as well as profitability. Regarding regulation, we identify a decrease in regulatory capital ratios as well as a drop in profitability after the implementation of the Basel II Accord. JEL Classification: G32, G21, G28

Financial Regulation and Nation State Crisis Management: Evidence from Germany, Ireland and the UK

We study the unfolding of the credit crisis until 2008, and the diversity of policy responses in Germany, Ireland, and the UK. We show that although the channels through which these three European states manifested financial distress were different, the crisis evoked similar reactions by regulators and national governments. Our conclusion emphasise the role of state regulatory bodies as a primary source of the “rules of the game” in financial markets, and they support several of the policy measures taken in the aftermath of the credit crisis. In particular, we argue that adverse regulatory incentives at a national level require strengthening regulation at the European level, to avoid national capture and a resulting race to the bottom by national financial regulators.