Rima Turk-Ariss

Do Depositors Discipline Banks and Did Government Actions During the Recent Crisis Reduce this Discipline? An International Perspective

The recent financial crisis highlights the importance of both regulatory and market discipline. Government reactions to the crisis included expanding deposit insurance coverage and rescuing troubled institutions, including some institutions that might not otherwise be considered too important to fail. These actions may have the unintended consequence of a reduction in market discipline that might otherwise penalize banks for risk-taking behavior. Alternatively, market discipline may have increased during the crisis due to heightened awareness of the risks of bank failures. To address these issues, we first test for the presence of depositor discipline effects in the period leading up to the financial crisis in both the US and the EU. Second, we test whether depositor discipline decreased or increased during the crisis. We find significant depositor discipline prior to the crisis in both the US and EU, but this varies between the US and the EU as well as with banking organization size and with listed versus unlisted status. We also find that depositor discipline mostly decreased during the crisis, except for the case of small US banks.The recent financial crisis highlights the importance of both regulatory and market discipline. Government reactions to the crisis include expanding deposit insurance coverage and rescuing troubled institutions, including some that might not otherwise be considered too big to fail, which may have the unintended consequence of a reduction in depositor discipline that might otherwise penalize banks for risk-taking behavior. To examine the potential for this to occur, we test for the presence of depositor discipline effects in the period leading up to the financial crisis in both the US and the EU. We find significant depositor discipline in both the US and EU, but this varies between the US and the EU, and also varies with banking organization size and with listed versus unlisted status. We also find that depositors appear to react more consistently to equity ratios than measures of loan portfolio performance, the latter of which may sometimes considered too manipulable to be trusted. This is consistent also with the requirements of Basel III that increase the minimum amount of Tier 1 common equity.

Do Markets Perceive Sukuk and Conventional Bonds as Different Financing Instruments

The last decade witnessed a proliferation in issues of sukuk, Islamic financial instruments structured to replicate the cash flows of conventional bonds. Using a market-based approach on Malaysian data, we consider whether investors react differently to the announcements of sukuk and conventional bond issues. Our findings suggest the stock market is neutral to announcements of conventional bond issues, but reacts negatively to announcements of sukuk issues. We attribute this finding to the excess demand for Islamic investment certificates and explain the difference in stock market reactions as an adverse selection mechanism that favors sukuk issuance by lower-quality debtor companies. Unlike previous studies, our findings indicate markets readily distinguish between sukuk and conventional bonds.

Bank Market Power Rents and Risk: Theory and Measurement

This paper presents new measures of market power rents in loan and deposit markets and examines their impact on bank risk-taking. These new measures are derived from optimality conditions common to a wide variety of theoretical models of banks operating under uncertainty and choosing their risk profile. We estimate loan and deposit market power rents using two large European panel datasets of bank consolidated and unconsolidated accounts. Three main results obtain. First, bank loan and deposit rents are significant and highly positively correlated both at a consolidated and unconsolidated level. Second, larger bank loan and deposit rents predict higher probabilities of bank failures and lower bank capitalization. Third, the quest for market power rents is an important driver for bank consolidation. These results are consistent with the absence of a trade-off between competition and stability, as well as with market power rents being an important driver of bank consolidation and increased systemic risk.

Are Islamic Investment Certificates Special? Evidence on the Post-Announcement Performance of Sukuk Issues

The last decade has witnessed rapid expansion of Islamic financial instruments, notably with the proliferation of Islamic investment certificates called Sukuk. Sukuk generally represent the Islamic financial instrument equivalent to conventional bonds. We evaluate the economic differences between these financing techniques and appraise the implications on the future expansion of Sukuk. We use a market-based approach to investigate whether investors react differently to the announcements of issues of Sukuk and conventional bonds. We find that the stock market is neutral to the announcement of conventional bonds, but we observe a significant negative stock market reaction to the announcement of Sukuk. We explain this different stock market reaction using the adverse selection mechanism, which favors Sukuk issuance by lower-quality debtor companies. Unlike arguments presented in prior literature, our results support the view that differences exist between Sukuk and conventional bonds because the market is able to distinguish among these securities.

What Influences Stock Market Reaction to Sukuk Issues? The Impact of Scholars and Sukuk Types

Sukuk, the shari’a-compliant alternative mode of financing to conventional bonds, have considerably expanded over the last decade. We analyze the stock market reaction to two key features of sukuk: type and characteristics of the shari’a scholar certifying the issue. We use the event study methodology to measure abnormal returns for a sample of 131 sukuk from eight countries over the period 2006-2013 and find that Ijara sukuk structures exert a positive influence on the stock price of the issuing firm. We observe a similar positive impact from shari’a scholar reputation and proximity to issuer. Overall our results support the hypotheses that the type of sukuk and the choice of scholars hired to certify these securities matter for the market valuation of the issuing company.

Credit Constraints, Political Instability, and Capital Accumulation

We investigate the complex interactions between credit constraints, political instability, and capital accumulation using a novel approach based on Kiyotaki and Moore’s (1997) theoretical framework. Drawing on a unique firm-level data set from Middle-East and North Africa (MENA), empirical findings point to a large and significant effect of credit conditions on capital accumulation and suggest that continued political unrest worsens credit constraints. The results support the view that financial development measured by a relaxing of financial constraints is key to macroeconomic development.

Bank Pricing Under Oligopsony-Oligopoly: Evidence from 103 Developing Countries

We propose a generic oligopsony-oligopoly model to study bank behavior under uncertainty in developing countries. We derive a pricing structure that acknowledges market power in both the deposit and loan markets and identify two theoretical components to the loan rate: a rent extraction component resulting from the interaction between the choke price of loans and prevailing banking structures, and a markup on deposit funding costs that captures the transformation efficiency of financial intermediation. We then test our structural specification with longitudinal data for 103 non-OECD countries and find that both the market structure under uncertainty and the deposit rate matter significantly in pricing. However, the role played by the rent-extraction share in pricing, on average, dominates funding costs in developing countries, and so underscores the importance of market structure in banks’ pricing power.

Legal Systems, Capital Structure, and Debt Maturity in Developing Countries

Manuscript type. Empirical. Research Question/Issue. This paper analyzes the importance of two aspects of the legal system in shaping firm leverage and debt maturity structure across developing countries. Research Findings/Insights. Using a larger number of developing countries compared to prior research, four main findings are obtained. First, whereas corruption increases firm debt financing, its effect is moderated when considering the impact of stronger laws. Second, the common versus civil law distinction does matter for firm financing in developing countries, but in the opposite direction documented for developed countries. Third, less corruption combined with stronger laws increases reliance on long‐term debt. Finally, by listing on a developed exchange abroad, firms in developing countries are able to raise equity and extend the maturity of their debt.Theoretical/Academic Implications. The findings on the relative importance of the legal system for firm financing decisions in developing countries do not necessarily agree with prior findings for developed countries. Future research focusing exclusively on developing countries may be warranted to better understand the drivers of private sector‐led growth in these economies. Practitioner/Policy Implications. This study reinforces the importance of strengthening public governance and laws as well as deepening capital markets in developing countries to improve financing conditions.

Who Pays for Financial Crises? Price and Quantity Rationing of Different Borrowers by Domestic and Foreign Banks

Financial crises result in price and quantity rationing of otherwise creditworthy business borrowers, but little is known about the relative severity of these two types of rationing, which borrowers are rationed most, and the roles of foreign and domestic banks. Using a dataset from 50 countries containing over 18,000 business loans with information on the lender, the borrower, and contract terms, we find that publicly-listed borrowers are rationed more by prices or interest rates, whereas privately-held borrowers are rationed more by the number of loans. Also, the global financial crisis appears to have changed how banks price borrower risk. Further, there are important differences between foreign and domestic banks and between U.S. and non-U.S. loans.

Credit Conditions and Firm Investment: Evidence from the MENA Region

The Arab Spring is a clear indicator of the urgency of achieving inclusive growth and ensuring job creation in the Middle East and North Africa (MENA) region, where private sector development is still hindered by limited access to credit. Following Kiyotaki and Moores (1997) seminal model, we apply a novel methodological approach to a unique data set of MENA firms to estimate credit limits and their impacts on capital accumulation. Notably, we find higher credit limits in countries where the Arab Spring erupted than in other MENA countries and that their marginal effect on capital accumulation has been statistically and economically significant.