Essays on Bank Risk

abstractita

This thesis comprises research on banks’ risk. The work is presented in three empirical essays. The first essay investigates the relationship between bank capital and liquidity and the impact of those connections on the market probability of default. Using quarterly balance sheet data of large European banks over the period 2005-2015 and various configurations of capital and liquidity; we first analyse through a simultaneous equation model the connections between capital and liquidity. The results of the model show a bidirectional positive relationship between capital and funding liquidity risk in line with the “financial fragility” and the “crowding out of deposits” hypotheses developed in theoretical papers. The results also indicate the importance of off-balance sheet exposures and the limitation of risk based capital ratios in explaining the relationship. Given the importance of capital and liquidity for financial stability, in the second part of the paper we explore whether those variables provide incremental information on banks’ risk. To do so, we use a factor model to analyse if leverage and funding liquidity risk are reflected in CDS spreads. We find that capital appears to have a large impact on CDS spread changes, while liquidity risk is priced only when it falls below the regulatory threshold. The second essay examines the causal effect of bank credit rating changes on bank capital structure decisions. In this paper, we hypothesize that bank managers’ concern for credit ratings due to the discrete cost and benefits associated with different credit levels. Using a unique data set with quarterly detailed information on rating changes and bank’s balance sheets for 76 banks based in EU and US from 2005Q1 to 2015Q4, we find that rating changes matter for bank capital structure decisions. More precisely, we find that a downgrade event triggers reductions in leverage, long-term funding and lending. While upgrades do not cause capital structure adjustments. In doing our empirical exercise, we also exploit the asymmetric impact of rating changes of banks based in countries that experienced the sovereign debt crisis. This asymmetric effect leads to greater: capital adjustments, reductions in long-term funding and lending of banks from those stressed countries. The third essay examines how bank risks affects the transmission mechanism of unconventional monetary policy measures taken by the Federal Reserve (FED) in response to the financial crisis. Using quarterly balance sheet data and employing a GMM approach, for a sample of 149 US banks over the period 2007 to 2016, I find that bank risk positions are relevant for the transmission mechanism through the bank lending channel during the FED Quantitative easing (QE) programmes. The empirical findings suggest that QE programs helped banks to supply new loans through the reduction of bank risk conditions, as perceived by financial market investors.