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How might financial market information be used for supervisory purposes?

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Author Info

  • John Krainer
  • Jose A. Lopez

Abstract

Bank supervisory monitoring, both on-site and off-site, generates a wealth of information with which to judge the safety and soundness of banks and bank holding companies (BHCs). For BHCs with publicly traded securities, the monitoring efforts of investors generate additional information that may complement the supervisory information set. In this paper, we address three public policy questions related to how supervisors might use this financial market information. First, can financial markets detect changes in BHC risk characteristics? To address this question, we summarize the academic literature on the topic and present our own empirical results using BHC stock returns and bond spreads. We find that securities prices signal changes in supervisory ratings of BHC condition up to a year prior to their assignment. Second, do securities prices provide information that complements supervisory information? Using forecasts generated by an off-site monitoring model developed by Krainer and Lopez (2001), we find that securities prices do improve forecasts of supervisory ratings changes, although the improvement is not statistically significant. Third, what is an appropriate level of accuracy to demand of financial market signals and off-site monitoring models more generally? We examine this question by studying the model's ratio of correct forecasts to incorrect forecasts.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Economic Review.

Volume (Year): (2003)
Issue (Month): ()
Pages: 29-45

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Handle: RePEc:fip:fedfer:y:2003:p:29-45

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Keywords: Financial markets ; Risk ; Bank supervision;

References

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  1. Rebel Cole & Jeffery Gunther, 1998. "Predicting Bank Failures: A Comparison of On- and Off-Site Monitoring Systems," Journal of Financial Services Research, Springer, vol. 13(2), pages 103-117, April.
  2. Diana Hancock & Myron Kwast, 2001. "Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?," Journal of Financial Services Research, Springer, vol. 20(2), pages 147-187, October.
  3. Julapa Jagtiani & George Kaufman & Catharine Lemieux, 1999. "Do markets discipline banks and bank holding companies? evidence from debt pricing," Emerging Issues, Federal Reserve Bank of Chicago, issue Jun.
  4. Berger, Allen N & Davies, Sally M & Flannery, Mark J, 2000. "Comparing Market and Supervisory Assessments of Bank Performance: Who Knows What When?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 641-67, August.
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  8. DeYoung, Robert, et al, 2001. "The Information Content of Bank Exam Ratings and Subordinated Debt Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(4), pages 900-925, November.
  9. Diana Hancock & Myron L. Kwast, 2001. "Using subordinated debt to monitor bank holding companies: is it feasible?," Finance and Economics Discussion Series 2001-22, Board of Governors of the Federal Reserve System (U.S.).
  10. Bongini, Paola & Laeven, Luc & Majnoni, Giovanni, 2002. "How good is the market at assessing bank fragility? A horse race between different indicators," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1011-1028, May.
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  15. Beverly J. Hirtle, 1996. "Derivatives, Portfolio Composition and Bank Holding Company Interest Rate Risk Exposure," Center for Financial Institutions Working Papers 96-43, Wharton School Center for Financial Institutions, University of Pennsylvania.
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  17. Arturo Estrella & Sangkyun Park & Stavros Peristiani, 2000. "Capital ratios as predictors of bank failure," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 33-52.
  18. Gropp, Reint & Richards, Anthony J., 2001. "Rating agency actions and the pricing of debt and equity of European banks: What can we infer about private sector monitoring of bank soundness?," Working Paper Series 0076, European Central Bank.
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  21. Mark Flannery, 2001. "The Faces of “Market Discipline”," Journal of Financial Services Research, Springer, vol. 20(2), pages 107-119, October.
  22. Robert R. Bliss, 2000. "The pitfalls in inferring risk from financial market data," Working Paper Series WP-00-24, Federal Reserve Bank of Chicago.
  23. Jeffery W. Gunther & Mark E. Levonian & Robert R. Moore, 2001. "Can the stock market tell bank supervisors anything they don't already know?," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q II, pages 2-9.
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Citations

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Cited by:
  1. Kyle Moore & Chen Zhou, 2012. "Identifying systemically important financial institutions: size and other determinants," DNB Working Papers 347, Netherlands Central Bank, Research Department.
  2. Martin CIHAK, 2007. "Systemic Loss: A Measure of Financial Stability (in English)," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(1-2), pages 5-26, March.
  3. Curry, Timothy J. & Elmer, Peter J. & Fissel, Gary S., 2007. "Equity market data, bank failures and market efficiency," Journal of Economics and Business, Elsevier, vol. 59(6), pages 536-559.
  4. Peresetsky, A. A., 2011. "What factors drive the Russian banks license withdrawal," MPRA Paper 41507, University Library of Munich, Germany.

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