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Market discipline under systemic risk - evidence from bank runs in emerging economies

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  • Levy-Yeyati, Eduardo
  • Martinez Peria, Maria Soledad
  • Schmukler, Sergio L.

Abstract

The authors show that systemic risk exerts a significant impact on the behavior of depositors, sometimes overshadowing their responses to standard bank fundamentals. Systemic risk can affect market discipline both regardless of and through bank fundamentals. First, worsening systemic conditions can directly threaten the value of deposits by way of dual agency problems. Second, to the extent that banks are exposed to systemic risk, systemic shocks lead to a future deterioration of fundamentals not captured by their current values. Using data from the recent banking crises in Argentina and Uruguay, the authors show that market discipline is indeed quite robust once systemic risk is factored in. As systemic risk increases, the informational content of past fundamentals declines. These episodes also show how few systemic shocks can trigger a run irrespective of ex-ante fundamentals. Overall, the evidence suggests that in emerging economies, the notion of market discipline needs to account for systemic risk.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3440.

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Date of creation: 01 Nov 2004
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Handle: RePEc:wbk:wbrwps:3440

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Keywords: Payment Systems&Infrastructure; Financial Intermediation; Financial Crisis Management&Restructuring; Banks&Banking Reform; Labor Policies; Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Insurance&Risk Mitigation; Environmental Economics&Policies;

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References

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  1. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  2. Andrea Sironi, 2001. "Testing for market discipline in the European banking industry: evidence from subordinated debt issues," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 366-384.
  3. Abhiman Das & Saibal Ghosh, 2004. "Market Discipline In The Indian Banking Sector: An Empirical Exploration," Finance 0410020, EconWPA.
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  6. Augusto de la Torre & Eduardo Levy Yeyati & Sergio L. Schmukler, 2003. "Living and Dying with Hard Pegs: The Rise and Fall of Argentina's Currency Board," Journal of LACEA Economia, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  7. Eduardo Levy Yeyati & Tito Cordella, 1997. "Public Disclosure and Bank Failures," IMF Working Papers 97/96, International Monetary Fund.
  8. Martinez Peria, Maria Soledad & Schmukler, Sergio L., 1999. "Do depositors punish banks for"bad"behavior? : market discipline in Argentina, Chile, and Mexico," Policy Research Working Paper Series 2058, The World Bank.
  9. Roberto Steiner & Adolfo Barajas, 2000. "Depositor Behavior and Market Discipline in Colombia," IMF Working Papers 00/214, International Monetary Fund.
  10. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  11. Maria Soledad Martinez Peria, 2001. "Do Depositors Punish Banks for Bad Behavior? Market Discipline, Deposit Insurance, and Banking Crises," Journal of Finance, American Finance Association, vol. 56(3), pages 1029-1051, 06.
  12. Allen N. Berger, 1991. "Market discipline in banking," Proceedings, Federal Reserve Bank of Chicago, pages 419-437.
  13. Brenda González-Hermosillo, 1999. "Determinants of Ex-Ante Banking System Distress: A Macro-Micro Empirical Exploration of Some Recent Episodes," IMF Working Papers 99/33, International Monetary Fund.
  14. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
  15. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt as bank capital: a proposal for regulatory reform," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 40-53.
  16. Demirguc-Kunt, Asli & Huizinga, Harry, 2004. "Market discipline and deposit insurance," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 375-399, March.
  17. Schumacher, Liliana, 2000. "Bank runs and currency run in a system without a safety net: Argentina and the 'tequila' shock," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 257-277, August.
  18. Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
  19. Eduardo Levy Yeyati & Maria Soledad Martinez Peria & Sergio Schmukler, 2004. "Market Discipline in Emerging Economies: Beyond Bank Fundamentals," Business School Working Papers marketdiscipline, Universidad Torcuato Di Tella.
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Citations

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Cited by:
  1. Agustin Villar, 2006. "Is financial stability policy now better placed to prevent systemic banking crises?," BIS Papers chapters, in: Bank for International Settlements (ed.), The banking system in emerging economies: how much progress has been made?, volume 28, pages 99-122 Bank for International Settlements.
  2. Ghosh, Saibal & Das, Abhiman, 2005. "Market Discipline, Capital Adequacy and Bank Behaviour: Theory and Indian Evidence," MPRA Paper 17398, University Library of Munich, Germany.
  3. Renzo G. Avesani, 2005. "FIRST: A Market-Based Approach to Evaluate Financial System Risk and Stability," IMF Working Papers 05/232, International Monetary Fund.
  4. Alain Ize & Eduardo Levy Yeyati, 2005. "Financial De-Dollarization: Is It for Real?," Business School Working Papers isitforreal, Universidad Torcuato Di Tella.
  5. Eduardo Levy Yeyati, 2004. "Dollars, Debt and the IFIs: Dedollarizing Multilateral Lending," Business School Working Papers dedollmultlending, Universidad Torcuato Di Tella.
  6. Eduardo Levy Yeyati & Maria Soledad Martinez Peria & Sergio Schmukler, 2004. "Market Discipline in Emerging Economies: Beyond Bank Fundamentals," Business School Working Papers marketdiscipline, Universidad Torcuato Di Tella.
  7. Christoph Trebesch, 2009. "The Cost of Aggressive Sovereign Debt Policies: How Much is thePrivate Sector Affected?," IMF Working Papers 09/29, International Monetary Fund.

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