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The role of relative performance in bank closure decisions

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  • Kenneth Kasa
  • Mark M. Spiegel

Abstract

This paper studies a banking industry subject to common and idiosyncratic shocks. We compare two types of regulatory closure rules: (1) an “absolute closure rule,” which closes banks when their asset–liability ratios fall below a given threshold, and (2) a “relative closure rule,” which closes banks when their asset–liability ratios fall sufficiently below the industry average. There are two main results: First, relative closure rules imply forbearance during “bad times,” defined as adverse realizations of the common shock. This forbearance occurs for incentive reasons, not because of irreversibilities or political economy considerations. Second, relative closure rules are less costly to taxpayers, and these savings increase with the relative variance of the common shock. To evaluate the model, we estimate a panel-logit regression using a sample of U.S. commercial banks. We find strong evidence that U.S. bank closures are based on relative performance. Individual and average asset-liability ratios are both significant predictors of bank closure.

Suggested Citation

  • Kenneth Kasa & Mark M. Spiegel, 2008. "The role of relative performance in bank closure decisions," Economic Review, Federal Reserve Bank of San Francisco, pages 17-29.
  • Handle: RePEc:fip:fedfer:y:2008:p:17-29
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    References listed on IDEAS

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    1. Mailath George J. & Mester Loretta J., 1994. "A Positive Analysis of Bank Closure," Journal of Financial Intermediation, Elsevier, vol. 3(3), pages 272-299, June.
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    3. Nagarajan, S. & Sealey, C. W., 1995. "Forbearance, deposit insurance pricing, and incentive compatible bank regulation," Journal of Banking & Finance, Elsevier, vol. 19(6), pages 1109-1130, September.
    4. Giammarino, Ronald M & Lewis, Tracy R & Sappington, David E M, 1993. " An Incentive Approach to Banking Regulation," Journal of Finance, American Finance Association, vol. 48(4), pages 1523-1542, September.
    5. Fries, Steven & Mella-Barral, Pierre & Perraudin, William, 1997. "Optimal bank reorganization and the fair pricing of deposit guarantees," Journal of Banking & Finance, Elsevier, vol. 21(4), pages 441-468, April.
    6. Mark E. Levonian, 1991. "What happens if banks are closed "early"?," Proceedings 321, Federal Reserve Bank of Chicago.
    7. Nagarajan, S. & Sealey, C. W., 1998. "State-contingent regulatory mechanisms and fairly priced deposit insurance," Journal of Banking & Finance, Elsevier, vol. 22(9), pages 1139-1156, September.
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    Cited by:

    1. Acharya, Viral V & Yorulmazer, Tanju, 2005. "Cash-in-the-Market Pricing and Optimal Bank Bailout Policy," CEPR Discussion Papers 5154, C.E.P.R. Discussion Papers.
    2. Di Nicolo, G. & Gamba, A. & Lucchetta, M., 2011. "Capital Regulation, Liquidity Requirements and Taxation in a Dynamic Model of Banking," Discussion Paper 2011-090, Tilburg University, Center for Economic Research.
    3. Ignatowski, Magdalena & Korte, Josef, 2014. "Wishful thinking or effective threat? Tightening bank resolution regimes and bank risk-taking," Journal of Financial Stability, Elsevier, vol. 15(C), pages 264-281.
    4. repec:taf:rjapxx:v:14:y:2009:i:1:p:5-26 is not listed on IDEAS
    5. Spiegel, Mark M., 2000. "Bank Charter Value and the Viability of the Japanese Convoy System," Journal of the Japanese and International Economies, Elsevier, vol. 14(3), pages 149-168, September.
    6. Korte, Josef, 2015. "Catharsis—The real effects of bank insolvency and resolution," Journal of Financial Stability, Elsevier, vol. 16(C), pages 213-231.
    7. Acharya, Viral V. & Yorulmazer, Tanju, 2007. "Too many to fail--An analysis of time-inconsistency in bank closure policies," Journal of Financial Intermediation, Elsevier, vol. 16(1), pages 1-31, January.
    8. Mark M. Spiegel, 1999. "Moral hazard under the Japanese "convoy" banking system," Economic Review, Federal Reserve Bank of San Francisco, pages 3-13.

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    Keywords

    Bank failures ; Problem banks;

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