The role of relative performance in bank closure decisions
This paper studies a competitive banking industry subject to common and idiosyncratic shocks. The induced correlation across bank portfolio returns can be used by a regulator to improve inferences about bank portfolio choices. We compare two types of closure rules: (1) an 'absolute closure rule', which closes banks when their own individual asset/liability ratios fall below a given threshold, and (2) a 'relative closure rule', which closes banks when their asset/liability ratios fall below the industry average by a given amount. ; Two main results emerge from the model. First, a relative closure rule implies 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, a relative closure rule is less costly to taxpayers, and the cost 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 for the period 1992 through 1997. 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, and their coefficient estimates are consistent with the theory. We conclude that relative performance is a valuable input to bank closure decisions, and that U.S. bank regulators seem to be aware of this.
|Date of creation:||1999|
|Contact details of provider:|| Postal: P.O. Box 7702, San Francisco, CA 94120-7702|
Phone: (415) 974-2000
Fax: (415) 974-3333
Web page: http://www.frbsf.org/
More information through EDIRC
|Order Information:|| Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- Nagarajan, S. & Sealey, C.W., 1993.
"Forbearance, Deposit Insurance Pricing, and Incentive Compatible Bank Regulation,"
93-05, Columbia - Graduate School of Business.
- 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.
- 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.
- Fries,S. & Mella-Barral,P. & Perraudin,W.R.M., 1995. "Optimal Bank Reorganisation and the Fair Pricing of Deposit Garantees," Cambridge Working Papers in Economics 9417, Faculty of Economics, University of Cambridge.
- Giammarino, R.M. & Sappington, D.E.M., 1990.
"An Incentive Approach to Banking Regulation,"
367, California Davis - Institute of Governmental Affairs.
- George J. Mailath & Loretta J. Mester, 1993.
"A positive analysis of bank closure,"
94-2, Federal Reserve Bank of Philadelphia.
- Lazear, Edward P & Rosen, Sherwin, 1981.
"Rank-Order Tournaments as Optimum Labor Contracts,"
Journal of Political Economy,
University of Chicago Press, vol. 89(5), pages 841-864, October.
- Mark E. Levonian, 1991. "What happens if banks are closed "early"?," Proceedings 321, Federal Reserve Bank of Chicago.
When requesting a correction, please mention this item's handle: RePEc:fip:fedfap:99-07. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Diane Rosenberger)
If references are entirely missing, you can add them using this form.