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Bank systemic risk and the business cycle: An empirical investigation using Canadian data

Listed author(s):
  • Christian Calmès

    ()

    (Chaire d'information financière et organisationnelle ESG-UQAM, Laboratory for Research in Statistics and Probability, Université du Québec (Outaouais))

  • Raymond Théoret

    ()

    (Chaire d'information financière et organisationnelle ESG-UQAM, Université du Québec (Montréal), Université du Québec (Outaouais))

Since financial institutions are subjected to increasingly tighter requirements regarding the way they conduct their loan business, we could assume that built-in regulatory pressures induce them to adopt collective business strategies, with the unintended consequence of persistently weakening the banking system ability to cope with external shocks. Surprisingly, we find rather the opposite. This paper documents how banks, as a group, react to macroeconomic risk and uncertainty, and more specifically the way banks systemic behaviour evolves over the business cycle. Adopting the methodology of Beaudry et al. (2001), our results clearly indicate that the dispersion across banks traditional portfolios has actually increased through time. We introduce an estimation procedure based on EGARCH and re-fine Baum et al. (2002, 2004, 2009) and Quagliariello (2007, 2009) framework to analyze the question in the new industry context, i.e. shadow banking. Consistent with finance theory, we first confirm that banks tend to behave homogeneously vis-à-vis macroeconomic uncertainty. Additionally, we find that the cross-sectional dispersions of loans to assets and non-traditional activities shrink essentially during downturns, when the resilience of the banking system is at its lowest. Our results also indicate that banks herd-like behaviour remains predominantly a cyclical phenomenon, almost unaffected by the new banking environment. Most importantly however, the cross-sectional dispersion of market-oriented ac-tivities appears to be both more volatile and sensitive to the business cycle than the dispersion of the traditional banking business lines.

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Paper provided by Département des sciences administratives, UQO in its series RePAd Working Paper Series with number UQO-DSA-wp322011.

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Length: 50 pages
Date of creation: 19 Dec 2011
Handle: RePEc:pqs:wpaper:322011
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