TOO MANY TO FAIL Evidence of Regulatory Reluctance

TOO MANY TO FAIL? Evidence of Regulatory Reluctance in Bank Failures when the Banking Sector is Weak Craig O. Brown Serdar Dinç Craig_Brown@baruch. cuny. edu s-dinc@kellogg. northwestern. edu October 2006 Brown & Dinç

Regulation in Banking is one of the most regulated sectors (Berger et al. (1995), Barth et al. (2006)) q Entry, e. g. , restrictions on branching, scope, licensing q Operations, e. g. , capital requirements q Exit, e. g. , license revocations, government takeovers Banks can defer failure by issuing new deposits until regulators take action Brown & Dinç 2

Regulatory Reluctance & Intervention in Failing Banking Regulators seem reluctant to intervene in failing banks if the whole sector is also weak. Theory: Mitchell (2001), Acharya & Yorulmazer (JFI, forth. ) S&L Crisis in U. S. : Kane (1989), Kroszner & Strahan (JF, 1996) Banking Crisis in Japan: Hoshi & Kashyap (2001) Are these two cases exceptions? ? Brown & Dinç 3

Bank Failures in Emerging Markets q Crisis Literature (country-level): Economic, institutional, and regulatory framework that makes crises more likely e. g. , Barth et al. (2006), Beck et al. (JBF 2006), Caprio and Klingebiel (2002), Claessens et al. (2005), Demirguc-Kunt and Detragiache (1998, JME 2002) q Bank Failures in Asian Crisis (bank-level, 4 East Asian Countries): Political connections, market’s ability to predict failures Bongini et al. (JFSR 2001), Bongini et al. (JBF 2002) q Politics of Bank Failures (bank-level, 21 major emerging markets): Politicians wait until after the elections before closing/taking over a failing bank. Brown & Dinç (QJE 2005) Brown & Dinç 4

Focus of the Paper Are the regulations about failing banks implemented regardless of the health of other banks? Or, Are the regulators reluctant to close/take over failing banking if the whole sector is weak? Null Hypothesis: Government takeover or closing of a failing bank does not depend on the health of other banks (once the macroeconomic factors are controlled for) Brown & Dinç 5

Main Result: Preview Government is less likely to take over or close failing banks if other banks are also weak!! This is robust to… üBank-specific Factors; üMacroeconomic Factors; üIMF Programs; üElection Concerns Brown & Dinç 6

Sample Construction (Same sample as in Brown & Dinç (QJE 2005)) Beginning sample: Largest 10 banks in 1993 in each of 21 major countries All the emerging countries for which The Economist provides statistics, except China, and Egypt: Argentina, Brazil, Chile, Colombia, Czech, Hungary, India, Indonesia, Israel, Malaysia, Mexico, Peru, Poland, Russia, Singapore, S. Africa, S. Korea, Taiwan, Thailand, Turkey, Venezuela Main Data Sources • Bank Failures: Factiva • Ownership, Mergers: Bankscope, Factiva, Bankers’ Almanac • Balance Sheet: Bankscope Brown & Dinç 7

Banks Failures by Country (Table 1 -first half) Brown & Dinç 8

Banks Failures by Country (Table 1 - cont. ) Brown & Dinç 9

Bank Failures Around the World q Bank Failures are very common. 24% of all private banks failed. q Bank Failures are evenly distributed across the continents. q Take-over of failing banks by the Government is very common. 85% of all failures. Brown & Dinç 10

Sample Statistics (Table 2) Brown & Dinç 11

Econometric Methodology Cox Proportional Hazard analysis for the time until bank failure xi: Bank specific (and macroeconomic) variables z-i: A measure of health for other banks in the same country. (Typically, the weighted average across all other banks for a bank specific variable included in xi) Null hypothesis g=0 (a failing bank is closed regardless of other banks) Regulatory reluctance g>0 (the healthier other banks are, the more likely a bank is closed by the regulators) (Errors are clustered at the country level) Brown & Dinç 12

Regulatory Reluctance to Fail Banks if Other Banks are also Weak (Table 3) Brown & Dinç 13

Regulatory Reluctance: Robustness? Government is less likely to take over or close failing banks if other banks are also weak!! Is this effect robust to… q. Macroeconomic Factors? q. IMF Programs? q. Election Concerns? q. Additional Bank-specific Factors? Brown & Dinç 14

Regulatory Reluctance: Robustness to Macroeconomics (Table 4 A) Brown & Dinç 15

Regulatory Reluctance: Robustness to Macroeconomics (Table 4 B) Brown & Dinç 16

Regulatory Reluctance: Elections & IMF Lending (Table 5) Brown & Dinç 17

Regulatory Reluctance: Additional Bank. Level Controls (Table 6) Brown & Dinç 18

Main Result: Summary Government is less likely to take over or close failing banks if other banks are also weak!! This is robust to… üBank-specific Factors; üMacroeconomic Factors; üIMF Programs; üElection Concerns Brown & Dinç 19