BIS has released Working Paper #265, by Blaise Gadanecz, Kostas Tsatsaronis and Yener Altunbase, with the captioned title.
The paper is quite interesting. First, the authors grouped banks according to FitchRatings’ assessment of their external (state) support:
In addition to the more traditional types of creditworthiness assessment, Fitch Ratings assigns to banks ratings related to the strength of outside support. The so-called support rating is an assessment of the likelihood and level of outside financial support that the bank may receive from outside entities (the government, its owners or third parties) in case of financial difficulty. The rating scale ranges from very high support (level 1) to no support (level 5). For the purposes of this paper banks with a rating of 1 or 2 are identified as “supported”. This choice was based on the characterisation that Fitch gives to these rating classes in its manual. Level 1 support indicates “a clear legal guarantee or state support would be forthcoming”. Level 2 is assigned in cases where “state support would be forthcoming in the absence of a legal guarantee”. This choice is consistent with other studies in the literature that rely on the same indicator of safety net support.9 The ratings methodology does not strictly identify the government purse as the source of financial support. However, for the higher support rating categories the methodology points to the existence of a legal commitment or highlights the systemic importance of the institution in the national and/or international arena. For the purpose of this analysis this is treated as being practically tantamount to government support. No private entity would have the resources or the incentives to provide this financial support in the case of financial difficulty.
This was then compared with details of each bank’s participation in international syndicated loans:
The syndicated loan information has been extracted from the Dealogic Loanware database. Each loan facility record identifies the members of the syndicate and their role as senior or junior members.
…
The information on the individual loan facilities was combined with information on the syndicate banks extracted from Bankscope. This database contains details about the balance sheet composition and income statement of individual banks.
The authors conclude:
Where supported banks seem to differ substantially from their peers is the attitude towards risk. Supported banks hold portfolios of loans that are on average lower priced than a market benchmark (although some of these lower spreads may be recouped in the form of higher fees, meaning that they may be substituting revenue for risk compensation). Moreover, as senior arrangers they tend to be involved in initiating loans that carry thinner spreads that the average loan with similar characteristics. Finally, they also seem to be less responsive to indicators of balance sheet risk in deciding whether to invest on a particular loan as compared to other banks.
This relatively relaxed attitude towards risk is more problematic from a policy perspective. It is an indication that support distorts the incentives of these banks and encourages risk taking that is not remunerated by market expected returns. Combined with a non-innovative attitude towards investment also suggests that these banks are likely to be using the funding benefits of their status to engage in price competition in the international loan market. This behaviour is not compatible with the typical motivation for support, and is akin to an abuse of their privileged status.
These results shed a sceptical light on the beneficial impact of state support. Clearly, the data used in this paper cannot examine the overall behaviour of the banks, but only a small component in their activities in the international arena. More research is needed to generate a more complete picture of the impact of support on the banks. Nevertheless, the results suggest that there are externalities from state support that go beyond the national markets. Hence, they warrant a more careful consideration of the conditions at which support is made available and the governance structures in these institutions.
As the authors remarked in the introduction:
Public sector interest is often associated with the existence of explicit forms of financial support or the market perceptions of implicit guarantees should the banks come under stress. Banking is also a business of taking and managing risk. The theory of moral hazard suggests that ill-conceived insurance against downside risks may lead to distorted incentives and excessive risk taking by banks.
We can only hope that the conclusions of this paper make their way into the hands of the G-20 planners of the New World Order (Financial Department).
[…] is not a good sign for consumation of the BCE deal – even if the banks like the deal (even when properly risk-adjusted!) they might not have room for […]