Working Papers presented as PDF files on this page reference Portable Document Format (PDF) files. Adobe Acrobat, a reader available for free on the Internet, is required to display or print PDF files. (PDF Help)
| Working Papers – 2015 |
|---|
Stress Testing Banks: Whence and Whither? FDIC Center for Financial Research Working Paper No. 2015-07 This Version: November 2015 Published as: Kapinos, Pavel, Christopher Martin, and Oscar Mitnik. "Stress Testing Banks: Whence and Whither?" Journal of Financial Perspectives 5, no. 1 (2018):68-87. Abstract This paper provides a brief overview of the recent practice of stress testing banking institutions, focusing on capital adequacy. We argue that stress testing has been successfully used to mitigate bank opacity; quantify systemic risk under extreme but plausible stress; keep the participants mindful of severely adverse shocks, thereby mitigating "disaster myopia" and concomitant financial instability; and improve the data collection and analytical capabilities of financial institutions. Our paper then reviews several critiques of stress testing made by policymakers and academics. We also propose several modifications of the current stress-testing practice, such as the fusion of liquidity and capital adequacy stress testing, expansion of granular data availability, and explicit modeling of sectors inextricably connected to banking as well as the feedback mechanisms from these sectors. Addressing these issues is likely to keep stress testing highly relevant for promoting financial stability in the future. |
Loss Given Default for Commercial Loans at Failed Banks FDIC Center for Financial Research Working Paper No. 2015-06 This Version: October 2015 Abstract This paper extends what we know about loss given default (LGD) on commercial loans by studying certain types of these loans that have been excluded from previous research but that may be more representative of loans held by small and mid-sized banks. We use a newly available dataset on commercial loan losses from failed banks that were resolved by the FDIC using loss share agreements. We examine LGD for more than 50,000 distressed loans, broken into three categories: construction and development loans, other commercial real estate loans, and commercial and industrial loans. We compare the characteristics of these loans with those of previous studies and find many similarities as well as significant differences. We explore the relationship between LGD and default date, workout period, loan modification, asset size, bank characteristics, geography, lien status, and other factors that may be related to loss severity. The results inform commercial lenders and regulators about the factors that influence losses on defaulted loans during periods of distress, and provide a useful benchmark for stress testing for smaller banks. To the best of our knowledge, this paper also offers the first published empirical analysis of LGD for construction and development loans. |
Proving Approval: Bank Dividends, Regulation, and Runs FDIC Center for Financial Research Working Paper No. 2015-05 This Version: August 2017 Forthcoming as “A Prudential Paradox: The Signal in (not) Restricting Bank Dividends” in Journal of Money, Credit and Banking. Abstract Bank stability depends on information. Regulators can allow banks to release some information about their safety and soundness. This paper shows how dividend regulation and information interact to affect bank stability. In the model, wealth-expropriation, excess cash flow, and signaling incentives affect a bank's decision to pay dividends. The regulator aims to prevent wealth expropriation through dividend restrictions on undercapitalized banks. However, this action increases the banks' incentives to pay dividends for signaling. Signaling incentives are further exacerbated in the presence of bank runs. We show that the first best solution is achievable through dividend restrictions only if capital requirements are sufficiently high. Furthermore, a more restrictive dividend regulatory policy is optimal in stressed economic environments, when banks are more run-prone, allowing the weak banks to pool with strong. |
Small Businesses and Small Business Finance during the Financial Crisis and the Great Recession: New Evidence from the Survey of Consumer Finances FDIC Center for Financial Research Working Paper No. 2015-04 First Version: March 2015 We use the Federal Reserve's 2007, 2009 re-interview of 2007 respondents, and 2010 Surveys of Consumer Finances (SCFs) to study how small businesses owned and actively managed by households fared during those turbulent years. Even though the surveys contain extensive data on a broad cross-section of firms and their owners, to the best of our knowledge this is the first paper to use these SCFs to study small businesses. We find that the financial crisis and the Great Recession severely affected the vast majority of small businesses, including tight credit constraints. We document complex interdependencies between the finances of small businesses and their owner-manager households, including a more complicated role of housing assets than reported previously. We find that workers who lost their job during the recession responded in part by starting their own small business, and that factors related to the survival of a small business are hard to identify. Our results support the importance of relationship finance to small businesses and the primary role of commercial banks in such relationships. We find that both cross-section and panel data are needed to understand the complex factors associated with the creation, survival and failure of small businesses. JEL Codes: D12, D22, G21, L25, L26 |
What Drives Loss Given Default? Evidence From Commercial Real Estate Loans at Failed Banks FDIC Center for Financial Research Working Paper No. 2015-03 This Version: March 2015 Published as: Johnston Ross, Emily, and Lynn Shibut. “Loss Given Default, Loan Seasoning and Financial Fragility: Evidence from Commercial Real Estate Loans at Failed Banks.” The Journal of Real Estate Finance and Economics 63, no. 4 (2021): 630-661. Abstract This paper extends what we know about loss given default (LGD) by examining a newly available dataset on commercial real estate (CRE) loan losses. These data come from 295 failed banks resolved by the FDIC using loss-share agreements between 2008 and 2013. We examine over 14,000 distressed CRE loans to study the relationship between LGD and loan size, workout period, loan seasoning, asset price changes over the life of the loan, and other factors related to losses. We also examine the relationship between LGD and certain bank characteristics. The results inform commercial lenders and regulators about the factors that influence losses on defaulted loans during periods of distress. JEL Codes: G21, G32 |
A Top-Down Approach to Stress-Testing Banks FDIC Center for Financial Research Working Paper No. 2015-02 First Version: December 2013 Published as: Kapinos, Pavel S. and Oscar A. Mitnik. "A Top-Down Approach to Stress-Testing Banks." Journal of Financial Services Research (2015): 1-36. Abstract We propose a simple, parsimonious, and easily implementable method for stress-testing banks using a top-down approach that evaluates the impact of shocks to macroeconomic variables on banks' capitalization. Our method relies on a variable selection method to identify the macroeconomic drivers of banking variables combined with a principal component analysis. We show how it can be used to make projections, conditional on exogenous paths of macroeconomic variables. We also rely on this approach to identify the balance sheet and income statement factors that are key in explaining bank heterogeneity in response to macroeconomic shocks. We apply our method, using alternative estimation strategies and assumptions, to the 2013 and 2014 stress tests of medium- and large-size U.S. banks mandated by the Dodd-Frank Act, and obtain stress projections for capitalization measures at the bank-by-bank and industry-wide levels. Our results suggest that while capitalization of the U.S. banking industry has improved in recent years, under reasonable assumptions regarding growth in assets and loans, the stress scenarios can imply sizable deterioration in banks' capital positions. JEL Codes: G17, G21, G28 |
Bank Size, Leverage, and Financial Downturns FDIC Center for Financial Research Working Paper No. 2015-01 First Version: October 2013 Abstract I construct a macroeconomic model with a heterogeneous banking sector and an interbank lending market. Banks differ in their ability to transform deposits from households into loans to firms. Bank size differences emerge endogenously in the model, and in steady state, the induced bank size distribution matches two stylized facts in the data: bigger banks borrow more on the interbank lending market than smaller banks, and bigger banks are more leveraged than smaller banks. I use the model to evaluate the impact of increasing concentration in US banking on the severity of potential downturns. I find that if the banking sector in 2007 was only as concentrated as it was in 1992, GDP during the Great Recession would have declined by much less than it did, and would have recovered faster. JEL Codes: E02, E44, E61, G01, G21 |
The Center for Financial Research (CFR) Working Paper Series allows CFR staff and their coauthors to circulate preliminary research findings to stimulate discussion and critical comment. Views and opinions expressed in CFR Working Papers reflect those of the authors and do not necessarily reflect those of the FDIC or the United States. Comments and suggestions are welcome and should be directed to the authors. References should cite this research as a “FDIC CFR Working Paper” and should note that findings and conclusions in working papers may be preliminary and subject to revision.