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Asli Demirguc-Kunt is Chief Economist, Financial and Private Sector Development Network and Senior Research Manager, Finance and Private Sector, Development Research Group The World Bank. Ouarda Merrouche is an Economist in the Finance and Private Sector, Development Research Group, The World Bank. Demirguc-Kunt is grateful for financial support from the U. K. Department for International Development (DFID). We thank Stijn Claessens, Noel Sacasa, and seminar participants at Williams College and the IMF Institute for useful comments.
Diamond and Rajan (2000) presents a theory of bank capital in a framework that also explains why financial intermediaries exist. In this theory, capital helps bank deal with unexpected withdrawals from depositors, but increases ex post rent extraction from borrowers, which is undesirable ex ante. For a review of the literature on bank capital, see for instance Santos (2001).
In July 2010, the Basel Committee agreed to introduce a Tier 1 leverage ratio of 3 percent on a trial basis, and later on, in September 2010, it formulated new, strengthened risk-adjusted capital requirements. Specifically, the common equity ratio will increase from 2 to 4.5 percent, with an additional counter-cyclical buffer of 0-2.5 percent at the discretion of country supervisors. In addition, banks will be required to hold a ―capital conservation” buffer of an additional 2.5 percent of common equity, bringing the total to 7 percent. The Tier 1 capital requirement will increase to 6 percent from 4 percent, while the total risk-adjusted capital requirement will remain unchanged at the existing 8 percent level. Banks will be able to meet the difference between the total capital requirement and the Tier 1 requirement with Tier 2 capital. Definitions of various forms of capital have also become more stringent. Particularly, there will be stronger limits on the amount of intangible capital (mortgage servicing rights, deferred tax assets, minority interests). All changes will be phased in gradually, and the transition will have to be completed by 2019.
Only two banks in our sample were closed down during our sample period (both of them U.S. banks), so attrition bias should not be a serious concern.
For a similar empirical model relating stock returns during the financial crisis to firm characteristics, see Tong and Wei (forthcoming).
For a discussion of why it is desirable to include these variables directly in the regressions as firm characteristics rather than going through a factor model, see Tong and Wei (forthcoming) and Whited and Wu (2006).
Using a dataset of monthly U.S. stock prices and balance sheet variables from Daniel and Titman (2008), Petersen (2009) finds that standard errors clustered by time are much larger than standard errors clustered by firm, and recommends clustering by time. In our dataset, however, there appears to be little difference. Petersen also points out that clustering by time is similar to using Fama-Macbeth regressions.
The negative coefficient of the recapitalization dummy may indicate that recapitalization diluted shareholders or that it signaled bad news about the future profitability of the bank.
For instance, the median common equity ratio is 6.2 percent in the full sample but only 4.1 percent in the large bank sample.
The notional amounts of CDS contracts fell by 25 per cent between June and December 2008, as concerns about counterparty risk grew. Hart and Zingales (2009) argues that CDS contracts should be traded on an exchange where the counterparty risk can be minimized, and the positions of the various parties are transparently disclosed.
The bank’s leverage (ratio of debt to assets) should not be confused with its leverage ratio (ratio of book capital to assets).