A healthy banking system is a fundamental condition for financial stability. When assessing the riskiness of the banking system, analysts often restrict their focus to large banks. This may create a distorted picture in countries like Germany with fragmented banking systems. In Germany, savings banks and cooperative banks taken together are important players in the market. However, little is known about their default risk. The reason is that these banks usually resolve financial distress within their own organisations, which means defaults are not observable from the outside. In this paper we use a new dataset which contains information about financial distress and financial strength of all German savings banks and cooperative banks. The data have been gathered by the Deutsche Bundesbank for microprudential supervision and have never before been exploited for macroprudential purposes. We use the data to identify the main risk drivers. To this end we estimate a default prediction model (hazard model). A second goal of the paper is to analyse the impact of macroeconomic information for forecasting banks' defaults. Recent findings for the USA have cast some doubt on the usefulness of macroeconomic information for banks' risk assessment. Contrary to recent literature, we find that macroeconomic information significantly improves default forecasts. Keywords:bank failure, default probability, time-discrete hazard rate Non-technical summaryThere is little evidence on the default risk of German savings banks and cooperative banks, although they constitute an integral part of the German banking system. Our aim is to develop a statistical system which estimates probabilities of default (PDs) for savings banks and cooperative banks. We also try to find evidence for the importance of macroeconomic developments for the estimation of PD. Since we adopt a prudential supervisory perspective, default is defined as any event that jeopardises the bank's viability as a going concern.The paper uses a dataset from the Deutsche Bundesbank that combines default events with balance sheet information, audit reports, and macroeconomic variables. The data is used to estimate a discrete hazard model. Hazard models are particularly suited for our purposes because they simultaneously include macroeconomic and microeconomic data.Our main findings are as follows.

Should banks be diversified or focused? Does diversification indeed lead to enhanced performance and, therefore, greater safety for banks, as traditional portfolio and banking theory would suggest?This paper investigates the link between banks' profitability (ROA) and their portfolio diversification across different industries, broader economic sectors and geographical regions measured by the Herfindahl Index. To explore this issue, we use a unique data set of the individual bank loan portfolios of 983 German banks for the period from 1996 to 2002. The overall evidence we provide shows that there are no large performance benefits associated with diversification since each type of diversification tends to reduce the banks' returns. Moreover, we find that the impact of diversification depends strongly on the risk level. However, it is only for moderate risk levels and in the case of industrial diversification that diversification significantly improves the banks' returns.Keywords: focus, diversification, monitoring, bank returns, bank risk JEL Classification: G21, G28, G32 Non-Technical SummaryShould banks be diversified or focused? Does diversification indeed lead to enhanced performance and therefore greater safety for banks as traditional portfolio and banking theory would suggest? In this paper we try to shed some light on these questions by empirically investigating the situation for German banks. By exploiting a unique data set of individual bank loan portfolios for the period from 1996 to 2002, we analyse the link between banks' profitability measured by ROA and their portfolio diversification measured by the Herfindahl Index across different industries, broader economic sectors and geographical regions. To the best of the authors' knowledge, this is the first paper to study the effect of all three types of diversification based jointly on micro-level data on German banks.The relevant academic literature puts forward two conflicting theories concerning the optimal degree of diversification. While traditional banking and portfolio theory recommends that banks should be as diversified as possible to reduce their risks of suffering a costly bank failure, corporate finance theory suggests that a bank should focus so as to obtain the greatest possible benefit from management's expertise and to reduce agency problems.Our results clearly support the latter theory, as the evidence we present indicates that each kind of diversification tends to lower German banks' returns, ie focusing generally increases profitability.Furthermore, the impact of any diversification on banks' return changes in line with the risk level.While the effect of sectoral focus on return declines monotonously with increasing risk, there is mixed evidence to suggest either a monotonously decreasing or a U-shaped relationship for regional focus as well as a rather distinct indication of a U-shape with respect to industrial focus. In addition, our data shows that diversification significantly improves banks' profits only in the case of mo...

The inability of most bank merger studies to control for hidden bailouts may lead to biased results. In this study, we employ a unique data set of approximately 1,000 mergers to analyze the determinants of bank mergers. We use data on the regulatory intervention history to distinguish between distressed and non-distressed mergers. We find that, among merging banks, distressed banks had the worst profiles and acquirers perform somewhat better than targets. However, both distressed and non-distressed mergers have worse CAMEL profiles than our control group. In fact, non-distressed mergers may be motivated by the desire to forestall serious future financial distress and prevent regulatory intervention.

Should banks be diversified or focused? Does diversification indeed lead to enhanced performance and, therefore, greater safety for banks, as traditional portfolio and banking theory would suggest?This paper investigates the link between banks' profitability (ROA) and their portfolio diversification across different industries, broader economic sectors and geographical regions measured by the Herfindahl Index. To explore this issue, we use a unique data set of the individual bank loan portfolios of 983 German banks for the period from 1996 to 2002. The overall evidence we provide shows that there are no large performance benefits associated with diversification since each type of diversification tends to reduce the banks' returns. Moreover, we find that the impact of diversification depends strongly on the risk level. However, it is only for moderate risk levels and in the case of industrial diversification that diversification significantly improves the banks' returns.Keywords: focus, diversification, monitoring, bank returns, bank risk JEL Classification: G21, G28, G32 Non-Technical SummaryShould banks be diversified or focused? Does diversification indeed lead to enhanced performance and therefore greater safety for banks as traditional portfolio and banking theory would suggest? In this paper we try to shed some light on these questions by empirically investigating the situation for German banks. By exploiting a unique data set of individual bank loan portfolios for the period from 1996 to 2002, we analyse the link between banks' profitability measured by ROA and their portfolio diversification measured by the Herfindahl Index across different industries, broader economic sectors and geographical regions. To the best of the authors' knowledge, this is the first paper to study the effect of all three types of diversification based jointly on micro-level data on German banks.The relevant academic literature puts forward two conflicting theories concerning the optimal degree of diversification. While traditional banking and portfolio theory recommends that banks should be as diversified as possible to reduce their risks of suffering a costly bank failure, corporate finance theory suggests that a bank should focus so as to obtain the greatest possible benefit from management's expertise and to reduce agency problems.Our results clearly support the latter theory, as the evidence we present indicates that each kind of diversification tends to lower German banks' returns, ie focusing generally increases profitability.Furthermore, the impact of any diversification on banks' return changes in line with the risk level.While the effect of sectoral focus on return declines monotonously with increasing risk, there is mixed evidence to suggest either a monotonously decreasing or a U-shaped relationship for regional focus as well as a rather distinct indication of a U-shape with respect to industrial focus. In addition, our data shows that diversification significantly improves banks' profits only in the case of mo...

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in ______________________________________________________________________ AbstractThe aim of this paper is to assess how German savings banks adjust capital and risk under capital regulation. We estimate a modified version of the model developed by Shrieves and Dahl (1992). In comparison to former research, we impose fewer restrictions with regard to the impact of regulation on capital and risk adjustments. Besides, we complement our analysis with dynamic panel data techniques and a rolling window approach.We find evidence that the coordination of capital and risk adjustments depends on the amount of capital the bank holds in excess of the regulatory minimum (the so-called capital buffer). Banks with low capital buffers try to rebuild an appropriate capital buffer by raising capital and simultaneously lowering risk. In contrast, banks with high capital buffers try to maintain their capital buffer by increasing risk when capital increases.