Equity returns in the banking sector in the wake of the Great Recession and the European sovereign debt crisis

Abstract

Another result of this study is that higher capitalization and lower leverage make banks' equity returns more resilient to adverse economic and sovereign risk shocks. The measure of bank capital matters: the equity to asset ratio has a positive effect on equity returns but the more commonly used Tier-1 capital to risk-weighted assets has an insignificant effect, partly owing to the fact that risk-weighted assets may fail to reflect risks adequately. This finding suggests that while official efforts to increase bank capital are well directed and should be commended, careful thought should be exercised on the choice of the right bank capitalization metric. We also find that the equity returns of banks less reliant on wholesale funding, as approximated by the loan to deposit ratio, tend to outperform after controlling for other variables. Higher reliance on wholesale funding, which is generally short-term, makes banks more vulnerable to funding shortages during periods of extreme market uncertainty. In contrast, deposits tend to be a more stable funding source. Nicht-technische Zusammenfassung AbstractThis study finds that equity returns in the banking sector in the wake of the Great Recession and the European sovereign debt crisis have been driven mainly by weak growth prospects and heightened sovereign risk and to a lesser extent, by deteriorating funding conditions and investor sentiment. While the equity return performance in the banking sector has been dismal in general, better capitalized and less leveraged banks have outperformed their peers, a finding that supports policymakers' efforts to strengthen bank capitalization.JEL Classification: G01, G14, G21

Innovative Empirical Model for Predicting National Banks’ Financial Failure with Artificial Intelligence Subset Data Analysis in the United States

“…Despite the massive programs introduced during the Great Economic Recession, banks still face an upward climb as it pertains to being repeatedly downgraded and having declining equity prices. According to Chan-Lau et al (2015), weak growth prospects and heightened solvent risk are driving the returns on equity within the banking sector after the Great Economic Recession and the European sovereign debt crisis. However, even with dismal ROE performance, the banking sector is showing evidence that is has outperformed its peers during these times.…”

“…The authors' findings did suggest that capital played a vital role in shielding banks during times of extreme stress. Thus, high reliance on wholesale funding made banks more vulnerable to shortages during the period of market uncertainty (Chan-Lau et al, 2015). Duffie (2010) and Gorton and Metrick (2012) reiterated this in their separate studies of the Great Economic Recession of 2008.…”

“…Even so, one may ask how the Great economics recession influenced equity. Chan-Lau, Liu, and Schmittmann (2015) analyzed how the Great Economic Recession of 2008 influenced the ongoing debt crisis in the euro area. Despite its large centralized banks, euro area banks still faced significant operating challenges.…”

How the euro-area sovereign-debt crisis led to a collapse in bank equity prices

“…Among the factors that were found to influence bank performance were the following: (1) measures of market characteristics, including economies of scale, management efficiency, and bank size; (2) bank characteristics, including capital positions, loan-to-deposit ratios, and equity-to-total assets ratios; and (3) indicators of macroeconomic performance, including economic growth and the state of the business cycle. Recent studies that take into account the crisis period (beginning in 2007) include Yang and Tsatsaronis (2012), Chan-Lau, Liu and Schmittmann (2014) and Castrén, Fitzpatrick and Sydow (2006). 1 The effects of sovereign risk on bank performance have been less researched than the factors (i.e., bank characteristics and indicators of macroeconomic performance) mentioned above.…”

Extreme Returns in the European financial crisis

“…Another paper that studies the effect of the European Financial Crisis on stock returns is Chan‐Lau et al . (), but this paper only takes into account the stocks of 68 banks. Indeed, the study of bank stocks is significant during a financial crisis, but this paper goes a step beyond and studies the behaviour of 15 stock indices.…”