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

The Impact of the Eurozone Crisis on European Banks Stocks Contagion or Interdependence?

“…Indeed, either L SOV  and/or NL SOV  are negative and their sum is always below zero: when the VSTOXX surges above a threshold (c) estimated between 30 (for Spain) and 63 (for the UK) European banks stock returns drop in response to a rise in the Sovereign risk of the three countries most adversely hit by the European sovereign debt crisis. This finding is consistent with the results of Chan-Lau et al (2012) and Grammatikos and Vermeulen (2012)  =0 cannot be rejected), but nonetheless significant. For some countries, such as Greece or Spain, the negative impact is more sizable ( L SOV  being larger) -which may explain why Arnold (2012) mainly captures this effect -though it does not appear to be further strengthened when the VSTOXX increases sharply.…”

Risk Exposures and Financial Spillovers in Tranquil and Crisis Times: Bank-Level Evidence

“…The result holds in 2011 but again only for the European sub-sample. This is in line with similar findings in Chan-Lau et al (2012).…”

“… Finally, both the results of Tressel (2011) and Chan-Lau et al (2012) suggest that the coefficient on exposure to sovereign crisis countries has an expected positive sign.…”

“…Several recent studies have focused on banks' equity returns during the current EA crisis, using regressions of changes in bank stock returns or CDS spreads on macroeconomic and bank-specific variables. Chan-Lau et al (2012) find that bank equity returns have been driven mainly by weak growth prospects and heightened sovereign risk and to a lesser extent, by deteriorating funding conditions and investor sentiment. Banks with a greater reliance on wholesale funding and a low ratio of equity capital to assets are found to underperform their peers.…”

Deciphering financial contagion in the euro area during the crisis

“…However, our analysis does not allow us to draw conclusions about the ultimate success or failure of these policy responses. 8 The statistical approach identifies days during which sovereign bond markets exhibit unusually large movements. The test for contagion focuses squarely on those particular days.…”