Financial penalties and the systemic risk of banks · 2017. 6. 28. · Scopeofthepaper 1: Motivation HannesKoesterandMatthiasPelster(Leuphana) 2/23 HannesKoesterandMatthiasPelster

Financial penalties and thesystemic riskofbanks

Hannes Koester and Matthias PelsterLeuphana University Lüneburg

June 28th, 2017

Scope of the paper1: Motivation

Hannes Koester and Matthias PelsterHannes Koester and Matthias Pelster(Leuphana) 2/23

Continuously increasing financial penalties over the last fewyearsConcerns about the impact of these penalties on the bankingindustry have been voicedESRB warns that the levels of financial penalties might posesystemic risk

Total financial penalties (in Mio. USD)1: Motivation


Origin of financial penalties (fraction of TA)1: Motivation


Contribution1: Motivation


First paper that investigates the relationship between financialpenalties and the systemic risk of banks:

Informs the debate on the design of a well-functioningregulatory environmentExtends the literature on the determinants of systemic riskContributes to the literature on corporate misconduct byfocusing on the dimension of riskResults will be helpful for banking supervisors andpolicymakers

Hypothesis development2: Hypothesis


Financial penalties might ...restore the investors’ and customers’ confidence in the bankingsystem a�er a misconduct scandalprevent repeated future o�enses of banksencourage banks not to enter specific businesses that areassociated with excessive risk-taking and thus are related with ahigher systemic risk

Financial penalties might debilitate banks to such extent thatthey ...

are more vulnerable for global crisesmight collapse and initiate a cascade of bank failures via directlinkagesmight transmit losses via indirect linkages between banks (firesales, information spillovers)discontinue specific financial services and no substitutes arereadily available

Hypothesis development2: Hypothesis


Systemic risk exposure: Measures the extent to which a bankis a�ected by a system-wide collapse.

Financial penalties may weaken the banks andmake themmore vulnerable for systemic events.

Systemic risk contribution: Measures the sensitivity of thefinancial system to a negative shock in a single bank.

Financial penalties could increase public concerns about thebusiness model and solvency of banks.Bankmay withdraw from specific financial markets, such thatthe functioning of a particular market is undermined.

H1: The financial penalties of a bank will increase a bank’ssytemic risk.

Data3: Data andmethodology


Hand-collected database671 cases of financial penalties (2007-2014)68 banks from 20 countriesNewspaper archives and banking authorities databases

Thomson Worldscope databaseThomson Reuters Financial Datastream

Methodology I3: Data andmethodology


Fixed e�ects panel regressions

Systemic riskit = α + β1PENALTYit +J∑j=2

βjXjit

+T∑k=1

γkYear_(k)it +N∑k=1

κkBank_(k)it + εit

Systemic riskit: MES and∆CoVaRPENALTYit: Sum of financial penalties to total assetsXit: control variables (SIZE, INC, FUND, ...)time-fixed and bank-fixed e�ects to control for unobservedheterogeneity

Methodology II3: Data andmethodology


Marginal Expected Shortfall (ES): systemic risk exposureMeasures the extent to which a bank is a�ected by asystem-wide collapseMeasures the average return of each bank during days when themarket as a whole experiences enormous downwardmovements

Conditional Value at Risk (∆CoVaR): systemic risk contributionMeasures the sensitivity of the financial system to a negativeshock in a single bankMeasures the di�erence between CoVaR conditional on thefinancial institution being in distress and the CoVaR conditionalon the normal (median) state of the financial institution

Systemic risk I4: Results


Distance to default4: Results


Systemic risk II4: Results


Dependent variable : Dynamic MES

Robustness checks I4: Results


Robustness checks II4: Results


Robustness checks III4: Results


Conclusion5: Conclusion


Financial penalties increase the systemic risk exposure ofbanks, whereas they do not significantly a�ect banks’contribution to systemic risk

Financial penalties raise banks’ default probability andmakesthemmore vulnerable for systemic eventsFinancial penalties neither promote nor prevent the possibilitythat individual shocks will propagate throughout the bankingsystem

The design of the regulatory and supervisory framework of acountry influences the e�ects of financial penalties onsystemic risk exposure

More stringent capital requirements andmore promptcorrective power of national authorities mitigate the positiverelationship



Stronger power of supervisory authorities to declare insolvencyand a greater external monitoring culture exacerbate thepositive relationship



Policy implications:Findings suggest that authorities should take themacro-prudential perspective into consideration when theyimpose financial penalties on banksFindings support the e�orts by supervisory authorities tostrictly monitor misconduct risk and the correspondingfinancial penalties of banksFindings indicate that authorities around the world shouldcoordinate their e�orts before imposing significant financialpenalties on banks

Hypothesis development: bank risk6: Extensions


Aim of financial penalties is to enforce banking discipline andto deter banks from engaging in unsound risky behavior

Penalties may discourage illegal und unethical behaviorPenalties may also change the general risk policyPenalties may jeopardize profitability targets of managers whoin turn may be drawn to riskier business

H2: The financial penalties of a bank will have a significantnegative impact on its risk-taking behavior.Note: A bank’s willingness to engage in illegal or unethicalpractices may not be captured by standard risk measures asthis kind of practices does not appear in banks’ balance sheetsand is unknown to investors if undetected

Bank risk-taking behavior6: Extensions


Financial penalties do not seem to have enough power tochange the general risk policy of a bank

Bank stock performance6: Extensions


Investors are content thatthe financial penalty issmaller relative to theeconomic gain accruedfrom the banks’misconductEuropean banks:

Financial penaltieshave a significantnegative impact ona�er-tax profitabilityNo significant positivestock marketadjustment in contrastto US banks

Conclusions6: Extensions


Bank riskSignificant negative relation between financial penalties anddistance-to-defaultNo significant correlations with bank risk taking behavior(Positive correlations with systemic risk exposure, but nocorrelations with systemic risk contributions)

Stock performanceSignificant positive relation between financial penalties andbuy-and-hold returns

I Investors are content that the financial penalties are smallerrelative to the economic gains accrued from the banks’misconducts

I supported by positive abnormal returns

Documents

Financial penalties and the systemic risk of banks · 2017. 6. 28. · Scopeofthepaper 1: Motivation HannesKoesterandMatthiasPelster(Leuphana) 2/23 HannesKoesterandMatthiasPelster