Too Many to Fail - The Effect of Regulatory Forbearance on Market Discipline

8/20/2019 Too Many to Fail - The Effect of Regulatory Forbearance on Market Discipline

1/38

Too Many To Fail:

The Effect of Regulatory Forbearance on Market Discipline

Wook Sohn and Hyosoon Choi∗

ABSTRACT

This paper investigates whether regulatory forbearance for savings banks in Korea affects

the market discipline of depositors using data from 2000 to 2010, which are characterized

by a series of exits of savings banks. We find that depositors’ sensitivity to the savings

banks’ asset quality decreases when there is regulatory forbearance for failing savings

banks. This forbearance effect is also observed in the behavior of the depositors of the

neighboring savings banks in the same business area. These results suggest thatregulatory forbearance may cause depositors to misjudge bank risks, increasing the

expected costs of bank failure.

Keywords : Depositor discipline, Regulatory forbearance, Prompt corrective action,

Savings bank, Korea

JEL Classification : G21, G28

∗

Wook Sohn: KDI School of Public Policy and Management, 87 Hoegiro, Seoul 130-868, Korea; phone:

+82-2-3299-1062; e-mail: wooksohn@ kdischool.ac.kr.

Hyosoon Choi: Korea Deposit Insurance Corporation, 33 Da-Dong, Seoul, 100-180, Korea; phone: 82-2-

758-0901; e-mail: [email protected].


2/38

Too Many To Fail:

The Effect of Regulatory Forbearance on Market Discipline

ABSTRACT

This paper investigates whether regulatory forbearance for savings banks in Korea affects

the market discipline of depositors using data from 2000 to 2010, which are characterized

by a series of exits of savings banks. We find that depositors’ sensitivity to the savings

banks’ asset quality decreases when there is regulatory forbearance for failing savings

banks. This forbearance effect is also observed in the behavior of the depositors of the

neighboring savings banks in the same business area. These results suggest that

regulatory forbearance may cause depositors to misjudge bank risks, increasing the

expected costs of bank failure.

Keywords : Depositor discipline, Regulatory forbearance, Prompt corrective action,

Savings bank, Korea

JEL Classification : G21, G28


3/38

1

1. Introduction

Market discipline constrains the risk-taking behavior of banks and thus has the

potential to contribute to reducing the probability of bank failures and minimizing the

costs of failures that do occur. Bank regulators’ forbearance practices have been criticized

for causing market discipline to fail in more than a few cases. For example, since the late

1980s, the unprecedented losses from bank failures have provoked serious criticism of

regulatory forbearance, which allows insolvent banks to continue their operations. This

criticism is based largely on the proposition that banks have a greater incentive to gamble

with deposit insurance funds when the likelihood of forbearance is greater (Nagarajan

and Sealey, 1995). Some studies analyzing financial crises designate the lack of market

discipline or a poor regulatory environment as a cause of the crises and emphasize the

enhancement of market discipline to prevent financial crises (Kaufman, 2000; Yoon and

Miller, 2004). 1 Although market discipline has been considered a supplement to direct

regulation in the control of bank risks, research addressing the direct interaction between

regulatory forbearance and market discipline is sparse. 2

1 Allen and Saunders (1993), Dreyfus et al. (1994) and Nagarajan and Sealey (1995) introduce regulatory

forbearance into their theoretical models of valuation of deposit insurance. However, they do not focus on

the effects of regulatory forbearance on market participants’ behavior. Hanweck and Spellman (2002) and

Schellhorn and Spellman (2000) examine the effect of forbearance on subordinated debt yields and

shareholders’ behavior.

2 Pillar 3 of the Basel II Accord of the Basel Committee on Bank Supervision views market discipline as a

complement to minimum capital requirements or supervisory processes.


4/38

2

This study attempts to examine the effect of forbearance on depositors’ market

discipline. To find evidence for regulatory forbearance diminishing market discipline, we

empirically test whether the sensitivity of deposit growth rate to bank risks is affected by

regulatory forbearance. We examine not only the depositors of the banks subject to

forbearance but also those of neighboring banks.

If depositors believe that a regulator does not intend to close a bank in the

foreseeable future, they will not withdraw their deposit, even though the bank risks are at

a substantially high level. In other words, depositors prefer enjoying the high-interest

income provided by failing banks to withdrawing their funds from those banks, as long as

they believe that enough time remains to withdraw their deposits before the bank is

closed by the regulator’s order.

This depositor behavior should be more evident in circumstances where bank failures

are triggered mainly by regulators’ closure decisions, not by depositors’ runs. In this

situation, deposit decisions may rely more on bank regulators’ intentions than on

available bank risk information. Moreover, if regulator forbearance is combined with

generous deposit protection from insurers, the impairment of market discipline will be

more pronounced and evident. This situation is more likely to be observable in

developing nations, where mandatory information disclosures are less frequent and bank

regulations are more prone to be influenced by politics than in advanced countries.

Considering the regulatory environment of savings banks, we believe that Korea’s

savings bank industry provides a good opportunity to test our hypotheses. The laboratory

of our study is a set of savings banks in Korea from 2000 to 2010, which is a period


5/38

3

characterized by a series of exits of savings banks under the restructuring of the

regulatory authority.

The contribution of this paper stems from the literature’s excessive focus on U.S.

data since the early 1990s. Evidence from another country, one that is sufficiently

different from the U.S. to offer another data point but not so different as to make that data

point difficult to interpret, could bring into sharp relief the key factors necessary to make

market discipline an effective contributor to the supervisory process. Such evidence is

particularly important in light of the market-discipline pillar in Basel II, which will be

applied internationally. To this end, we scrutinize depositor behavior under country-

specific circumstances where there is a high possibility of regulatory forbearance. 3

This study contributes to the literature in two more aspects. First, we identify

regulatory forbearance using cases where the regulator explicitly postpones Prompt

Corrective Actions (PCAs) or does not take any action for failing banks. Second, we test

the spillover effect of forbearance by analyzing the behavior of depositors of other banks

in the same operating region as the banks subject to regulatory forbearance.

We find that the sensitivity of deposit growth rates to banks’ non-sound asset ratios

significantly decreases when regulatory forbearance is apparent. These forbearance

effects are observed not only in the banks subject to forbearance but also in neighboring

banks in the same business region. Based on the findings, we suggest that savings banks’

risk information be more accurately disclosed, especially through the regulator’s

supervisory measures. Otherwise, regulatory forbearance may cause an increase in the

3 Variations in the extent of market discipline across countries should in part reflect international

differences in the operation of the financial safety net to limit depositor losses in the case of a bank failure.


6/38

4

expected costs of bank failure through depositors’ loose discipline with regard to bank

risks.

This paper is organized as follows. Section 2 describes the regulatory forbearance

and its relationship to market discipline. Section 3 explains the characteristics of Korean

savings banks and the regulatory environment. In Section 4, we propose our hypotheses

and develop empirical models to test them. Empirical results are provided in Section 5.

Section 6 concludes the paper.

2. Regulatory forbearance and market discipline

Regulatory forbearance can be defined as a discretionary delay in enforcing

appropriate actions to reduce the cost of bank failure. Previous studies have used the term

“forbearance” in various contexts, such as the delay of a PCA, the delay of receivership

(Schellhorn and Spellman, 2000), and bailouts without enforcement rules (Osterberg and

Thomson, 1992).

Why does regulatory forbearance occur? One explanation is a breakdown in the

incentives that cause the regulator to defend the regulated banks (Kane, 1986, 1990; Boot

and Thakor, 1993). In particular, Boot and Thakor (1993) formalize the notion that a bank

regulator may pursue self-interest rather than social welfare. According to this model, the

regulator’s desire to acquire a reputation as a capable bank monitor can distort bank

closure policy and increase the liability of deposit insurance. Schellhorn and Spellman

(2000) suggest that regulators may delay receiverships for banks they believe are

insolvent when the banks’ stockholders have the potential to appeal to the courts to


7/38

5

reverse the receivership and assess monetary damages. Allen and Saunders (1993) argue

that the response of regulators has often been characterized by delay due to budgetary and

political considerations. In this paper, regulatory forbearance is defined as the

postponement of a PCA or no PCA for failing banks.

U.S. bank regulators have been criticized for their slow and inadequate response to

the thrift crisis as well as for the forbearance granted to many failing savings and loan

associations in the late 1980s. 4 However, the empirical evidence on the cost of

forbearance is largely inconclusive. Mailath and Mester (1994) suggest that forbearance

may sometimes be optimal, whereas Acharya and Dreyfus (1989) argue that forbearance

is always suboptimal. The question of whether the enforcement of regulations must be

restricted to explicit, pre-announced and credible rules or whether regulator discretion

should be maintained is yet unanswered (Sijben, 2002). Benston and Carhill (1992) argue

that forbearance may have saved the Federal Savings and Loan Insurance Corporation

(FSLIC) a significant amount of costs ex post in the 1980s. In contrast, DeGennaro and

Thompson (1996) argue that the regulatory forbearance of the early 1980s was costly to

regulators and a bad bet for taxpayers. However, all of these papers focus on ex post costs

and do not shed light on ex ante costs or the benefits of forbearance (Nagarajan and

Sealey, 1995). 5

4 Huizinga and Laeven (2010) show that banks have systematically understated the impact of the

impairment of assets on bank capital in their financial reporting, which is evidence of widespread

regulatory forbearance toward distressed banks during the financial crisis. Choi (2002) also reports

regulatory forbearance during the financial crisis in Korea.

5 In the context of Japan, Dekle and Kletzer (2004) use an endogenous growth model with financial

intermediation to show that deposit insurance with regulatory forbearance leads to banking crises.


8/38

6

The term “market discipline” is commonly associated with two different meanings.

Bliss and Flannery (2000) argue that the concept of market discipline incorporates two

distinct components: market monitoring and market influence. Market monitoring refers

to the hypothesis that investors accurately understand changes in a firm's condition and

promptly incorporate their assessment into the firm's security prices. Since the mid-1980s,

a number of studies have examined whether uninsured depositors respond to bank risks

by withdrawing their deposits and/or requiring higher interest rates. Although not

unanimous, these studies find evidence consistent with the hypothesis that market

discipline is at play (Ioannidou and de Dreu, 2006). Market influence is the process by

which a security price change leads firm managers to counteract adverse changes in firm

conditions.

The interaction between bank regulation and market discipline has also been shown

to differ depending on the situation. Jordan et al. (1999) find that the announcement of a

formal enforcement action results in a large negative abnormal stock return for the bank,

suggesting that the announcement reveals new, adverse information about the bank’s

financial condition. However, Gilbert and Vaughan (2001) find no evidence of unusual

deposit withdrawals or spread increases around the announcements of regulatory

enforcement actions. They conclude that the public announcement does not spark bank

runs or enhance depositor discipline. 6

6 Empirical tests of market discipline have been executed in various contexts. Factors affecting market

discipline are the deposit insurance system (Cook and Spellman, 1991; Demirguc-Kunt and Huizinga,

2003; Ioannidou and de Dreu, 2005), bank failure (Goldberg and Hudgins, 1996; Jordan, 2000; Jagtiani and

Lemieux, 2001), banking crises (Martinez Peria and Schmukler, 2001), and ownership structure

(Mondschean and Opiela, 1999).


9/38

7

3. Savings banks and the regulatory environment in Korea

Savings banks in Korea are depository institutions that are licensed and supervised

by the Financial Supervisory Commission (FSC). They issue demand and savings

deposits insured by the Korea Deposit Insurance Corporation (KDIC). The savings bank

industry of Korea in the early 2000s represents an interesting case for analyzing the

impact of regulatory actions on depositors’ market discipline. During the period of this

study (2000-2010), Korea was in the late stage of its banking sector restructuring, which

began shortly after the financial crisis of 1997. The restructuring of the commercial

banking sector was coming to an end in 2000, but the restructuring of the savings banks

did not begin until late 1999. The reasons for such a delay in restructuring savings banks

are two-fold. The first is that the deteriorated credit of small- and medium-sized

enterprises and individuals, who were the main customers of savings banks, was

disclosed later than that of large corporations. Second, the regulatory authority did not

place a priority on the restructuring of savings banks due to their relatively small scale

and low systemic risk.

There has been a dramatic change among savings banks in Korea since the

restructuring of the savings bank industry. As of the end of 1999, 186 savings banks were

in operation. Among the 186 savings banks in existence at the end of 1999, 88 savings

banks were restructured by license revocations, mergers and acquisitions (M&As), or

purchase and assumptions (P&As) by 2010. During this period, nine banks were newly


10/38

8

established, and two of them were restructured. As a result, the number of savings banks

was reduced to 105 by the end of 2010 (see Table 1). 7

As shown in Table 1, deposit insurance protects 77.4% of the total amount of

deposits and 98.2% of the total number of depositors as of the end of 1999. Depositor

protection for savings banks in Korea can be characterized as follows. First, membership

is compulsory. Savings banks automatically become a member of the deposit insurance

system as soon as they become licensed for business, and the membership status is

maintained until the business license is revoked or until they are liquidated or declared

bankrupt. Second, all types of deposits are insured, including term deposits, time

installment savings, mutual installments, and cover notes. Third, the coverage limit is set

at 50 million won, nearly five times as high as the 2001 per capita GDP of Korea.

Savings banks that survived the restructuring made efforts to meet the capital

requirements strengthened by the forward-looking criteria of the FSC. As a result, the

overall financial condition of savings banks improved: the substandard credit ratio

decreased substantially from 26.2% to 10.8%, and the BIS capital ratio improved by 2.47

percentage points. Meanwhile, as is evidenced by the average number of branches per

savings bank (1.5) as of the end of 1999, the business of a savings bank is conducted

mostly in the operating region of its head office.

7 However, despite the decrease in the number of savings banks, the industry’s scale grew approximately

250% in terms of both assets and deposits during that period. This high growth rate is attributed to the fact

that the assets and liabilities of insolvent savings banks were transferred to other acquiring savings banks

and that deposits in the closed savings banks were protected by deposit insurance and absorbed into other

savings banks.


11/38

9

The characteristics of Korean savings banks and the regulatory environment must be

explained because they should contribute to bringing different empirical results from

others. First, the asset sizes of individual savings banks are small relative to other

depository institutions. The possibility of one savings bank’s failure threatening the

stability of the financial system of the nation is therefore low. This characteristic means

that the “too big to fail” doctrine is not applied when the regulatory authority makes the

closure decisions for failing banks.

Second, in the early 2000s, there were too many financially weak savings banks for

the regulator to close them all at once. Approximately 30% of the savings banks had a

negative equity book value, and the regulator may have had to consider the potential

adverse economic effects of bank closures. In other words, “too many to fail” was a

major concern for the regulatory authority.

Third, there is little publicly available and reliable risk information because the

capital level is low and shareholders are not diversified. In May 2002, the FSC reinforced

a disclosure policy that made savings banks disclose their management conditions,

including their BIS capital ratio. However, the large number of savings banks has made it

difficult for the regulator to conduct frequent on-site examinations, decreasing the

reliability of risk information. Due to this shortage of reliable information on the risk

profile of savings banks, depositors are much more likely to depend on regulatory actions

for their decisions. In addition, historically in Korea, bank failures have mostly been

triggered by regulatory action, not by bank runs. This finding could be another reason

why depositors pay more attention to the regulator’s intention than to the bank’s financial

condition.


12/38

10

Fourth, savings banks operate within a small, restricted region because of their low

level of capital and small number of branches. This characteristic makes savings banks’

competition and performance specific to the restricted operating region. Under this

circumstance, depositors have good reason to believe that their bank’s probability of

failure is closely correlated with that of neighboring banks.

4. Data and empirical models

4.1. Measuring regulatory forbearance

Identifying the existence of regulatory forbearance is not an easy task because many

factors influence regulatory outcomes. In this study, regulatory forbearance is identified

by using an explicit announcement of forbearance by the regulatory authority and the

accounting data disclosed by savings banks.

The regulatory authority may enforce a PCA on a savings bank that is under-

capitalized or that has scored a low grade in the management evaluation. The criteria of

PCA enforcements are essentially based on both the risk-weighted capital ratio and the

management status evaluated by the FSC. There are three types of PCAs: “recommend,”

“demand,” and “order” of management improvement. For instance, a savings bank with a

BIS ratio under 1%, 3% and 5% is given a PCA of “order”, “demand” and “recommend”,

respectively. When the authority enforces a PCA, it reveals its decision to the public.

Although the main purpose of PCAs is to preclude regulatory forbearance, the law allows

regulators to take discretionary action. The regulator sometimes chooses not to enforce a

PCA for a particular savings bank for some period when it believes that there are reasons


13/38

11

to hold off. Such information is also released to the public. We name this type of

forbearance “PCA postpone.”

The three types of PCAs (recommend, demand and order) are meant to indicate the

strength of the each PCA. For example, PCA measures that are imposed on the savings

banks are stronger in the case of “PCA order” than in the case of “PCA recommend”.

However, the discretionary decision on “PCA postpone” is based not on the strength of

the PCA types but on how plausible and implementable the management improvement

plan submitted by a savings bank to the regulatory authority is. 8 Therefore, it is not

always the case that “PCA postpone” is more likely to occur when a savings bank is

categorized as requiring “PCA recommend” than “PCA order”. In fact, Table 2 shows

that there were 15 cases of “PCA postpone”, among which 12, 2 and 1 cases were

categorized as ”PCA order”, “demand” and “recommend”, respectively, according to the

criteria of financial soundness if PCAs have been executed for these banks. This finding

suggests that regulatory forbearance was more likely to be given to a savings bank that

merited a stronger regulatory measure.

The second type of forbearance is detected using savings banks’ accounting

information. If a given savings bank approaches failure in default by book value, that is,

its liabilities exceed its assets, and if no regulatory action is taken against that savings

bank, we assume that regulatory forbearance occurs. We name this type of forbearance

“no action.”

8 According to the Regulation of Supervision of Mutual Savings Bank Business (Article #50) enacted by

the FSC, the supervisor may postpone a PCA enforcement for a specified period of time under PCA criteria

when it is recognized that a savings bank is likely to satisfy the standards within a short period of time

through an increase in capital or the sale of its assets.


14/38

12

Table 2 summarizes the supervisory measures taken against savings banks and the

ultimate status of the savings banks from January 2000 to 2010. As of the end of 1999,

PCAs were taken for the 49 savings banks in the form of “recommend,” “demand,” or

“order.” 9

After tracing the restructuring of savings banks, we find that some savings banks

were revoked or consolidated without previously being subject to PCAs or developing a

negative equity book value; these banks are classified as “sudden closure” (31 savings

banks). Depositors in this type of savings bank would not have been aware of their banks’

upcoming restructuring because the regulatory authority would have been unable to take

any measure, due to the banks’ the sound financial structure. Considering that most

M&As and P&As in the savings bank industry were initiated by the regulator, we classify

“sudden closure” in the category of the “enforcement” group. The “enforcement” group

thus consists of 49 PCA-enforced savings banks and 31 savings banks of sudden closure.

In the category of regulatory forbearance, there are 16 “PCA-postponed” savings

banks and 32 savings banks subject to a “no action” of any supervisory measure (we refer

to these 48 savings banks hereafter as the “forbearance” group). The “no action” is

assumed to have occurred three months after the banks’ equity capital became negative,

considering that this a sufficient amount of time for the banks to report and for the

regulators to take action. Finally, 67 savings banks are classified as in a “healthy state”

because they ran their business without any record of “enforcement” or “forbearance”

9 Seven savings banks are excluded due to incomplete data on restructuring. Though not specified in Table

2, there are some savings banks that have been subject to PCAs more than once. In this case, the type of

PCA is recorded according to the first PCA type.


15/38

13

and their equity values remained positive during the entire period of this study.

After tracing the restructuring of savings banks until the end of 2010, we find that 31

savings banks, or 63.3% of the 49 PCA-enforced savings banks, were closed. Of the 48

savings banks in the “forbearance” group, 28 were restructured, accounting for 58.3% of

the banks in this group, which is a percentage surprisingly similar to that of the PCA-

enforced savings banks.

4.2. Empirical models

It has been well recognized that depositors’ reactions to banks’ financial weakness

could occur through a decrease in deposits. If bank failures are mainly triggered not by a

stream of deposit withdrawals but by regulatory action, bank regulators’ intentions would

become one of the determinants of bank failures. Under the circumstance in which the

regulator postpones a PCA for a failing bank or does not take any regulatory action,

depositors may believe that the bank has the ability to recover. Although depositors

expect that the failing bank will eventually fail, they may believe that there remains

sufficient time to withdraw funds before the regulator closes the failing bank. We thus

present the following hypothesis:

(H1) Regulatory forbearance for failing banks diminishes the effects of depositor risk

sensitivity on the banks’ deposit growth rates.

The depositors of neighboring banks find no reason to hurry and withdraw their


16/38

14

deposits, despite the weak financial condition of their banks, because they may believe

that the regulator will apply the same laxity to their banks. In other words, regulatory

forbearance for some banks may lead neighboring banks’ depositors to expect similar

treatment in the future. We thus present the following hypothesis:

(H2) Regulatory forbearance for failing banks diminishes the effects of depositor

risk sensitivity on neighboring banks’ deposit growth rates.

Our hypotheses are partly related to the theoretical development of regulatory

forbearance and market discipline. Alen and Saunders (1993) and Dreyfus et al. (1994)

introduce regulatory forbearance into their theoretical models valuating deposit insurance.

In particular, Dreyfus et al. (1994) construct a theoretical model to show that the cost-

minimizing insured deposit cap is at a higher level in the presence of moral hazard (more

regulatory forbearance) or an inelastic supply of deposits (less discipline among

depositors).

In contrast to the existing literature, Morrison and White (2011) justify regulatory

forbearance on failing banks. A bank’s failure through the regulator’s decision

undermines confidence in the regulator’s competence, leading depositors to withdraw

funds from other banks screened by the same regulator. The optimal regulatory response

to avoid this contagion effect is to exhibit forbearance privately to a failing bank.

Nagarajan and Sealey (1995) also show that a state-contingent forbearance policy can be

an effective tool for alleviating risk-shifting behavior among banks.

Before testing the effect of forbearance on depositors’ market discipline, we must


17/38

15

examine whether depositors’ market discipline exists in Korean savings banks. Because a

depositor’s response to savings bank risk is reflected in their deposit behavior, we run

regressions of deposit growth rate (and uninsured deposit ratio) on savings bank risk

variables as follows.

Deposit Growth it (or Uninsured Deposit it ) = α0 + α1 NSAit-1 + α2 Capital it-1 + α3 ROAit

+ α4 Sizeit-1 + α5 Liquidity it + α6 Deposit Interest it + α7 Interest Rate t + α8

GDP t + ∑ j α9j YR j + ε1it (1)

where Deposit Growth is the change in the log of the total deposits of savings bank i

during a quarter t and Uninsured Deposit is the ratio of uninsured deposits to total

deposits . NSA is the non-sound asset ratio. Capital is equity/total assets. ROA is net

income/total assets. Size is the log of total assets. Liquidity is total deposits/total loans.

Deposit Interest is interest payment/total deposits. Interest Rate is the average interest

rate on commercial banks’ time deposit . GDP is the GDP growth rate during the quarter.

∑YR are year dummies indicating 2001 through 2010. 10 The variables NSA, Capital , and

Size are measured by their values at the end of the previous quarter.

The dependent variables are the total deposit growth rate or the uninsured deposit

ratio. We believe that deposit insurance is the main driver that weakens market discipline

and thus that we should consider that depositors who are not covered would have much

more incentive to care about regulatory forbearance. We therefore use the uninsured part

10 The non-sound asset ratio ( NSA) is calculated as (substandard loan + non-operating real estate) / (total

loan + non-operating real estate).


18/38

16

of deposits as a dependent variable to pin down the effect of regulatory forbearance on

the discipline. 11

We also use the total deposit growth rate as a dependent variable because even

though their deposit amount is below the coverage limit, depositors have incentives to

have market discipline. Protected depositors also face risks in the event of their bank

failure, such as financial losses from possibly low interest payments and economic losses

from inconvenience in transactions and delay in payment. First, depositors are unable to

transact with their account in the event of bank failure. Second, they may lose some

interest because KDIC does not protect interest that exceeds some level KDIC designates

based on commercial banks’ interest level, which is substantially lower than that of

savings banks. Third, depositors must wait for several months before receiving their

deposit claims; the average time to pay claims from the suspension is 5.1 months for

savings banks failed during 2003-2010, whereas in the U.S., deposit claims are normally

paid out in the next working day.

Regarding the explanatory variables, we choose to use the variables that the

regulator uses in monitoring, as well as those that empirical studies have shown to be

important explanatory variables in the deposit models.

After examining the existence of depositors’ market discipline, we test whether

market discipline is weakened by regulatory forbearance. We expect that depositors’

11 Goldberg and Hudgins (1996) and Park and Peristiani (1998) also use the uninsured deposit ratio or its

growth rate, whereas Demirgüc-Kunt and Huizinga (2003) and Ioannidou and de Dreu (2006) use the total

deposit growth rate as a dependent variable.


19/38

17

perception of forbearance makes them less sensitive to proxy variables indicating the

possibility of failure of a savings bank.

Studies of the effect of a regulatory action typically employ three different means of

analysis: (1) regressions using a dummy variable indicating a regulatory action, (2)

regressions for subsamples of pre- and post-action and (3) a simple comparison of

variables of interest for sample and control groups. First, Athavale (2000) uses an event

dummy variable representing “too-big-too-fail” policy in an ordinary least square (OLS)

regression to analyze the effect of the policy on a depositor’s behavior. He finds that

markets perceive uninsured bank deposits to be safer because of the regulatory

forbearance – the commitment to the TBTF policy. Aggarwal and Jacques (1998) also

use dummy variables to signify the degree of regulatory pressure in their OLS regressions.

Second, Barajas et al. (1999) and Hall et al. (2004) run regressions for the subsample of

before and after the banking liberalization and the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA), respectively. Third, Gilbert and Vaughan (2001)

simply compare deposit growth rates before and after the announcements at the sample

banks and a control group. Goldberg and Hudgins (2002) also measure depositors’

reactions to the announcements of enforcement actions.

We use the first approach using a dummy variable indicating periods of regulatory

forbearance for each savings bank. We use a dummy variable D1 or D2 to introduce

regulatory forbearance into the regression model as follows.

Deposit Growth it (or Uninsured Deposit it ) = β 0 + β 1 D1 (or D2)+ β 2 NSAit + β 3 D1

(or D2)*NSA it + β 4 Capital it + β 5 D1 (or D2)*Capital it + β 6 ROAit + β 7 Sizeit


20/38

18

+ β 8 Liquidity it + β 9 Deposit Interest it + β 10 Interest Rate t + β 11GDP t + ∑ j

α12jYR j + ε2it (2)

The dummy variable indicating regulatory forbearance is defined differently when

we test the two hypotheses. In testing (H1), D1 in regression model (2) is one if the

regulatory actions is “PCA postpone” or “no action” and zero otherwise. We consider a

three-quarter time window centered on the quarter when regulatory forbearance occurs to

allow information leakage and a slow adjustment of depositors. In other words, D1 is one

for t = -1, t = 0, and t = 1, where t = 0 represents the quarter when the regulatory

forbearance occurs.

We define a business region as a whole whether it is a forborne or enforced region.

We use the number of cases of two types of regulatory responses when banks are failing.

Therefore, D2 is one if the number of cases of forborne (“PCA postpone” and “no

action”) banks exceeds that of enforced (“PCA enforcement” and “sudden closure”)

banks within the operating region of each savings bank and zero otherwise. For instance,

there were one “enforcement” and three “forbearance” cases in the region of Pusan in the

fourth quarter of 2000 (“PCA postpone”). In this case, the number of enforcement cases

(3) is greater than the number of forbearance cases (1). We thus state that there was

forbearance in the Pusan region for that quarter and set the dummy variable to one for all

healthy banks located in Pusan for the fourth quarter of 2000.

In testing whether regulatory forbearance for a particular savings bank impacts the

neighboring savings banks’ depositors (H2), we run the regression only for the subsample

of “healthy” savings banks. Savings banks that ran their business with no record of


21/38

19

forbearance or restructuring during this research period are classified as being in a

“healthy state” to measure the influence of risks of “unhealthy” savings banks in the same

business area. 12

We conduct pooled regressions of all the observations. We are concerned about the

sudden increase in deposits simply from acquiring deposits from failed savings banks.

Therefore, we check whether there was a sudden increase in deposits for an acquiring

savings bank from M&As or P&As during the sample period. We identify nine cases of

sudden increase in deposits from M&A and eight cases from P&A. We exclude these 17

savings banks in our analyses to remove the effect of consolidation on the deposit growth

(see page 17).

5. Empirical evidence

5.1. Data and summary statistics

The non-sound asset ratio and capital ratio are drawn from the balance sheet and

income statement data of individual savings banks. The other sources of data consist of

Quarterly Business Reports and Monthly Deposit Reports filed with the KDIC. These

reports publish ROA, size of assets, loans and deposits, uninsured part of deposits, and

interest payment . Data are collected during the period from January 2000 to December

12 The fifteen operating regions are based on the administrative regions of the nation as follows: Seoul,

Pusan, Incheon, Taegu, Daecheon, Kwangju, Kyeongki, Kangwon, Chungbuk, Chungnam, Cheonbuk,

Cheonnam, Kyeongbuk, Kyeongnam, and Jeju.


22/38

20

2010, which is characterized by a series of exits of savings banks resulting from the

restructuring plan of the Korean regulatory authority.

Table 3 presents summary statistics of major variables of interest during the period

from 2000 to 2010. The deposit growth rates ( Deposit Growth ) of both “enforcement”

(panel A) and “forbearance” (panel B) groups are negative, and the difference of the two

groups in not statistically significant. The uninsured deposit ratio ( Uninsured Deposit ) of

“enforcement” is 22.5%, whereas that of “forbearance” is 17.9%, and the difference is

statistically significant. Judging by capital ratio, the “enforcement” group is found to

have a higher capital ratio than the “forbearance” group around the announcements of

supervisory decisions. This statistically significant ( t =5.15) result suggests that market

participants, who have limited access to the risk information of individual savings banks,

are at risk of misjudgment in evaluating their banks’ safety when using supervisory

measures rather than financial ratios.

The mean value of deposit growth rates of “healthy” savings banks (panel C) is 3.3%,

whereas those of savings banks subject to “forbearance” and “enforcement” (panel A plus

B) are -0.6% and -0.7%, respectively. The t-statistics on the mean differences between

“healthy” and “unhealthy” (“enforcement” and “forbearance” together) are 6.28,

suggesting that the difference is statistically significant. The mean difference in the

uninsured deposit ratio of “healthy” and “unhealthy” banks is also statistically significant

(t =5.44). We also find that the asset quality, capital adequacy, and profitability of

“healthy” savings banks are superior to those of “unhealthy” savings banks. These results

are consistent with the conjecture that market discipline is properly functioning. With

regard to deposit interest rates ( Interest ), this difference is not statistically significant.


23/38

21

In Table 4, the deposit growth rates and the soundness indicators of the

“enforcement” and “forbearance” groups are summarized during the previous quarter ( t =

-1) and the quarter ( t = 0) when regulatory actions or forbearance occurred and the

following quarter ( t = 1). The difference in the capital ratio of the two groups is

statistically significant at the end of a quarter ahead of the supervisory actions. It is

surprising that the supervisory authority tends to forbear more for a savings bank with a

lower (in fact negative) capital ratio. It is noteworthy that during the three quarters, the

total deposit growth rate is negative and the uninsured deposit ratio continues to rise in

the “enforcement” group. This finding suggests that depositors of enforced savings banks

withdraw large shares of the insured portion of their deposits. However, the uninsured

portion of deposits does not change substantially in the case of forborne savings banks.

5.2. Regression results and discussions

Table 5 presents the results of regressions for equation (1), which test whether

market discipline is present in savings banks in Korea. Market discipline can be

determined by the sensitivity of deposit growth rates to the risk variables of savings

banks. In this study, the non-sound asset ratio ( NSA) is selected as the major risk variable.

This result shows that the estimated coefficient of NSA ( -0.072) for the OLS regression of

Deposit Growth is statistically significant. A low ratio of NSA indicates that the financial

soundness is good, increasing depositors’ trust level in savings banks. This result remains

the same in the regression of uninsured deposit ratio ( Uninsured Deposit). The

statistically significant, positive coefficients of capital ratio (0.036) and ROA (0.043) in

the regression also indicate that a savings bank with more sound financial variables has a


24/38

22

higher deposit growth rate.

In addressing the possible endogeneity problem between the deposit growth rate and

the deposit interest payment, we conduct a 2SLS model that measures Deposit Interest in

the predicted term. In other words, in the first stage, Deposit Interest is regressed against

a lagged Deposit Growth and contemporaneous Interest Rate, and the predicted Deposit

Interest is used in the second stage of regression. The results remain qualitatively the

same and statistically significant. 13

In particular, the coefficient is larger for the regression of uninsured deposits than

for total deposits. This result is related to that of Park and Peristiani (1998), who report

the presence of market discipline in fully insured deposits, although statistical

significance is substantially lower than in uninsured deposits. 14 Overall, we find empirical

evidence supporting the existence of depositors’ market discipline in the savings bank

industry in Korea.

Most prior work contains only one data point. 15 In the U.S., the cost of collecting

and analyzing information on bank conditions has been low, but the benefit from doing so,

13 Maechler and McDill (2006) model an endogenous process of the price and quantity response of

uninsured deposits in the face of deteriorating fundamentals. They find that good banks can raise uninsured

deposits by raising their price, whereas weak banks cannot, suggesting that depositor discipline not only

increases the cost of choosing a higher level of risk but also may constrain bank managers’ behavior.14 Goldberg and Hudgins (2002) find that failed institutions exhibit declining proportions of uninsured

deposit ratio prior to failure, suggesting that uninsured deposits will be governed by market discipline.

15 This data point is characterized by a country in which mergers, failures, and Basel I produced an industry

with historically robust capital protection, in which strong macroeconomic performance generated high

rates of profitability and low rates of failure and in which FIRREA and Sarbanes-Oxley strengthened an

already sound disclosure regime.


25/38

23

given the strong banking and macroeconomic conditions during the period, may have

been even lower, perhaps accounting for weaker-than-expected market discipline.

Table 6 shows the results for equation (2) of how regulatory forbearance affects the

sensitivity of deposit growth rates to savings bank risks. The major risk variable NSA is

interacted with D, a dummy variable for the savings banks subject to regulatory

forbearance. For our hypothesis that forbearance weakens the market discipline to be

supported, the sign of the estimated coefficient of NSA should be negative, whereas that

of NSA interacted with D should be positive.

As shown in Table 6, in the regression of deposit growth rate, the weakened market

discipline is not evident. However, in the regression of the uninsured deposit ratio, the

coefficients of NSA and D*NSA are -0.079 and 0.161, respectively, and are statistically

significant. This result implies that the sensitivity of uninsured deposits to the non-sound

asset ratio is significantly low for the savings banks subject to forbearance, which is a

result consistent with regulatory forbearance as a weakening force on market discipline.

This result is also consistent with our expectation that the deteriorating effect of

forbearance on market discipline should be more evident in the uninsured portion of

deposits than in total deposits.

With regard to the effect of regulatory forbearance on market discipline, which is

closely related to this study, previous studies do not show consistent conclusions.

Nagarajan and Sealey (1995) argue that the rational forbearance policy can induce banks

to improve the ex ante quality of assets, whereas some recent empirical studies (Hosono

et al., 2004; Covitz et al., 2004) show that stricter regulation may diminish market

discipline. These studies examine the effect of different forbearance levels resulting from


26/38

24

the different regulatory regimes across the country (Hosono et al., 2004) or over time

(Covitz et al., 2004). This paper differs from these two studies in that it identifies

forbearance in the regulatory action enforced for a specific bank and not in the overall

regulatory regime of a nation.

This paper is also related to Brown and Dinc (2011) documenting the too-many-to-

fail channel of regulatory forbearance in that our sample period is characterized by a

series of exits of savings banks resulting from the restructuring plan of the Korean

regulatory authority. They study bank failures in 21emerging market countries in the

1990s to show that a government is less likely to take over or close a failing bank if the

banking system is weak, which implies the existence of too-many-to-fail policy.

Table 7 shows the existence of a forbearance effect on the healthy banks neighboring

forborne or enforced banks. If more savings banks are subject to “forbearance” measures

than to “enforcement,” we consider the business area to be a forborne area. The purpose

is to verify the impact of forbearance on the market discipline of depositors in the vicinity.

The coefficient of NSA is -0.156, and that of D2*NSA is 0.101 for the regression of the

uninsured deposit ratio, implying that regulatory forbearance hurts not only the market

discipline of depositors of savings banks subject to forbearance but also that of the

depositors of the neighboring healthy savings banks. This finding supports our hypothesis

(H2). To the best of our knowledge, this is the first paper to show explicitly the contagion

effect of regulatory forbearance on other banks not subject to regulatory actions.

6. Conclusion


27/38

25

Using data on savings banks in Korea from 2000 to 2010, this paper examines

whether regulatory forbearance practices affect the market discipline of bank depositors.

Regulatory forbearance is assumed to exist when the bank regulator postpones a PCA or

does not take any explicit action on savings banks whose book value of equity is negative.

We measure the strength of depositors’ market discipline by the sensitivity of the deposit

growth rate and uninsured deposit ratio to savings banks’ non-sound asset ratio. The

results show that depositors’ sensitivity to the savings banks’ non-sound asset ratio

decreases when there is a regulatory forbearance for failing savings banks. This

forbearance effect is also observed in the behavior of the depositors of healthy savings

banks in the same business area as the forborne banks.

This study suggests a desirable relationship between market participants and bank

regulators from the perspective of enhancing market discipline. Based on the findings, we

suggest that savings banks’ risk information be more accurately disclosed, especially

through the regulator’s supervisory measures. Regulatory actions may mislead bank

depositors’ perception of bank risks and thus should be modified to act as trustworthy

state signals of savings banks’ risks. This finding leads us to conclude that regulators

should take extra caution when they forebear appropriate actions for failing savings banks,

as such forbearance may cause an increase in the expected costs of bank failure through

depositors’ insensitivity to bank risks.


28/38

26

References

Acharya, S., J. Dreyfus. 1989. Optimal bank reorganization policies and the pricing of

Federal Deposit Insurance. Journal of Finance 44, 1313-33.

Aggarwal, R., Jacques, K., 1998. Assessing the impact of prompt corrective action on

bank capital and risk. Economic Policy Review of Federal Reserve Bank of New

York 4, 23-32.

Allen, L., Saunders, A., 1993. Forbearance and valuation of deposit insurance as a

callable put. Journal of Banking and Finance 17, 629-643.

Athavale, M., 2000. Uninsured deposits and the too-big-to-fail policy in 1984 and 1991.

American Business Review 18, 123-128.

Barajas, A., Steiner, R., Salazar, N., 1999. Interest spreads in banking in Colombia, 1974-

96. IMF Staff Papers 46, 196-224.

Benston, G. J., Carhill, M., 1992. The thrift disaster: myths and realities. Proceedings of a

Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago,

121-144.

Bliss, R. R., Flannery, M. J., 2000. Market discipline in the governance of U.S. bank

holding companies: monitoring vs. influencing. European Finance Review 6, 361-395.

Boot, A., Thakor, A., 1993. Self-interested bank regulation. American Economic Review,

83, 206–212.

Brown, C. O., Dinc, I. S., 2011. Too many to fail? evidence of regulatory forbearance

when the banking sector is weak. Review of Financial Studies 24, 2011, 1378-1405

Choi, J-W., 2002. Regulatory forbearance and financial crisis. Asian Survey 42, 251-275.


29/38

27

Cook, D. O., Spellman, L. J., 1991. Federal financial guarantees and the occasional

market pricing of default risk: evidence from insured deposits. Journal of Banking

and Finance 15, 1113-1130.

Covitz, D. M., Hancock, D., Kwast, M. L., 2004. Market discipline in banking

reconsidered: the roles of funding manager decisions and deposit insurance reform.

Finance and Economics Discussion Series, Federal Reserve Board.

DeGennaro, R. P., Thomson, J. B., 1996. Capital forbearance and thrifts: examining the

costs of regulatory gambling, Journal of Financial Services Research 10, 199-211..

Dekle, R., Kletzer, K., 2004. Deposit insurance, regulatory forbearance and economic

growth: implications for the Japanese banking crisis. SSRN Working Paper.

Demirgüc-Kunt, A., Huizinga, H., 2003. Market discipline and deposit insurance. Journal

of Monetary Economics 51, 375-399.

Dreyfus, J., Saunders, A., Allen, L., 1994. Deposit insurance and regulatory forbearance:

are caps on insured deposit optimal? Journal of Money, Credit and Banking 26, 412-

438.

Gilbert, R. A., Vaughan, M. D., 2001. Do depositors care about enforcement actions?

Journal of Economics and Business 53, 283-311.

Goldberg, L., Hudgins, S., 1996. Response of uninsured depositors to impending S&L

failures: evidence of depositor discipline. Quarterly Review of Economics and

Finance 36, 311-325.

Goldberg, L., Hudgins, S., 2002. Depositor discipline and changing strategies for

regulating thrift institutions, Journal of Financial Economics 63, 263–274.

Hanweck, G. A., Spellman, L. J., 2002. Forbearance expectations and the subordinated


30/38

28

debt signal of bank insolvency. FDIC/JFSR Conference.

Hall, H., King, T., Meyer, A., Vaughan, M., 2004. Did FDICIA enhance market

discipline? a look at evidence from the jumbo-CD market. SSRN Working Paper.

Hosono, K., Iwaki, H., Tsuru, K., 2004, Bank regulation and market discipline in the

world, RIETI Discussion Paper Series 04-E-031.

Huizinga, H., Laeven, L., 2010. Bank valuation and regulatory forbearance during a

financial crisis. SSRN Working Paper .

Ioannidou, V. P., de Dreu, J., 2006. The impact of explicit deposit insurance on market

discipline. mimeo.

Jagtiani, J., Lemieux, C., 2001. Market discipline prior to Bank failure. Journal of

Economics and Business 25, 313-324.

Jordan, J. S., 2000. Depositor discipline at failing banks. New England Economic Review,

15-28.

Jordan J. S., Peek, J., Rosengren, E. S., 1999. The impact of greater bank disclosure

amidst banking crises. Federal Reserve Bank of Boston Working Paper.

Kane, E., 1986, Appearance and reality in deposit insurance. Journal of Banking and

Finance 10, 175–188.

Kane, E., 1990. Principal-agent problems in S&L salvage. Journal of Finance 45, 755–

764.

Kaufman, G. G., 2000. How real is the risk of a massive banking collapse?, Regulation

23, 25-30.

Maechler, A., McDill, K., 2006. Dynamic depositor discipline in US banks. Journal of

Banking and Finance 30, 1871-1898.


31/38

29

Mailath, G., L. Mester. 1994. A positive analysis of bank closure. Journal of Financial

Intermediation 3, 272-299.

Martinez Peria, M. S., Schmukler, S. L., 2001. Do depositors punish banks for bad

behavior? market discipline, deposit insurance, and banking crises. Journal of Finance

56, 1029-1051.

Mondschean, T. S., Opiela, T. P., 1999. Bank time deposit rates and market discipline in

Poland: the impact of state ownership and deposit insurance reform. Journal of

Financial Service Research 15, 179-106.

Morrison, A., White, L., 2011. Reputational contagion and optimal regulatory

forbearance. The ECB Working Paper.

Nagarajan, S., Sealey, C. W., 1995. Forbearance, deposit insurance pricing, and incentive

compatible bank regulation. Journal of Banking and Finance 10, 1100-l 131.

Osterberg, W. P., Thomson, J. B., 1992. Forbearance, subordinated debt, and the cost of

capital for insured depository institutions. Federal Reserve Bank of Cleveland

Economic review 28, 16-26.

Park, S., Peristiani, S., 1998. Market discipline by thrift depositors. Journal of Money,

Credit and Banking 30, 347-364.

Schellhorn, D. C., Spellman, L. J., 2000. Bank forbearance: a market-based explanation.

Quarterly Review of Economics and Finance 40, 451–466.

Sijben, J. J., 2002. Regulation and market discipline in banking supervision: an overview.

Journal of International Banking Regulation 3, 363-380.

Yoon, S. S., Miller, G., 2004. The restructuring of the Korean economy following the

financial crisis in 1997. International Journal of Management 21, 232-239.


32/38

30

Table 1. Savings banks in Korea

end-1999(A)

end-2010(B)

(B/A)-1(%)B-A(%p)

Number of savings banks 186 105 -43.5 Number of branches 277 373 34.7 Number of employees 4,574 8,863 93.8

Total asset (bil. Korean won) 25,704 86,821 237.8Total deposit (bil. Korean won) 21,327 76.792 260.1

Insurance-covered deposit/Eligible deposit (%) a 77.4 91.0 13.6

#Covered depositors / #Total depositors (%) 98.2 96.8 -1.4Savings banks deposit /

Commercial banks deposit (%) 4.1 7.8 3.7Substandard credit ratio (%) 26.2 10.8 -15.4BIS capital ratio (%) 6.57 9.04 2.47Return on asset (%) -1.71 -22.89 -21.18#Number of Savings banks with negative equity/

#Number of total savings banks (%) 29.5 8.6 -20.9

Note:a Deposits from the government and other insured financial institutions are not eligible for deposit

insurance.


33/38

31

Table 2. Regulatory actions and the status of savings banks

Regulatory Actions

No. ofSavings banks

Closed(during 2000-2010) Survived

(tillend-2010)end-1999

Establishedsince 2000 Revoked P&A M&A

Enforcement 78 2 25 22 15 18(PCA Recommend) 19 - 1 8 - 10(PCA Demand) 9 - 2 2 - 5(PCA Order) 21 - 11 7 - 3(Sudden Closure) a 29 2 11 5 15 -

Forbearance 46 2 21 6 1 20(PCA Postpone) b 16 - 7 1 - 8

(No Action)c

30 2 14 5 1 12Sub-total 124 4 46 28 16 38Healthy State d 62 5 67Total 186 9 46 28 16 105 Notes:a “Sudden Closure” refers to a case where a savings bank was restructured without being subject to any

regulatory action or financial default prior to the restructuring. b “PCA Postpone” refers to a case where the regulator announced the postponement of PCA.c “No Action” refers to a case where there was no regulatory action such as PCAs or restructuring but a

savings bank has financially defaulted.d “Healthy State” refers to a surviving bank as of the end of 2010 that was not subject to any regulatory

action or financial default during the period 2000-2010.


34/38

32

Table 3. Summary statistics

Mean Std.dev. Min Max Median t-test c Total (n=195) a

Deposit Growth 0.030 0.111 -1.46 2.44 0.023Uninsured Deposit 0.246 0.149 0.01 0.92 0.218

NSA 0.186 0.147 0.00 0.96 0.140Capital 0.082 0.087 -0.67 0.91 0.072

ROA -0.006 0.170 -2.75 2.22 0.009 Deposit Interest 0.051 0.736 -52.06 1.38 0.056Size 12.249 1.079 9.48 15.56 12.117

Liquidity 1.202 0.339 0.04 5.48 1.133A. Enforcement b (n=80)

Deposit Growth -0.007 0.080 -0.29 0.42 -0.008 -1.07Uninsured Deposit 0.225 0.178 0.16 0.74 0.173 2.33**

NSA 0.321 0.169 0.03 0.76 0.286 -0.81Capital 0.045 0.086 -0.45 0.37 0.040 5.15***

ROA -0.077 0.347 -1.62 0.77 0.007 -0.20 Deposit Interest 0.064 0.043 -0.06 0.23 0.059 -0.11Size 11.813 1.066 9.48 14.49 11.727 -4.78***

Liquidity 1.272 0.355 0.64 3.14 1.180 0.22B. Forbearance b (n=48)

Deposit Growth -0.006 0.129 -0.72 0.67 -0.004Uninsured Deposit 0.179 1.144 0.01 0.79 0.159

NSA 0.336 0.177 0.03 0.90 0.311Capital -0.009 0.107 -0.65 0.25 0.008

ROA -0.070 0.280 -1.99 0.72 -0.024 Deposit Interest 0.065 0.043 -0.08 0.28 0.054Size 12.356 0.962 9.93 14.38 12.375

Liquidity 1.263 0.422 0.26 4.08 1.209C. Healthy state (n=67)

Deposit Growth 0.033 0.110 -1.46 2.44 0.025 6.28***Uninsured Deposit 0.249 0.148 0.01 0.92 0.221 5.44***

NSA 0.175 0.139 0.00 0.96 0.132 -19.23***Capital 0.087 0.084 -0.67 0.91 0.074 15.18***

ROA -0.002 0.154 -2.75 2.22 0.010 7.51*** Deposit Interest 0.050 0.762 -52.06 1.38 0.056 -1.24Size 12.258 1.081 9.73 15.56 12.125 2.20**

Liquidity 1.198 0.335 0.04 5.48 1.129 -3.59*** Notes:a The number of savings banks (n) include the savings banks established since 2000.

b Enforcement (panel A) consists of PCA “recommend,” “order,” “demand,” and “sudden closure,” andForbearance (panel B) consists of “PCA postpone” and “no action.”

c The test statistic on the mean difference between “Enforcement” and “Forbearance” is reported in thelast column of Panel A. The test statistic on the mean difference between “Healthy state” andunhealthy (a combination of “Enforcement” and “Forbearance”) banks is reported in the last columnof Panel C.

e ***, **, and * denote the significance levels of 1%, 5%, and 10%, respectively.


35/38

33

Table 4. Comparison between the “enforcement” and “forbearance” groups around of supervisorydecisions

DepositGrowth

Uninsured Deposit NSA-1 Capital -1

t = -1

Enforcement .0032 .2054 .2891 .0598Forbearance -.0008 .1884 .3250 -.0040t-test c .734 .523 -1.228 3.750***

t = 0

Enforcement -.0132 .2261 .3326 .0406Forbearance -.0113 .1739 .3598 -.0463t-test c -.097 1.599 -.881 4.427***

t = 1

Enforcement -.0123 .2565 .3472 .0312Forbearance .0053 .1745 .3193 .0334t-test c -.643 1.964* .658 -.133

Notes:a The test statistic on the mean differences between “Enforcement” and “Forbearance”

b ***, **, and * denote the significance levels of 1%, 5%, and 10%, respectively


36/38

34

Table 5. Depositors’ risk sensitivity

Deposit Growth Uninsured DepositOLS 2SLS OLS 2SLS

Constant -0.028(-7.751)***

-0.044(-1.132)

0.461(13.166)***

0.655(3.958)***

NSA-1 -0.072( -6.149)***

-0.127(-6.438)***

-0.072(-4.359)***

-0.272(-2.356)**

Capital -1 0.036(1.954)*

0.026(0.861)

0.617(25.605)

0.654(6.242)***

ROA 0.043(4.755)***

0.049(3.183)***

0.087(5.367)***

0.039(0.535)

Size 0.012(6.974)***

0.007(2.523)**

-0.018(-8.438)***

-0.027(-2.796)***

Liquidity 0.033(7.248)***

0.037(4.690)***

-0.036(-6.115)***

-0.029(-1.126)

Deposit Interest

0.002(0.946)

-0.183(-7.585)***

0.000(0.063)

-0.691(-2.141)**

Interest Rate

0.010(2.707)***

-0.005(-1.732)*

0.002(0.493)

-0.004(-0.351)

GDP 0.001(0.806)

0.002(1.123)

0.000(0.198)

-0.001(-0.070)

DepositGrowth

-0.028(-1.544)

0.024(0.267)

n 5,085 4,920 5,085 4,920Adj. R 2 0.077 0.029 0.195 0.012F 24.400*** 18.998*** 60.445*** 6.884***

Notes:a The year dummy variables are included as regressors, although their estimates are not

reported. b The number in parentheses is the t-statistic computed using heteroskedasticity-robust

standard errors.c ***, **, and * denote the significance levels of 1%, 5%, and 10%, respectively.


37/38

35

Table 6. The estimated effects of regulatory forbearance on depositor’s risk sensitivity

Deposit Growth c Uninsured Deposit c

Constant -0.244 (-7.611)*** 0.457 (13.029)***

D1 b -0.011 (-0.928) -0.033 (-2.018)**

NSA-1 -0.062 (-5.118)*** -0.079 (-4.611)***

D1*NSA -1 -0.025 (-0.609) 0.161 (2.492)**

Capital -1 0.016 (0.851) 0.626 (24.956)***

D1*Capital -1 0.138 (1.557) -0.053 (-0.307)

ROA 0.042 (4.597)*** 0.083 (5.091)***Size 0.011 (5.856)*** -0.018 (-8.341)***

Liquidity 0.032 (6.829)*** -0.033 (-6.051)***

Deposit Interest 0.002 (0.983) 0.000 (0.042)

Interest Rate 0.010 (2.678)*** 0.003 (0.628)

GDP 0.001 (0.818) 0.000 (0.064)

Deposit Growth -0.026 (-1.428)

n 5,085 4,920Adj. R 2 0.078 0.196

F 21.389*** 52.285*** Notes:a The existence of regulatory forbearance ( D1) is one for the three quarters around the supervisory

measures if the regulatory action is “forbearance” and zero otherwise. b The year dummy variables are included as regressors, although their estimates are not reported.c The number in parentheses is the t-statistic computed using heteroskedasticity-robust standard errors.d ***, **, and * denote the significance levels of 1%, 5%, and 10%, respectively.


38/38

Table 7. The estimated effects of regulatory forbearance on depositors’ risk sensitivity ofneighboring healthy banks

Deposit Growth b Uninsured Deposit c

Constant -0.344 (-5.233)*** 0.443 (5.497)***

D2 0.021 (1.783)* -0.056 (-3.202)***

NSA-1 -0.010 (-0.316) -0.156 (-2.193)**

D2*NSA -1 -0.038 (0.995) 0.101 (1.752)*

Capital -1 0.202 (3.180)*** 0.551 (5.886)***

D2*Capital -1 -0.148 (-1.954)* -0.055 (-0.496)

ROA 0.040 (2.491)** 0.080 (2.560)**

Size 0.012 (3.754)*** -0.014 (3.162)*** Liquidity 0.001 (0.099) -0.039 (-2.552)**

Deposit Interest -0.033 (-0.401) -0.319 (-1.802)*

Interest Rate 0.024 (2.962)*** 0.012 (0.963)

GDP 0.010 (0.099) 0.005 (0.960)

Deposit Growth -0.044 (-1.201)

n 2,838 2,838Adj. R 2 0.129 0.160F 12.147*** 12.071***

Notes:a The sample consists of healthy banks whose neighbor banks are subject to regulatory enforcement

or forbearance. The existence of regulatory forbearance ( D2) is one if the number of forborne banks exceeds that of enforced banks within the same business region of each healthy bank andzero otherwise.

b The year dummy variables are included as regressors, although their estimates are not reported.c The number in parentheses is the t-statistic computed using heteroskedasticity-robust standard errors.d ***, **, and * denote the significance levels of 1%, 5%, and 10%, respectively.

Documents

Too Many to Fail - The Effect of Regulatory Forbearance on Market Discipline