Bank Disclosure and Market Assessment of Financial Fragility: Evidence from Banks Equity Prices

1
Bank Disclosure and Market Assessment of
Financial Fragility Evidence from Banks
Equity Prices

• María Fabiana Penas
• Tilburg University/CentER/TILEC
• Günseli Tümer-Alkan
• Center for Financial Studies Tilburg University
• International Research Conference on Corporate
  Governance in Emerging Markets
• November 15th 17th, 2007
• Sabanci University, Istanbul

2
Motivation

• Macro literature emphasizes three main balance
  sheet indicators of financial fragility
  (Dornbusch, 2001)
• maturity mismatches
• currency mismatches
• nonperforming loans.
• Financial fragility is argued to be an important
  factor in turning a crisis into a major one.
• The worse the fragility indicators, the larger
  the fall of capital that follows after sharp
  increases in interest rates and/or sharp currency
  depreciations

3
Our paper

• We investigate whether Turkish banks with clear
  signs of financial fragility were subject to
  market monitoring during the years prior to the
  crisis (1992-2001).
• Market discipline has two different components
  (Bliss and Flannery, 2002)
• Investors ability to accurately assess the
  condition of a firm (market monitoring).
• Investors ability to actually affect managerial
  actions (influencing).
• Did the stock market react to changes in
  indicators of financial fragility (maturity and
  currency mismatches and nonperforming loans) at
  the time of disclosure of banks financial
  statements?
• Does the quality and timeliness of the disclosure
  affect market reaction?

4
Contribution

• First paper that investigates markets reaction
  to changes in maturity and currency mismatches in
  an emerging country.
• Policy implications
• Which disclosure practices improve the ability of
  the market to assess the banks financial
  condition?
• Contribute to a recent policy debate on whether
  the existence of market monitoring is sufficient
  to guarantee banks safety and soundness
• (Jordan, Peek and Rosengren, 2000, Bliss and
  Flannery, 2002, Nier and Baumann 2006)

5
Why Turkey?

• A clear example of financial fragility leading to
  crisis
• Before the crisis, Turkish banking system
  presented clear signs of financial fragility
• Increased currency risk borrowing heavily in
  foreign currency, while lending to the government
  in local currency
• Increased liquidity-interest rate risk lending
  at relatively longer maturities, which was partly
  financed in the daily repo market
• Key factors that contributed to the crisis!
• Ability to measure mismatch variables more
  precisely
• Data collected from BS footnotes
• Not available for a cross-country study

6
Why Turkey?

• Changes in disclosure policy during the sample
  period
• 1995 - The Turkish Capital Markets Board required
  publicly traded firms to disclose additional
  information with their financial statements.
• 1999 - the enactment of the Banks Act 4389
• considerable changes in the disclosure
  requirements of banks

7
Data Set

• 12 banks listed on Istanbul Stock Exchange for
  1992-2001
• represent 37 of the assets of the industry
  between 1997-2000.
• Data Banks daily stock prices, market index,
  quarterly balance sheets and disclosure dates
• Returns adjusted for dividends and stock splits
• Balance sheet footnotes available after 1995-
  hand collected

8
Methodology

• Event study methodology
• CARs computed using market-adjusted-return model
• Robustness compute CARs using market model
• Examine the event window (-1, 0)
• Correct for potential cross-correlation of
  abnormal returns
• Because disclosure dates are the same for some
  banks for some quarters
• Cluster by time (disclosure date) (Petersen,
  2006)

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Explanatory Variables

• Test variables
• Quarterly changes in
• Nonperforming Loans Nonperforming Loans to Total
  Loans
• Maturity weighted gap in months
• Interaction with Dummy DI
• (equal to 1 if the ex-post 3 month change in
  interest rates is positive)
• Interaction with Dummy DD
• (equal to 1 if the ex-post 3 month change in
  interest rates is negative)
• Currency (Foreign Exchange Liabilities Foreign
  Exchange Assets) to Total Assets
• Including forward agreements

10
Explanatory Variables

• Control variables
• Quarterly changes in
• Govn. Sec. Government Securities to Total
  Assets
• Yearly changes in
• Earnings Return on Equity

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Reaction to indicators of financial fragility
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Reaction to indicators of financial fragility - 2

• The results suggest that stock market
  participants viewed financial statements
  disclosure as informative.
• Shareholders reacted
• positively to increases in earnings,
• negatively to indicators of financial fragility.

13
Impact of Disclosure Policy

• How did quality and timeliness of the disclosure
  affected market reaction?
• 1999 - the enactment of the Banks Act 4389
• considerable changes in the disclosure
  requirements of banks including
• disclosing risk management procedures (which was
  not compulsory before) and
• improvements in the disclosure of non-performing
  loans .
• Financial statements subject to audit only in
  second and fourth quarters

14
Impact of Banks Act
15
Impact of Audit
16
Reporting Lags for Audit versus Non-audit quarters

• Calculate reporting lags (number of days between
  disclosure date and end of quarter) for audit
  versus non-audit quarters.
• The lag
• for audit quarters 47 days on average
• for non-audit quarters 31 days on average .
• The longer the lag the less informative the
  financial statements are for the market?

17
Impact of Reporting Lags
18
Robustness

• Exclude crises quarters
• Compute CARs using market model
• control for non-synchronous trading by including
  one lead and one lag of market returns

19

• Conclusions
• We find that the stock market reacted to changes
  in indicators of financial fragility at the time
  of disclosure of banks financial statements.
• Improvements in disclosure requirements increased
  the informativeness of accounting statements.
• Audited statements that show larger reporting
  lags, are not informative, pointing to the need
  of improving their timeliness.
• Policy implications
• The existence of market monitoring is not enough
  to guarantee the soundness of the banking
  industry.
• The effectiveness of market discipline depends on
  the regulatory environment.