Financial Liberalization, Risky Bank Lending, and Market Discipline: An Empirical Examination of Six Countries

1
Financial Liberalization, Risky Bank Lending, and
Market Discipline An Empirical Examination of
Six Countries

• William C. Gruben
• Jahyeong Koo
• Robert R. Moore

Federal Reserve Bank of Dallas
2
Approach

• Consider six countries
• look for market discipline
• look for heightened risk post-liberalization
• see whether market discipline and heightened risk
  are related

3
Deposit Insurance, Bank Risk, and Financial
Crises A Puzzle?

• Martinez Peria and Schmukler JF 2001
• deposit insurance does not diminish market
  discipline
• Demirgüç-Kunt and Detragiache JME 2002
• deposit insurance increases the likelihood of
  financial crises
• Barth, Caprio, and Levine 2001
• regulatory restrictions make financial crises
  more likely

4
Financial Crises and Financial Institution Risk

• Sources of financial crises
• force majeure
• heightened risk taking by financial institutions
• When will financial institutions take on
  heightened risk?

5
Market Discipline

• Deposit flows and bank characteristics
• Behavior in wake of shocks

6
Deposit Growth and Bank Characteristics
Constant term not shown
7
Risk Taking

• Ex post problems?
• Aggressive growth strategy/market share struggle
• increased quantity
• change in focus
• Liberalization/privatization

8
Bank Interest Rates Argentina
9
Bank Interest Rates Canada
10
Bank Interest Rates Mexico
11
Bank Interest Rates Norway
12
Bank Interest Rates Singapore
13
Interest Rates Texas SL
14
Measuring Preemptive Investment

• Shaffer 1993
• Perceived MR
• MRpP ?h(Q, Y, a)
• ?0 perfect competition
• ?gt0 market power underproduction
• ?lt0 supercompetition and overproduction

15
Estimation

• Q a0 a1P a2Y a 3 PZ a 4 Z a 5 PY a
  6YZ e
• P -?Q/(a1 a3 Z a5Y) (C/Q)(ß1 ß2 ln Q
  ß3 ln W1 ß4 ln W2) ?
• P -?Q/(a1 a3 Z a5 Y) (C/Q)(ß1 ß2 ln Q
  ß3 ln W1 ß4 ln W2)- ß5 DQ/(a1 a3 Z a5Y) ?

16
Estimation Results for Bank Risk Model
17
Depositor Discipline Limits Risk-Taking After
Liberalization
18
Conclusion

• Financial liberalization need not increase risk
• Market discipline constrains risk taking
• Financial liberalization need not precipitate
  financial crises