FDIC Regional Profile – Banking and Economic Conditions
FDIC, Fall 2005
This new quarterly publication offers regional snapshots of banking business conditions across the main regions of the United States, including an initial assessment of the impact of Hurricanes Katrina and Rita. The strongest economies in the West and South show vigorous commercial real estate activity and residential real estate activity helped by a “proliferation of innovative mortgage products”. However, even in these areas, which are characterised by bank growth, there are some signs that the economy is levelling off. Across the nation, loan losses remain at historic lows, but the impact of higher energy prices and hurricane damage is not yet fully apparent, the study says, while higher short term interest rates and a flattening of the yield curve mean that some banks are vulnerable to net interest margin pressures.

Global Financial Stability Report: Market Developments and Issues
International Monetary Fund, April 2005
This report is the IMF’s latest semi-annual assessment of global financial and banking markets. It addresses a number of key business risk issues emerging in the global banking market, including risk transfer to the household sector, risks facing emerging country economies, and banking sector developments in emerging markets. Various boxes look at special issues such as the maturing credit derivatives market and distance-to-default measures of bank soundness.

Learning by Observing: Information Spillovers in the Execution and Valuation of Commercial Bank M&As
Gayle DeLong and Robert DeYoung, Chicago Fed, working paper, 1 November 2004
This research paper looks at data from 216 mergers and acquisitions of large US commercial banks between 1987 and 1999. The authors try to determine whether banks have become better at managing acquisitions, and investors better at valuing those acquisitions, as more and more bank M&As have been executed since the modern wave of bank M&A began in the late 1980s. Their findings may explain why academics have found little evidence that bank M&A activity creates value.

Mergers and Acquisitions and Bank Performance in Europe: The Role of Strategic Similarities
Yener Altunbas and David Marques Ibanez, European Central Bank, working paper, October 2004
In what situations might it be better for merging banks to be similar to each other, and in what situations might it be better for them to be different? This paper finds that in domestic deals, it is a drawback to integrate institutions that are not the same in terms of earnings, loan and deposit strategies. But it seems to help if the merging banks’ capitalisation and technology strategies are diverse. Different rules seem to apply to cross border mergers. Here, it’s a bad sign if capitalisation and technology strategies are diverse. However, differences in loan and credit risk strategies signal that it is more likely there will be an improved return on capital for the eventual merged bank.

Competition, Product Differentiation and Quality Provision
Andrew Cohen and Michael Mazzeo, Federal Reserve and Kellogg School of Management, June 2004
What drives bank branching decisions? This empirical analysis discovers that competition from multimarket banks tends to be associated with denser branch networks in a region. The authors suppose this is because this kind of bank responds to competition by opening more branches. On the other hand, where competition in the market comes largely from single-market or thrift banks, there tend to be fewer branches per firm.

Competition in Banking: A Review of the Literature
Carol Ann Northcott, Bank of Canada, working paper, June 2004
How does the degree of competition in a banking market relate to bank risk management? Most economic theory tends to assume that competition is a good thing, but in the banking market competition can make it difficult for banks to charge appropriately for the risks they are running when extending loans. This could contribute to financial instability. This review of the literature offers a good introduction to the topic, covering subjects such as the effect of a bank franchise or charter on risk taking, and how market power relates to “relationship” versus “transactional” styles of banking.

The Evolving Role of Commercial Banks in US Credit Markets (download page)
Federal Deposit Insurance Corporation, Future of Banking Series, 25 March 2004
This study of the changing role of US commercial banks finds no real evidence of a decline in their importance – though the character of what they do has changed considerably over the last few decades. Banks have shifted from funding loans, to providing financial services around loans that are funded by other mechanisms, e.g., the securitization markets. Loans have tended to become longer term, and much more of a bank’s balance sheet is linked to real-estate lending than used to be the case.

The Effects of Bank Consolidation on Risk Capital Allocation and Market Liquidity 
Chris D'Souza and Alexandra Lai, Bank of Canada working paper series, February 2002
This paper investigates the effects of financial market consolidation on risk capital allocation in a financial institution, with special reference to market liquidity in dealership markets. The authors show that an increase in financial market consolidation can have ambiguous effects on liquidity in foreign exchange and government securities markets, where financial institutions use risk-management tools (for example, value-at-risk) in the allocation of risk capital among separate business lines. This effect depends on the correlation among cash flows from business activities at newly merged financial institution, and the authors suggest this should be taken into account when regulators examine merger proposals.

The Effects of Focus and Diversification on Bank Risk and Return (small download charge)
Viral Acharya, Iftekhar Hasan and Anthony Saunders, London Business School, New Jersey Institute of Technology, and Stern School of Business, CEPR discussion paper, March 2002
What does empirical evidence tell us about the relative attraction of focus (specialisation) versus diversification on the return and the risk of banks? In this study, credit experts look at data from 105 Italian banks over the period 1993-1999. Counter-intuitively, the results indicate that diversification with reference to industry sector tends to produce riskier loans, this effect being most powerful for high-risk banks. But geographical diversification does seem to improve the risk-return tradeoff for banks that exhibit relatively low levels of risk. The diversification of bank assets offers many benefits, but it seems it does not guarantee improved performance at banks - perhaps because some banks can't monitor their lending as efficiently when they expand into newer or more competitive industries.

The Effects of Cross Border Bank Mergers On Bank Risk and Value
Yakov Amihud, Gayle DeLong and Anthony Saunders, Stern School of Business and Zicklin School of Business, Stern Department of Finance working papers series, revised March 2002
A common argument in banking is that cross-border, or geographic, mergers have the potential to reduce bank risk: it is surely better for a bank not to 'put all its eggs in one basket'. However, this paper finds that the effect of an overseas acquisition is highly idiosyncratic. Because various costs offset the benefits, on average, cross-border bank mergers do not seem to change the risk of the acquiring bank in any significant way. This finding suggests that regulators should probably not fear any systemic implications from the rise in bank cross-border acquisitions. But it also suggests that banks themselves need to look more carefully at how the nature of the merging partners' operations might change, offsetting any natural diversification benefits.

Does Function Follow Organizational Form? Evidence From the Lending Practices of Large and Small Banks
Allen Berger, Nathan Miller, Mitchell A. Petersen and Jeremy Stein, Board of Governors of the Federal Reserve System, Northwestern University, University of Chicago, Harvard University, working paper, revised December 2001
Might small organisations do better than large organisations in processing 'soft' risk information, such as assessments of creditors' personal qualities? This working paper explores this idea in the context of bank lending to small firms, and finds that large banks are less willing than small banks to lend to informationally 'difficult' credits, such as firms that do not keep formal financial records. Moreover, large banks lend at a greater distance, rely more on standardised information, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. While this gives small banks the edge in certain markets, it also implies that they will need to change their skill-sets to compete in the large bank market.

Corporate Diversification: What Gets Discounted?
Sattar A. Mansi and David M. Reeb, Rawls School of Business, Kogod School of Business, Journal of Finance (forthcoming: October 2002 edition)
Empirical research seems to indicate that diversified firms of all kinds are valued in the equity markets at a discount relative to the sum of the imputed values of their individual business segments. But does this tell us anything about the value of a diversification strategy, or are the results related to the risk effects of conglomeration and its subsequent impact on firm value? This working paper, due to be published in a forthcoming edition of the Journal of Finance, explores the 'diversification discount' and argues that it stems from the risk-reducing effects of corporate diversification and from the benefits that are gained by bondholders. It finds that the apparent shareholder losses from a diversification strategy are a function of firm leverage; that all-equity firms do not exhibit a similar diversification discount; and that using book values of debt to compute excess value creates a downward bias for diversified firms.

Financial Soundness Indicators: Policy Papers
International Monetary Fund, June 2001
The world’s macroeconomic institutions are in the midst of standardising formal measures of risk for the domestic financial, and banking, systems of sovereign entities. These measures build on, and are analogous to, the microeconomic risk metrics used by individual financial institutions. Defining the measures is an ambitious task, though perhaps the biggest surprise is that banking system risk indicators and stress tests were not standardised decades ago. This paper brings the reader up to speed with the IMF’s approach to the problem (the BIS, ECB and others are also working on the issue). It defines and endorses a core set of 15 “financial soundness indicators”, explains their role in “macroprudential analysis” of banking systems, and looks at the probable role of stress testing in the world of macroeconomic risk management.

Bank Capital and Risk Management: Issues for Banks and Regulators
Kenneth A Froot, IFRI, June 2001
Banks are moving away from their traditional role as warehouses of risk and towards a role as originators and distributors of a diverse range of financial services. This means that business risks, as opposed to credit and market risks, are likely to become a larger part of total bank risk. This working paper, prepared for an International Financial Risk Institute roundtable in April 2001, grapples with the implications of this for bank economic and regulatory capital, and points out that the Basle II regulatory reform proposals take little account of the growing importance of business risk.

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