Knowledge that Transforms

This paper examines the effects of exchange rate depreciation on commercial bank failures in Indonesia during the period from January 1995 to December 1999. This included the period of the Asian crisis during which the Indonesian currency depreciated by about 75% in nominal terms or 25% in real terms. The estimation results show that due to a higher amount of foreign currency assets relative to the amount of foreign currency liabilities, exchange rate depreciation led to a lower probability of bank failure. Through reduced profit on lending in foreign currency, exchange rate depreciation led to a higher probability of bank failure.

This paper demonstrates that preferred stock may arise as an optimal security in a tax-induced equilibrium. This result is driven by graduated tax schedules and by uncertainty. In a more general sense, our results can be interpreted as a template for including any security with a different tax treatment in a firm's capital structure. The first part of the paper demonstrates that the Miller equilibrium framework can accommodate more than two securities if different investor classes are taxed differently on each security and the tax schedule for each investor group is upward sloping. We then simplify the tax schedule, but introduce uncertainty, which implies the possibility of bankruptcy and the possible loss of tax shelters. The interaction of tax rates and seniority now affects the contribution of each security to after-tax firm value, as in some states the firm may not be able to pay either interest (or dividends) or even principal to its various claimholders. It is shown why and how these features, i.e. the various tax rates and seniority, determine the financing equilibrium, which is obtained by equating the expected marginal tax benefit of all securities. We demonstrate that non-profitable firms will tend to issue preferred shares whereas profitable firms will not find preferred stock advantageous in our framework. Comparative statics with respect to various tax rates are derived as well. These predictions are tested using a large sample of firms for the last 25 years. The empirical testing broadly confirms the theoretical predictions.

This paper outlines the development of a practical approach to simulating a credit loss distribution function and to implementing a stress test exercise focusing on the entire Spanish mortgage portfolio. Specifically, we determine, via regression model, the main factors that explain why households fail to meet their mortgage payment commitments. This allows us to assign individual borrowers’ PDs and to estimate a rating system for the mortgage portfolio. Then, we simulate the empirical distribution function of mortgage loss rates using a Monte-Carlo resampling method, and compare the loss rates from this function with those provided by the Basel II IRB formulas. Finally, we assess, by running a stress exercise, the ability of banks to withstand certain adverse situations. The main result from this exercise is that, in general terms, Basel II IRB regulatory loss coverage offers fairly adequate protection for banks.

This paper investigates the use of debtor-in-possession (DIP) financing by firms reorganizing under Chapter 11. A model is developed in which there is asymmetric information between the creditors of a distressed firm and its management. In this context, it is demonstrated that reliance on DIP financing resolves informational asymmetries regarding the true economic value of distressed firms. The model's conclusions are empirically supported in the paper and by results of extant research. The signaling role of DIP financing is evidenced both by the positive stock price reaction to DIP announcements and the fact that firms employing DIP financing have more successful reorganizations.

This paper develops a model of banking fragility driven by aggregate liquidity shortages. Inefficiencies arise from a failure of the interbank market to smooth the available liquidity in such a shortage. We find that a standard lender of last resort policy is ineffective in restoring efficiency as it leads to offsetting changes in the banks’ supply of liquidity. In contrast, subsidizing the purchase of assets from troubled banks increases welfare by improving the banks’ liquidity holdings. The first best, however, is achieved by redistributing existing liquidity from healthy to troubled banks in a crisis.

In recent years, mergers, acquisitions and organic growth have meant that some of the largest and most complex financial groups have come to transcend national boundaries and traditionally defined business-lines. As a result, they have become a potential channel for the cross-border and cross-market transmission of financial shocks. This paper analyses the degree of comovement in the equity prices of a selected group of large complex financial institutions (LCFIs), and assesses the extent to which movements are driven by common factors. A relatively high degree of commonality is found for most LCFIs although there are still noticeable divisions between sub-groups of LCFIs, both according to geography and to a lesser extent primary business-line.

In the literature on currency and banking crises it has become the standard procedure to distinguish pure currency crises, pure banking crises and combined (“twin”) currency and banking crises. We show theoretically and empirically that a similar differentiation should be chosen with regard to currency and debt crises. Twin currency and debt crises differ from both pure currency and pure debt crises in their determinants, course of events, and economic consequences. We find that each type of crises has a unique set of macroeconomic causes. We also identify internal contagion and selection bias effects, which may lead to biased empirical estimates if twin crises are not treated as a specific type of crises. Such a separation allows in significantly improving the efficiency of early warning systems especially for debt and twin crises.

Outright bank failures without prior indication of financial instability are very rare. In fact, banks can be regarded as troubled to varying degrees before outright closure. But failure studies usually neglect the ordinal nature of bank distress. We distinguish four different kinds of increasingly severe events on the basis of the distress database of the Deutsche Bundesbank. Only the worst distress event entails a bank to exit the market. Since the four categories of hazard functions are not proportional, we specify a generalized ordered logit model to estimate respective probabilities of distress simultaneously. We find that the likelihood of ordered distress events changes differently in response to given changes in the financial profiles of banks. Consequently, bank failure studies should account more explicitly for the different shades of distress. This allows an assessment of the relative importance of financial profile components for different degrees of bank distress.

This paper provides a detailed descriptive analysis of multiple-plan Chapter 11 reorganizations and an empirical study of the determinants of multiple-plan adoption. In the presence of imperfect and asymmetric information multiple plans are a result of extended bargaining that facilitates the convergence of beliefs and resolution of incentives. The longer time in bankruptcy leads to costs that concern all claimants and affect recovery rates and deviations from absolute priority rules. The delay to reach a settlement is mainly due to firm valuation uncertainty, creditor coordination problems, shareholders receiving some consideration in the first plan, and presence of DIP financing.

This paper investigates the use of exit consents in a sample of bond exchange offers during 1986–1997. We find that exit consents are common, approximately 56% of the exchange offers in our sample have them and 60% of the exit consents are by non-financially distressed firms. Using a probit model, we find that a set of variables that proxy for holdout problems is able to significantly explain the use of exit consents. Reducing holdouts is necessary for timely and efficient debt restructurings and achieving financial stability particularly in sovereign debt markets.