The banking industry is one of the most important components of modern economies, providing a variety of essential economic functions. However, a banking system is inherently fragile, and this has been widely witnessed during the great financial crisis in 2008. Another lesson learnt from the crisis is that the cost of a banking crisis can be substantial. Thus, it is important for us to understand how a banking system could be destabilised and thus consider the prudential policies that could be specifically designed to prevent a banking crisis from occurring.
This thesis uses micro-econometric methods to explore factors that could have an impact on banking stability. The first essay examines whether a liquidity shock to a banking system could be transmitted to other economies through a network of bank ownership. First, it constructs cross-border ownership networks for banks located in European countries. Then, it exploits the liquidity crisis generated by the 2010 European sovereign debt crisis as a quasi-natural experiment. The analysis shows that subsidiary banks located outside of Greece, Ireland, Italy, Portugal and Spain (GIIPS) but with ownership linkages to these countries have a lower loan growth rate during the crisis period, which suggests that the liquidity shock experienced by the GIIPS countries was indeed transmitted to those banks through ownership linkages. Larger subsidiary banks and those subsidiaries that were more profitable are found to be more resilient to the shock. Furthermore, It also shows that the parent bank’s characteristics affect the transmission of the shock, supporting the notion of an internal capital market operating within these banking groups.
The second essay focuses on the effect of sovereign shocks on banks’ lending activities through their exposures to the distressed sovereigns. Furthermore, it identifies whether bank strength, specifically bank capital, can act as a transmission channel through which poorly capitalised bank tend to be more fragile in response to a sovereign shock. Using a rich dataset on banks’ sovereign exposures from the European
Banking Authority, it also disentangles the transmission channel by breaking down the type and accounting classification of the exposure. The results suggest that highly exposed banks tend to have lower lending over the crisis period. But it shows that it is banks’ available-for-sale sovereign exposures that play the key role in the transmission from sovereign distress to bank lending through the capital channel.
The third essay explores the relationship between banking competition and banking stability, using the staggered banking deregulation levied by individual states in the U.S. as a natural experiment. Specifically, it identifies the effect of the intensified competition induced by the deregulation on the stability of the U.S. banking sector. The analysis is conducted at state-level as well as bank-level, and the overall result shows that the competition shock improves banking stability at both state- and bank-level. Furthermore, it reveals that there is significant heterogeneity among banks in response to the intensified competition: intra-state competition shock has a greater effect on the stability of small banks while banks with a larger size or better profitability are more likely to be affected by the inter-state competition shock. It also suggests that there is a non-linear relationship between banking competition and stability, as the competition shock has a greater effect on banks operating in a less competitive environment.
Overall, the findings from this thesis may help regulatory authorities to maintain the stability of the banking sector in three ways. First, it helps regulators to design micro-prudential policies towards foreign banks to prevent them from transmitting foreign liquidity shocks which could potentially destabilise the domestic banking system. Second, it produces guidance on how the regulatory treatment on banks’ sovereign exposures should be specified in the future macro-prudential policy framework, to better isolate banks from sovereign shocks. Third, it helps regulators to balance between policies on facilitating competition in the banking sector and those on maintaining the stability of the financial system.
