Financial Econometrics

Week 10
Dr Arisyi Raz

Email: arisyi.fariza06@ui.ac.id
Do Creditors Discipline Banks?
 Regulators wish to constrain bank risk taking

 One way is to impose market discipline

 Creditors holding bank debt are exposed to large losses in

the event of bankruptcy

 They therefore have incentives to monitor the bank

 And force changes in bank behavior that make them

sounder
Do Creditors Discipline Banks?
 The European Union introduced depositor preference
law in 2014

 Idea:

 Subordinate nondepositors’ claims below uninsured

depositors’ claims

 Nondepositors face greater losses in bankruptcy

 Leads to more market discipline, less risk taking

 Do Creditors Discipline Banks?
Payout order in bankruptcy Payout order in bankruptcy
with out depositor with depositor preference
preference

1. Receiver 1. Receiver
2. Insured depositors 2. Insured depositors
3. Uninsured depositors & 3. Uninsured depositors
nondepositors 4. Nondepositors
4. Shareholders 5. Shareholders
Monitoring Matters
Danisewicz, McGowan, Onali and Schaeck (2017) ‘Debt
Priority Structure, Market Discipline, and Bank
Conduct’, Review of Financial Studies, forthcoming.

 Investigate whether this is the case using a natural

experiment in the United States

 Between 1983 and 1993 several US states randomly

introduced DPL

 But only for state chartered, not national chartered

banks
Monitoring Matters
 Introduction of the law is exogenous

 Due to lawmakers failing to recognize they did not have a

priority order

 Well defined treatment and control groups

 TG: state chartered banks

 CG: national chartered banks

 Groups are similar and operate within the same state

– economic conditions are identical for both
Similarity of the Groups
Diff-in-Diff Evidence of Monitoring

Creditors whose
claims become
junior demand
higher
compensation i.e.
more monitoring

Creditors whose
claims become
senior demand
less compensation
Diff-in-Diff Evidence of Influencing
Diff-in-Diff Evidence of Influencing
 An exogenous change in the law leads to significant
improvements in conduct with the TG relative to the
CG

 Higher Z-scores (move further from default)

 Improve profitability (ROA), reduce the variance of
profitability (ROASD) and improve capital ratio

 Lower non-performing loans rates

 Reductions in leverage