Financial Institutions in the Global Financial Crisis: The Role of Financial Derivatives, Bank Capital, and Clearing and Custody Services

Flashcards covering key concepts from the lecture notes on derivatives, bank capital, and clearing/settlement competition during the global financial crisis.

What is the main finding about the relationship between the use of financial derivatives by U.S. bank holding companies (BHCs) and their systematic risk exposures?

The use of financial derivatives (interest rate, exchange rate, and credit derivatives) is positively and significantly related to BHCs’ systematic risk exposures; derivatives used for trading and hedging both increase systematic risk, with stronger effects for larger banks.

What are the four components of the extended four-factor model used to measure systematic risk in Chapter 2?

Market risk, systematic interest rate risk, systematic exchange rate risk, and systematic credit risk.

How are the BHCs’ risk betas (Market, Interest Rate, Exchange, Credit) estimated in the first stage?

A monthly stock return regression against changes in market return, interest rate, exchange rate, and credit spread; betas capture the systematic exposures.

What is Hypothesis 2.1 in Chapter 2?

Financial derivatives (interest rate, exchange rate, and credit derivatives) impact the risk exposures (systematic risks) of a BHC.

What do Hypotheses 2.1a and 2.1b propose about derivatives used for hedging vs trading?

2.1a: derivatives used for hedging impact risks; 2.1b: derivatives used for trading impact risks; both contribute to risk exposures; both are positively related to systematic risk.

What are the main data sources for Chapter 2’s analysis of derivatives and risk?

FR Y-9C (for on-/off-balance-sheet derivatives and other BHC data), Center for Research in Security Prices (CRSP) for stock prices, and Federal Reserve data for macro variables.

What is the effect of Tier 1 capital on bank lending during the global financial crisis?

Tier 1 capital ratio has a positive effect on loan growth during the global financial crisis, helping sustain lending; Tier 2 capital’s effect is weaker and less consistent during the crisis.

How do customer deposits and interbank deposits relate to lending during the crisis?

Customer deposits positively affected lending during the crisis (stable funding); interbank deposits did not reliably support lending during the crisis and may have been less favorable.

How does the Tier 1 capital ratio of competing banks influence a bank’s lending during the crisis?

During the crisis, a bank tends to lend more when competing banks have a low Tier 1 capital ratio (i.e., higher competition from weak rivals), indicating competitive dynamics matter in crisis conditions.

What is the main conclusion about competition in clearing and settlement institutions (Chapter 4)?

The clearing and settlement industry operates in monopoly-like markets; competition increases during the global financial crisis; International CSDs face higher competition than national CSDs; competition grows with size and after mergers; U.S. markets are more competitive than European markets; vertical integration tends to reduce competition.

What is the Panzar-Rosse H-statistic used for in this study?

The H-statistic measures competition in the PR model; H > 0 suggests monopoly/ collusion, 0 < H < 1 suggests monopolistic competition with entry, and H = 1 indicates perfect competition.

What is the Lerner index and what does it indicate about competition?

The Lerner index is a price-cost margin (P − MC)/P; higher values indicate less competition (more market power); often found to be negatively correlated with H in banking studies.

What is the Boone indicator in this context?

A measure of competition based on the relationship between firms’ profits and marginal costs; a more negative Boone indicator implies higher competition; used to assess competition in clearing and settlement.

Which type of clearing and settlement institutions face higher competition: ICSDs or domestic CSDs?

International Central Securities Depositories (ICSDs) face higher competition than domestic central securities depositories (CSDs).

How do horizontal and vertical mergers affect competition in clearing and settlement, according to the study?

Horizontal mergers tend to increase competition (higher H-statistic, lower Lerner/Boone measures); vertical mergers tend to reduce competition (lower H-statistic, higher competitive concerns for access and pricing).

Which region shows higher competition in clearing and settlement, the U.S. or Europe?

The U.S. market shows higher competition than Europe according to the study’s measures.

What does SIFI stand for and what threshold defines it in this study?

SIFI = Systemically Important Financial Institution; defined as BHCs with total assets of $50 billion or more.

How is the crisis period defined in the study?

Crisis equals 1 during 2007Q3 to 2010Q4, and 0 otherwise.

What is the overall policy implication drawn from the clearing and settlement findings?

Despite technology and consolidation, disclosure suggests clearing and settlement operate in relatively noncompetitive markets; policy should consider measures to enhance competition, especially in Europe where fragmentation persists, while balancing efficiency gains.