Financial Institutions in the Global Financial Crisis - Lecture Notes Review

A set of Q&A 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 of Chapter 2 regarding the relationship between financial derivatives and risk exposures of U.S. bank holding companies (BHCs)?

The use of financial derivatives is positively and significantly related to BHCs’ systematic risk exposures; higher derivatives use is associated with greater systematic risk.

Do derivatives used for trading and hedging both increase systematic risk in BHCs?

Yes. Both derivatives used for trading and those used for hedging are positively and significantly related to systematic risk exposures.

Which types of derivatives are linked to higher systematic risk exposures in Chapter 2?

Interest rate derivatives, exchange rate derivatives, and credit derivatives.

How does the global financial crisis affect the derivatives-risk relationship according to Chapter 2?

During the crisis, the relationship between interest rate derivatives and exchange rate derivatives and risk exposures strengthened, while the positive link between credit derivatives and credit risk became less pronounced.

What data sources underpin the Chapter 2 analysis?

FR Y-9C (financial derivatives and balance-sheet data for U.S. bank holding companies), Center for Research in Security Prices (CRSP) for stock prices, and Federal Reserve macro data.

What empirical method is used in Chapter 2 to study derivatives and risk?

A two-stage time-series cross-sectional regression (SUR in the first stage) to obtain risk betas, followed by regressions of betas on on-balance-sheet and derivatives variables, with robustness checks including IV/2SLS.

How are bank holding companies categorized in the Chapter 2 analysis?

Into large BHCs (assets ≥ $50 billion) and small BHCs (assets < $50 billion).

What is Chapter 3 about?

Chapter 3 analyzes how bank capital structure (tier 1 vs tier 2) and funding sources affect bank lending, particularly during normal times vs the global financial crisis, including the roles of deposits and government guarantees.

What is the effect of Tier 1 capital on loan growth during the global financial crisis?

Tier 1 capital positively affected loan growth and acted as a buffer, helping banks continue lending during the crisis, especially for smaller banks and in non-OECD/BRIC countries.

How does Tier 2 capital affect lending in normal times versus during the crisis?

Tier 2 capital positively affects lending in normal times but does not support lending during the crisis (and may have a weaker or non-significant effect during crisis periods).

What deposits and funding dynamics matter for lending during the crisis according to Chapter 3?

Customer (retail) deposits positively affected lending during the crisis, while interbank deposits supported lending in normal times but did not support lending during the crisis (and may have negative effects in crisis).

What ownership effects influence lending during the global financial crisis as found in Chapter 3?

Government ownership helped sustain lending during the crisis (especially in non-OECD/BRIC countries); foreign ownership was associated with weaker lending; subsidiaries tended to fare better than stand-alone banks.

What is Chapter 4 about?

Competition in the clearing and settlement industry, using the Panzar-Rosse H-statistic, Lerner index, and Boone indicator with data from 1989–2012 across 46 institutions in 23 countries.

What are the main findings about competition in clearing and settlement (Chapter 4)?

The industry operates in monopoly-like conditions, but competition increases during the global financial crisis; International CSDs (ICSDs) face higher competition than domestic CSDs; competition has grown over time and with mergers; competition is higher in the U.S. than in Europe, and larger institutions tend to be more competitive.

What is the Panzar-Rosse H-statistic and what do its values imply in this study?

H-statistic measures revenue elasticities to input prices; H = 0 implies monopoly, 0 < H < 1 indicates monopolistic competition, H = 1 implies perfect competition. The study finds nonpositive H-statistics, indicating monopoly-like competition in clearing and settlement.

What are ICSDs and what competitive pattern do they show?

ICSDs are International Central Securities Depositories; they face higher competition than domestic CSDs due to cross-border services and network effects, though regulation and barriers still apply.

How do mergers affect competition in clearing and settlement according to Chapter 4?

Horizontal mergers tend to increase competition (higher H-statistic, lower monopoly power), while vertical mergers tend to reduce competition (lower competitive pressure).

Which three measures are used to assess competition in Chapter 4?

Panzar-Rosse H-statistic, Lerner index, and Boone indicator.

What is the data period and scope for Chapter 4’s competition analysis?

1989–2012, covering 46 clearing and settlement institutions across 23 countries (U.S. and Europe-focused).

What policy implication arises from Chapter 2’s findings about hedging vs trading derivatives?

Prohibiting trading derivatives alone may not reduce risk, because derivatives used for hedging are also associated with higher systematic risk; regulation should consider the complexity of risk and not rely on a simple trading vs hedging split.

What does the study use as a measure of government backing in Chapter 3?

The Fitch bailout probability (Bailout probability) as an indicator of implicit government guarantees.