Working Paper: CEPR ID: DP3122
Authors: Jan Hanousek; Grard Roland
Abstract: We present a model of bank passivity and regulatory failure. Banks with low equity positions have more incentives to be passive in liquidating bad loans. We show that they tend to hide distress from regulatory authorities and are ready to offer a higher rate of interest in order to attract deposits compared to banks that are not in distress. Therefore, higher deposit rates may act as an early warning signal of bank failure. We provide empirical evidence that the balance sheet information collected by the Czech National Bank is not a better predictor of bank failure than higher deposit rates. This confirms the importance of asymmetric information between banks and the regulator and suggests the usefulness of looking at deposit rate differentials as early signals of distress in emerging market economies where banks’ equity positions are often low.
Keywords: Bank Failures; Bank Supervision; Czech Banking Crisis; Default Risk; Transitional Economies
JEL Codes: C53; E58; G21; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Banks with low equity positions (G21) | Banks are passive in liquidating bad loans (G33) |
| Banks are passive in liquidating bad loans (G33) | Banks hide financial distress from regulators (G28) |
| Banks with low equity positions (G21) | Higher deposit rates offered by banks (G21) |
| Higher deposit rates offered by banks (G21) | Early warning signal of potential bank failure (G21) |
| Balance sheet information from Czech National Bank (E59) | Not a better predictor of bank failure than higher deposit rates (G21) |