Search

This paper investigates the impact of macro-prudential policy on bank credit risk using a unique data set consisting of bank-level and country-level data for 429 credit default swap (CDS) spreads related to 149 banks from 36 countries over the period 2010-2019. The macro-prudential policy encourages the mechanism that promotes credit availability, strong liquidity, lending and economic growth. We find that bank CDS spread increases during uncertain times, and prudential regulation measures (counter-cyclical capital buffers) prevent any increase in bank CDS spreads. More specifically, we show that capital-based macro-prudential policies such as a tightening of countercyclical capital buffers (CCyB) are effective in dampening bank credit risk. In the presence of CCyB, banks can draw down liquidity buffers in times of financial distress which can subsequently prevent a bank from being unstable during a period of financial stress. Given the interconnected nature in which developed markets operate, the failure of one large bank, may cause a domino effect, resulting in the simultaneous failure of several large financial institutions. Hence, for the robustness of our results, we further supplemented our analysis by incorporating the capitalbased macro-prudential policy instrument which include risk weights, systemic risk buffers, and minimum capital requirements. The objective of introducing systemic risk buffer, which is reflected in our alternative measure of macro-prudential policy, is to address systemic non-cyclical risks which arise from systemically important financial institutions that are very large. In the absence of uncertainties, our findings indicate that the alternative macro-prudential measure is negative and marginally significant, suggesting that banks with stricter capital regulation and systemic buffers are better able to narrow their CDS spread and mitigate any adverse effect on their credit risk. Moreover, our results indicate that during real uncertainty and in the presence of high market volatility (VIX), banks with stronger capital requirements and systemic buffers are better able to limit any increase in their credit risks. These results suggest that central bank actions in providing liquidity during the COVID-19 pandemic are justified for containing financial market risks. We further show that bank-level factors, such as (i) an improvement in liquidity, (ii) a rise in capital ratios, (iii) an increase in profitability and, to some extent, (iv) better asset quality and (v) a fall in leverage are associated with lower bank CDS spreads. In identifying the transmission mechanism, we find that banks with higher liquidity are better positioned to comply with macro-prudential regulation, while mitigating the rise in credit risk during uncertain times. Finally, our results reinforce the importance of the macroeconomic environment matters in driving the CDS spreads suggesting that periods of high inflation are linked with rising tensions in the banking sector; and a rise in (financial, macroeconomic and real) uncertainty is associated with a significant increase in bank CDS spreads. [ABSTRACT FROM AUTHOR]

This paper identifies the drivers of the CDS spread as a measure of credit risk by considering bank level factors (regulatory capital, leverage, liquidity, asset quality and operations Income ratio) and the housing market, in both developed and emerging countries. In addition, it investigates whether bank size matters in driving credit risk. The unique dataset allows us to uncover the behavior of the CDS spread and the fluctuations in credit risk both before and during the financial crisis, over the period of 2004-2011. The sample consists of 30 countries and 115 banks. The findings reveal that the strongest bank-level factors driving the CDS spread were found to be asset quality, liquidity and operations Income ratio. In fact, the more liquid banks, with better quality of assets, were found to face narrower CDS spread and reduced levels of credit risk. Furthermore, banks with higher levels of liquidity were better able to avoid bank-runs and sustain themselves in times of credit shortages. In addition, we find that banks with higher levels of operations Income ratio were found to be more resilient to default risk and therefore faced lower levels of CDS spread. When considering the impact of bank size on the CDS spread, our findings suggest that bigger banks were subject to higher CDS spreads and increased credit risk, while smaller banks experienced relatively lower CDS spreads and were considered to be safer, allowing to derive an optimal level of bank size. Any financial institution growing beyond that threshold becomes subject to higher credit risk. [ABSTRACT FROM AUTHOR]