The Role of Systemic Risk, Regulation and Efficiency within the Banking Competition and Financial Stability Relationship

Ellis, Scott (2019) The Role of Systemic Risk, Regulation and Efficiency within the Banking Competition and Financial Stability Relationship. Doctoral thesis, Northumbria University.

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Abstract

This thesis provides empirical evidence of the banking competition-stability nexus from the Basel jurisdictions with a main focus on the United States (US) banking sector from 2000 to 2015. In order to assess this relationship, three papers in the format of journal articles were used to explore different theoretical concepts.

The first paper, is a systematic literature review of 4,859 abstracts to identify the different types of systemic risk measures and the challenges regulators face in addressing systemic risk. 56 measures of systemic risk developed post-2000 were identified and critically appraised to inform academics and regulators of the models' vulnerabilities. Additionally, a number of measures were calculated using US bank data. The findings of this paper suggests that the majority of these measures tend to focus on individual financial institutions' risk rather than the entire system stability. This directly reflects the current regulations, which aim to ensure individual institutions' soundness. As macro-prudential regulation evolves, policy-makers face the issues of understanding contagion and how such regulation should be implemented.

The second paper is an empirical analysis of banking cost efficiency, the aim of this paper is threefold, firstly to conduct an empirical literature review of banking sector efficiency over the last two decades, thereby identifying banking risk and regulatory variables used to access efficiency. Secondly, Data Envelopment Analysis (DEA) and Stochastic Frontier Analysis (SFA) are applied to measure efficiency within the Basel jurisdiction's banks. Thirdly, it aims to investigate the determinates of cost efficiency in the US banks by employing System Generalised Methods of Moments (GMM) regression analysis using panel data. This paper found the GMM analysis econometric measures of efficiency provided more statistically significant regression models than when using accounting based measures of efficiency. Also it was found that credit and liquidity risks are negatively associated with efficiency, and regulations designed to mitigate these risks have a negative impact on efficiency.

The final paper combines the literature and calculations from papers one and two, to examine the role of risk, regulation and efficiency within the banking competition and financial stability relationship. Using GMM regression, this paper found a neutral view of the competition-stability nexus within the US banking sector, where both competition and concentration fragility co-exist. In addition, a unique polynomial competition-fragility relationship was found. Interestingly using the Composite Index of Systemic Stress (CISS) as a measure of systemic risk, altered the competition-stability relationship to identify a concave relationship.

This suggests that the competition-stability nexus within one country can differ at the microeconomic (financial stability) and macroeconomic (systemic risk) level. In regards to increased risk, credit, leverage, diversification and liquidity risk was found to be negatively associated with financial stability. Whilst increased capital requirements as proposed by Basel III enhanced stability, the Net Stable Funding Ratio (NSFR) was unexpectedly found to hinder stability, providing caution to regulators as this is currently implemented.

The findings within this thesis provide an incentive for further academic research in the area of liquidity & systemic risk, which would be relevant to practitioners and policy-makers to enhance their understanding of banking competition and financial stability.

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