Essays on Interbank Market Funding, Bank Conduct and Performance in the UK
The growing importance of interbank money markets, which allows banks to transact among themselves using various financial instruments that cover maturities spanning one day to one year, have been blamed for the systemic exposures that emanated due to the 2007-09 global financial crisis (Georg, 2013; Lucchetta, 2015). As competitive and liquidity pressures increased, several regulatory frameworks were enacted by regulatory authorities to safeguard the banking sector (Afonso et al., 2019). However, practically, banks are performance-driven institutions (Acharya, 2009). Given their distinct business models, objectives and regulatory constraints, they continued to assume higher risks by circumventing the new regulations towards achieving their performance and revenue goals. In some cases, these banks resorted to anti-competitive conducts by grouping together (collusion) and/or merging (monopolization) to deliberately manipulate the benchmark interbank rate and/or their true earnings position (opacity), and using various financial instruments to obtain mutual benefits that lead to cost savings and increased profits (Schrimpf and Sushko, 2019). In light of this, the overall aim of this thesis is to bridge the gap between interbank funding decision and bank’s strategic choices such as risk exposure and conduct, and whether the choice of bank business model drives a bank’s decision to manage their financial statements to smooth earnings. To address the overall objective, the thesis is segregated into three empirical essays, presented as chapters to address three key objectives. The first essay covers objective one which focuses on investigating the importance of bank risk exposures through interbank funding on bank efficiency levels. Although unsecured interbank markets enable banks to lend or borrow funds towards achieving their performance objectives, it also exposes banks to various risks which trigger changes in bank risk management and performance. To gain more insights about these linkages and design a comprehensive performance measure, Chapter 2 conceptualizes the overall bank performance management process as a multi-stage process using a three-stage network data envelopment analysis framework with feedback and alliance. The findings suggest that overall bank performance management is achieved via a complement of good alliance between risk and funding, and financial performance. Also, high financial or overall performance may not imply better risk management or allied process performance. Rather, banks are inherently performance driven institutions whose performance objectives are independently optimal but aggregately suboptimal. Hence, most banks will opt for superior performance outcomes at the expense of sophisticated risk management. The second essay examines the second objective: whether a concentrated interbank market stimulates anti-competitive bank conduct – i.e. bank collusion or monopolistic pricing, towards enhancing performance. To advance knowledge and understanding on the structure–conduct–performance paradigm within the interbank context, Chapter 3 adopts an approach that incorporates the role of bank conduct in the structure-conduct-performance nexus to offer a valid confirmation of hypothesis. The findings show that interbank market structure provides a channel for banks to collude and engage in monopolistic pricing in the market for bank and business loans, to consequently increase bank performance. This therefore provides support for the validity of the SCP hypothesis in an interbank context. Further, collusion and other anti-competitive behaviours in the interbank market exacerbate incentives for foreign and conglomerate bank entry. Large bank boards are also more likely to behave anti-competitive given their access to greater information, expertise, connections/affiliations and resources. The third essay, which examines the third objective, provides evidence on the impact of bank business model strategies - retail-oriented, wholesale-oriented, and diversified, on the degree of bank’s earnings opacity in the UK. Chapter 4 employs two alternative approaches: (i) explaining earnings opacity directly through the individual bank characteristics, (ii) using the common factors based on the factor analysis to capture inherent latent strategies of business models. To explore the business model effects, the chapter explicitly distinguishes between short-term (within) and long-term (between) effects. The findings suggest that that retail-oriented business models decrease the likelihood earnings management practices in the short-term but not over the long-term. However, wholesale-oriented business models increase the probability of earnings manipulation both in the short- and long-term. Also, while bank business models characterised by greater degree of functional diversification are likely to lower earnings manipulation in the short-term, the long-term incentives cannot be mitigated. The study also demonstrates that low failure risk represents an important channel in mitigating the inherent positive business model effect of on earnings management practices activities both in the short- and long-term.
- PhD