Abstract
The recent financial crisis has shown the relevance of liquidity in the banking industry. To ensure the stability of the financial system the regulator has increased liquidity constraints to the capital regulation. It has long been suggested that the existence of capital adequacy regulation plays, including the liquidity requirement, an essential role in helping financial firms to avoid bankruptcies and their negative externalities on the financial system (Dewatripont and Tirole, 1994).
Credit institutions across EU face an unprecedented amount of regulatory reforms. In detail, during the debate related to the Basel Capital frameworks some critics argue how stringent requirements can impact negatively the banking system in recessions with the consequent cut of lending activity (Peura and Jokivuolle, 2004). Specifically, in relation to liquidity, Basel 3 framework requires financial institutions to hold more liquid assets and issue more long-term debt. Banks are required to hold at all times liquid assets, the total value of which equals, or is greater than, the net liquidity outflows which might be experienced under stressed conditions over a short period of time (30 calendar days). Liquidity is represented as an equilibrium between loans and deposits and it decreases every time a bank sells loans to corporate and individual customers.
The provision of liquidity for banks assumes challenging connotations from different points of view. Raising new capital becomes hard every time that markets are illiquid as well as liquidity has a fundamental influence on the same systemic risk of the entire banking system (Bushman, 2014). Consequently bankers are not indifferent to combine capital and liquidity according to the risk management decisions that have important immediate implications for the bank’s access to funding (Calomiris et al., 2015). Furthermore, the same definition of liquid assets affects the behaviour of market participants, specifically the liquidity of different asset classes.
This thesis considers liquidity issue in banks from two concurrent perspectives: the market reactions to a liquidity shock, such as the announcements of the Quantitative Easing (QE) in the Euro zone among the years 2015-2016 and the market reactions to the mandatory disclosure of foreign cash held by European banks thanks to the new regulation of the “Country-by-Country-Reporting” (CBCR) in 2014.
The first study examines the capital markets’ assessments to the key events related to the QE adopted for the first time in the Euro zone. QE programme intends to provide new liquidity for European banks thanks to the intervention of the European Central Bank (ECB). The second study analyses investors’ reactions to the new key business information, particularly the mandatory disclosure related to the amount of foreign cash held by the European banks in their subsidiaries situated in countries different from the main residence country.
In detail, the first paper investigates on the stock market reactions to the announcements of the QE programme starting from January 2015 and following explains which, how and why bank characteristics might influence the investors’ reactions. Existing literature documents the different experiences of QE in other countries and in other time periods (Fawley and Neely, 2013), mainly in US and in UK after the boom of the last biggest financial crisis (2007-2008) and in Japan during the years 2001-2009. There is still an ongoing debate related to the beneficial effects of the Quantitative Easing policy. Even though central banks attempted in all cases to inject new liquidity to allow an economic recovery, it is also true that they didn’t always obtain those results as they expected. Our identification strategy consists in investigating on investors’ expectations taking into account that new liquidity injection might assume different connotations into the respect of banks’ characteristics. In this way, we identify the bank prior conditions at bank-level as instrument to explain and to understand the future economic consequences of an unconventional programme as the QE. While the extant literature points out the effects of the QE in other countries highlighting empirically the economic insights about QE consequences, this study attempts to provide different considerations about the financial and economic conditions of the European banking sector before the adoption of QE in the Euro zone.
The sample covers listed banks, such as commercial and investment banks, of the Euro zone countries, other countries of the EU as Sweden, Denmark and UK and finally banks of countries with a relevant presence in the Economic European Area (EEA), such as Norway and Switzerland. We adopt an event study approach among the key events leading to the adoption of QE programme and further we conduct the analyses at firm-level including as bank characteristics the capital adequacy, the asset quality and the risk exposure ratios of the European banks. These bank features represent the main drivers through which today investors conduct their valuations and capital allocation’s choices among the banking sector. The first findings report a negative overall market reaction among the six QE announcements and a positive association between the cumulative abnormal returns and specific bank characteristics such as liquidity ratio and leverage, while a negative association with RWA. Investors’ assessments are based on the valuation that banks will increase their liquidity and consequently banks will address this new liquidity to increase theirs assets (positive increase of assets growth) as well as their leverage and their capitalization. From these analyses it seems that banks not well capitalized might not get future benefits also according to their financial robustness and specifically in terms of regulatory capital. The main economic insights from the analyses conducted at bank-level are that investors might see new opportunity for banks to increase their risk-exposure given the new liquidity injection by ECB. Our contribution lies on to highlight how the relation between bank-specific characteristics and the stock market reactions becomes a sort of barometer for next future considerations about the effects in terms of improvement of the banks’ soundness and financial stability.
The second paper considers the new mandatory disclosure about the foreign cash held by European banks in their foreign subsidiaries. According to transparency policy dictated by the European Directive CRD IV “Access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms” (2013), European banks disclose for the first time in 2014 new key business information, particularly the amount of foreign cash per country, in a document called “Country-by-Country Reporting” (CbCR). This report lists not only the amount of foreign cash holding in countries different from the main residence country, but also further information, such as the amount of tax paid in each country, the income before tax, the number of employees for all the bank’s foreign subsidiaries, the description of activity of the foreign subsidiaries and the amount of governmental subsidies. The CbCR mandatory disclosure opens a new room on which to investigate and particularly how capital markets value the bank liquidity when it is held in a country different from the main residence country. Specifically, the presence of tax advantages in countries different from most part of EU countries might arise new economic considerations by investors among the European banking sector. Because liquidity, including the foreign cash holding, is a source to respond to several banks’ needs, it might assume different connotations according to agency costs and repatriation costs as proposed by the prior accounting studies.
After hand-collecting the data on the base of the new reports that all the European financial institutions are required to realize, the obtained sample includes 62 European financial institutions disclosing CBCR, while 121 not disclosing. Through a short-window event study to the announcements of the date of annual report publication, when it includes CBCR, and of the date of CBCR publication, when it is not included in the annual report, the main results show a positive market reaction on total cash when banks announce CBCR as well as a positive association between the cumulative abnormal returns and the foreign cash holding. When we split foreign cash held or not in countries classified as “tax haven”, findings show that investors don’t perceive positively the foreign cash held in countries with taxation advantages. Based on the prior literature (Dyreng and Lindsey, 2009; Hanlon and Heitzman, 2010; Dyreng et al., 2016) showing empirical evidences about the foreign cash holding and tax considerations as well as foreign cash holding and opacity in information environment, this study attempts to add new contributions. The mandatory disclosure given the CbCR is a further step for increasing transparency in the European banking sector particularly positively expected by the principal players of the capital markets as investors. Furthermore my efforts are addressed to investigate how investors value cash when it is held in tax havens. Foreign cash in tax havens implies negative valuation among the European banking sector, because of the presence of high tax repatriation costs and the probability to be just a benefit for bankers to hide further operations in the capital markets.
Overall the doctoral thesis considers two important aspects of bank liquidity relevant in the context of the significant headwinds faced by the banking sector and the European economy in recent years. The thesis focuses on two shocks both of considerable importance in terms of future banking regulation, economic growth and accounting policy and it attempts to provide new insights related to the banking liquidity issue, which presents still room to investigate on.