Working Papers

The Center includes original research written by CFR Advisors and Scholars, and FDIC Researchers on deposit insurance, banking performance, risk measurement and management, corporate finance, and financial policy and regulation. The results of CFR-sponsored research, FDIC staff research, and other invited papers on these research lines appear in the Working Paper Series.

FDIC Center for Financial Research SSRN eJournal showcases current working papers with the Social Science Research Network (SSRN).

• Stress Testing Banks: Whence and Whither? - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-07
  Pavel Kapinos, Oscar Mitnik and Christopher Martin
  
  Current Version: November 2015
  
  

  ABSTRACT
  This paper provides a brief overview of the recent practice of stress testing banking institutions, focusing on capital adequacy. We argue that stress testing has been successfully used to mitigate bank opacity; quantify systemic risk under extreme but plausible stress; keep the participants mindful of severely adverse shocks, thereby mitigating "disaster myopia" and concomitant financial instability; and improve the data collection and analytical capabilities of financial institutions. Our paper then reviews several critiques of stress testing made by policymakers and academics. We also propose several modifications of the current stress-testing practice, such as the fusion of liquidity and capital adequacy stress testing, expansion of granular data availability, and explicit modeling of sectors inextricably connected to banking as well as the feedback mechanisms from these sectors. Addressing these issues is likely to keep stress testing highly relevant for promoting financial stability in the future.
  
  Keywords: Stress testing, banks, Dodd-Frank Act, systemic risk, liquidity, disaster myopia, financial instability
  
  JEL Classifications: G21, G28



• Loss Given Default for Commercial Loans at Failed Banks - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-06
  Lynn Shibut and Ryan Singer
  
  Current Version: October 2015
  
  

  ABSTRACT
  This paper extends what we know about loss given default (LGD) on commercial loans by studying certain types of these loans that have been excluded from previous research but that may be more representative of loans held by small and mid-sized banks. We use a newly available dataset on commercial loan losses from failed banks that were resolved by the FDIC using loss share agreements. We examine LGD for more than 50,000 distressed loans, broken into three categories: construction and development loans, other commercial real estate loans, and commercial and industrial loans. We compare the characteristics of these loans with those of previous studies and find many similarities as well as significant differences. We explore the relationship between LGD and default date, workout period, loan modification, asset size, bank characteristics, geography, lien status, and other factors that may be related to loss severity. The results inform commercial lenders and regulators about the factors that influence losses on defaulted loans during periods of distress, and provide a useful benchmark for stress testing for smaller banks. To the best of our knowledge, this paper also offers the first published empirical analysis of LGD for construction and development loans.
  
  Keywords: Commercial lending, commercial real estate, CRE, construction and development lending, ADC lending, acquisition/development/construction lending, distressed assets, credit risk, default and loss, loss given default, LGD, recovery rates, liquidation
  
  JEL Classifications: G21, G28, G32, G33



• Proving Approval: Dividend Regulation and Capital Payout Incentives - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-05
  Levent Guntay, Stefan Jacewitz and Jonathan Pogach
  
  Current Version: November 2015
  
  

  ABSTRACT
  This paper describes the effects of dividend regulation on payout incentives. In the model, risk-shifting, excess cash flow, and signaling incentives affect a firm's decision to issue dividends. The regulator aims to prevent risk shifting through dividend restrictions on undercapitalized firms. However, this action increases the firms' incentives to pay dividends for signaling, potentially inducing capital outflows in some firms that would otherwise use funds for the real sector. Thus, welfare benefits of prudential dividend restrictions at risk-shifting firms are partially offset through less capital and investment at moderately capitalized firms. We discuss environments in which the signaling effect is stronger and suggest policies to mitigate inefficient capital outflows through dividends.
  
  Keywords: Dividends, Banking, Capital Regulation, Risk-Shifting, Signaling
  



• Small Businesses and Small Business Finance during the Financial Crisis and the Great Recession: New Evidence from the Survey of Consumer Finances - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-04
  Arthur B. Kennickell, Myron L. Kwast and Jonathan Pogach
  
  This Version: September 2015
  Forthcoming in NBER book Measuring Entrepreneurial Businesses: Current Knowledge and Challenges edited by John Haltiwanger, Erik Hurst, Javier Miranda, and Antoinette Schoar
  
  

  ABSTRACT
  We use the Federal Reserve's 2007, 2009 re-interview of 2007 respondents, and 2010 Surveys of Consumer Finances (SCFs) to study how small businesses owned and actively managed by households fared during those turbulent years. Even though the surveys contain extensive data on a broad cross-section of firms and their owners, to the best of our knowledge this is the first paper to use these SCFs to study small businesses. We find that the financial crisis and the Great Recession severely affected the vast majority of small businesses, including tight credit constraints. We document complex interdependencies between the finances of small businesses and their owner-manager households, including a more complicated role of housing assets than reported previously. We find that workers who lost their job during the recession responded in part by starting their own small business, and that factors related to the survival of a small business are hard to identify. Our results support the importance of relationship finance to small businesses and the primary role of commercial banks in such relationships. We find that both cross-section and panel data are needed to understand the complex factors associated with the creation, survival and failure of small businesses.
  
  Keywords: Small Business, Entrepreneurship, Great Recession, Credit Constraints
  
  JEL Classifications: D12, D22, G21, L25, L26



• What Drives Loss Given Default? Evidence From Commercial Real Estate Loans at Failed Banks - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-03
  Emily Johnston Ross and Lynn Shibut
  
  
  First Version: October 2014
  Current Version: March 2015
  
  

  ABSTRACT
  This paper extends what we know about loss given default (LGD) by examining a newly available dataset on commercial real estate (CRE) loan losses. These data come from 295 failed banks resolved by the FDIC using loss-share agreements between 2008 and 2013. We examine over 14,000 distressed CRE loans to study the relationship between LGD and loan size, workout period, loan seasoning, asset price changes over the life of the loan, and other factors related to losses. We also examine the relationship between LGD and certain bank characteristics. The results inform commercial lenders and regulators about the factors that in uence losses on defaulted loans during periods of distress.
  
  Keywords: loss given default; recovery rates; credit risk; commercial real estate
  
  JEL Classifications: G21, G32



• A Top-down Approach to Stress-testing Banks - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-02
  Pavel S. Kapinos and Oscar A. Mitnik
  
  First Version: December 2013
  Current Version: March 2015
  
  

  ABSTRACT
  We propose a simple, parsimonious, and easily implementable method for stress-testing banks using a top-down approach that evaluates the impact of shocks to macroeconomic variables on banks' capitalization. Our method relies on a variable selection method to identify the macroeconomic drivers of banking variables combined with a principal component analysis. We show how it can be used to make projections, conditional on exogenous paths of macroeconomic variables. We also rely on this approach to identify the balance sheet and income statement factors that are key in explaining bank heterogeneity in response to macroeconomic shocks. We apply our method, using alternative estimation strategies and assumptions, to the 2013 and 2014 stress tests of medium- and large-size U.S. banks mandated by the Dodd-Frank Act, and obtain stress projections for capitalization measures at the bank-by-bank and industry-wide levels. Our results suggest that while capitalization of the U.S. banking industry has improved in recent years, under reasonable assumptions regarding growth in assets and loans, the stress scenarios can imply sizable deterioration in banks' capital positions.
  
  Keywords: stress testing, banking, Dodd-Frank Act
  
  JEL Classifications: G17, G21, G28



• Bank Size, Leverage, and Financial Downturns - PDF (PDF Help)
  FDIC Center for Financial Research Working Paper No. 2015-01
  Chacko George
  
  First Version: October 2013
  Current Version: March 2015
  
  

  ABSTRACT
  I construct a macroeconomic model with a heterogeneous banking sector and an interbank lending market. Banks differ in their ability to transform deposits from households into loans to firms. Bank size differences emerge endogenously in the model, and in steady state, the induced bank size distribution matches two stylized facts in the data: bigger banks borrow more on the interbank lending market than smaller banks, and bigger banks are more leveraged than smaller banks. I use the model to evaluate the impact of increasing concentration in US banking on the severity of potential downturns. I find that if the banking sector in 2007 was only as concentrated as it was in 1992, GDP during the Great Recession would have declined by much less than it did, and would have recovered faster.
  
  Keywords: Financial crisis, interbank lending, concentration
  
  JEL Codes: E02, E44, E61, G01, G21