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Summary of "Visible Reserves in Banks: Determinants of Initial Creation, Usage and Contribution to Bank Stability"

Core Content

This study investigates the determinants of the initial creation and usage of General Bank Risk (GBR) reserves in German banks, as well as their contribution to bank stability. The research focuses on three main aspects: the reasons for creating GBR reserves, how they are used, and their impact on bank stability.

Main Viewpoints

1. Definition and Importance of GBR Reserves

• GBR reserves are designed to enhance bank stability and transparency in financial reporting.
• Introduced in German law via § 340g HGB, they are disclosed separately on the liability side of banks' balance sheets.
• GBR reserves are not subject to quantitative limits, as long as they are considered "reasonable."
• They share key features with CET-1 capital and are used alongside hidden reserves (§ 340f HGB) to cover general banking risks.

2. Determinants of Initial Creation

• Bank management discretion plays a significant role in the creation and use of GBR reserves.
• The study employs a Cox proportional hazard model and a logit model to analyze the determinants.
• Key variables include:
  • Loan-to-asset ratio (LOANS)
  • Asset quality (AAR, NPL, LCO)
  • Income (INR)
  • Regulatory capital (TIER1, ZSCORE)
  • Total assets (LNTA)
  • GDP growth (GDPGR)
  • Hidden reserves (340f)

3. Creation of GBR Reserves by Bank Sector

4. Usage of GBR Reserves

• A tobit model is used to analyze the usage of GBR reserves, given that the level is truncated at 0.
• Additional variables such as return on assets (ROA) and change in loan-to-deposit ratio (CHLTD) are included.
• The usage of GBR reserves is positively related to:
  • Earnings management (ROA)
  • Internal funding (CHLTD)

5. Contribution to Bank Stability

• A CAMEL-based rating model is used to assess the impact of GBR reserves on bank stability.

• GBR reserves are found to have a strong negative relationship with future bank distress and default events.

• The effect is observed across different measures of distress:

  • Broad definition: Capital support measures by banking associations
  • Narrow definition: Restructuring mergers and bank moratoria
  • Z-score as a measure of financial health

• The negative coefficient of GBR reserves on distress and default events suggests that they contribute to bank stability.

Key Information

Statistical Results

• Private banks: GBR reserves are used for internal funding, not earnings management.
• Savings banks: Strong support for both earnings management and internal funding hypotheses.
• Cooperative banks: GBR reserves are used for both risk provisioning and regulatory capital management.
• The negative relationship between GBR reserves and future distress is consistent across all three bank sectors.
• The effect size varies:
  • For D_DEFAULT, the coefficient is -1.2739 (significant)
  • For Z-score, the coefficient is 0.1210 (significant)
  • For D_DIFFRESS, the coefficient is -0.4671 (significant)

Model Specifications and Robustness Checks

• The study uses Cox proportional hazard models, tobit models, and logit models for analysis.
• Robustness checks include:
  • Excluding crisis years
  • Using different measures of distress and default
  • Considering both dummy variables and the amount of GBR reserves

Conclusion

• Main messages:
  • Risk provisioning is a minor motive for GBR reserve creation.
  • Regulatory capital management is the primary driver for GBR reserve creation and usage.
  • Earnings management also influences GBR usage in cooperative and savings banks.
  • GBR reserves contribute to bank stability, reducing the likelihood of distress and default events.
  • Their role is more pronounced in cooperative and savings banks compared to private banks.

Data Overview

• Data is sourced from the Bundesbank's prudential database (BAKIS), covering the period 1994–2011.
• The cooperative and savings bank sectors are more homogeneous in ownership, while the private bank sector is more diverse.