Ebook Bank Disclosure and Market Assessment of Financial Fragility: Evidence from Equity Prices of Turkish Banks
In November 2000 Turkey went through a liquidity squeeze that ended in a currency crisis in February 2001. This was the worst crisis Turkey experienced in its post-war history (Ozkan 2005). While a weak external and fiscal position were at the root of the crisis, most analysts point to the fragility of the financial and banking sector as a factor that increased the crisis magnitude. In this sense, the Turkish case relates directly to the third generation crisis literature that emphasizes financial fragility as an important factor in turning a crisis into a major one (Corsetti et al. 1998a, 1998b, Radelet and Sachs 1998, Kaminsky and Reinhart 1999).
In particular this literature points out that balance sheet problems in the banking and/or corporate sector work to increase the prospect of insolvency and can be a trigger for domestic and external investors to reassess their willingness to finance a country. Dornbusch (2001) emphasizes three sources of vulnerability: a substantially misaligned exchange rate, balance sheet problems in the form of nonperforming loans and balance sheet problems in the form of mismatched exposures.
The last of these sources includes maturity mismatches leading to liquidity issues as well as currency mismatches. These misalignments or mismatches become explosive when there is a perception that the current exchange rate is not sustainable or that debtors will not be able to meet their liabilities.
In this paper we investigate whether Turkish banks with worsening indicators of financial fragility were subject to market monitoring during the years prior to the crisis. We refer to market monitoring in the context of Bliss and Flannery (2002) who emphasize that effective market discipline has two different components. The first one is investors’ ability to accurately assess the condition of a firm (market monitoring).
The second one is investors’ ability to actually affect managerial actions (influencing). Our study will examine the first component of market discipline, monitoring. Specifically, we address the following questions. Did the stock market react to unexpected changes in indicators of financial fragility at the time of disclosure of banks’ financial statements? And does the quality and timeliness of the disclosure affect market reaction? Finding answers to these questions will help us understand which disclosure practices improve the ability of the market to assess the banks financial condition. Moreover it will allow us to contribute to a recent policy debate on whether the existence of market monitoring is sufficient to guarantee banks’ safety and soundness.
The case of Turkey presents several characteristics that make it ideal for our purposes. First, before November 2000, the Turkish banking system presented clear signsof financial fragility. Turkish banks were borrowing heavily in foreign currency, while lending to the government in local currency. In addition to the increased currency risk, banks’ combined liquidity-interest rate risk from domestic funding also rose, because the longer-term local currency lending to the government was mostly at fixed rates and at relatively longer maturities, which was partly financed in the daily repo market. Second, 16 private Turkish banks were publicly traded in the Istanbul Stock Exchange during our sample period, allowing us to test for market discipline. They represent 38% of the assets of the industry between the years 1997-2000.
Finally, disclosure policy was enhanced during the period. In 1995 the Turkish Capital Markets Board required publicly traded firms to disclose additional information with their financial statements that allowed investors to calculate more precise measures of maturity gaps and currency mismatches. Moreover in 1999 problems in the Turkish banking sector led to the enactment of the Banks Act 4389 followed by the establishment of an autonomous body, The Banking Regulation and Supervision Agency (BRSA).
The new regulation brought considerable changes in the disclosure requirements of banks, including the requirement of disclosing risk management procedures (which was not compulsory before) and improvements in the disclosure of non-performing loans. For example, with the new regulation, if one loan was non-performing, other loans of the same customer had to be classified also as non-performing. (Barth, Caprio and Levine, 2001).
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