Exploring Determinants of Bank Default Risk: An Assessment of Systemic and Idiosyncratic InfluencesP

Java Python Topic：Exploring Determinants of Bank Default Risk: An Assessment of Systemic and Idiosyncratic Influences

Focus and Objectives

The main body of this dissertation concentrates on analyzing the methods that banks use to gauge risk appetite, with the intention of highlighting the principle economic drivers which drive default risk in the banking industry. The primary objective of this study is to improve our understanding of risk management processes by providing a quantitative and qualitative characterization of the types of economic conditions that banks use to assess the likelihood of default.

Methodologies for assessing Risk Appetite in Banks

Identifying and analyzing the major factors predicting the default risk of banks

Examine the relationship between risk appetite settings and defaults for various banking models and environments.

Interest and Relevance

Risk management in banks is not only intellectually absorbing but also critical for the health of the banking sector and more broadly the economy. This issue has become more popular in the light of last financial crises as the 2008 financial crisis and later the European debt crisis, which showed the severe consequences of risk management failures. Because financial institutions are the bedrock of economic infrastructures, systemic failures can be severe enough to permeate global markets. Hence, research focusing on understanding the causes of bank risk-taking and its consequences on financial stability is crucial. It is hoped such a study can improve regulatory and risk management practices, in an effort to prevent further financial collapse.

Research Questions

This dissertation will explore the following research question:

1. Which are the major factors that affect the default risk of banks?

As for the associated themes in these questions, they are not just about the practical aspects of how banks address these risks but also delve into the theory behind and drive the risk management approaches for the case studies.

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Background

Personal Skills and Knowledge

During the course of my studies, I have acquired an extensive knowledge of financial theories, econometrics, and quantitative finance, which are necessary tools for the analysis of intricate financial data and risk assessment models. Additionally, I can use data analysis applications such as Stata and Python, which are critical for empirical work on big data from a scientific perspective. This experience will be particularly useful for understanding the challenges related to risk management practices in the banking sector, to ensure that this research is deeply rooted in both theory and practice.

Literature review

Existing Knowledge

Over the years, the literature on bank risk management has been thoroughly studied from models and theories that depict how banks control and manage risks, to the effect of these risks on their stability and performance. The early theoretical works of Modigliani and Miller (1958) laid down the cornerstone concepts of risk and return, later used for the construction of risk measurement models in the banking sector. Building on the Basel Accords guidelines, specifically as they relate to risk-weighted assets and Capital Adequacy Ratios (e.g., Basel Committee on Banking Supervision, 2010) other scholars have more recently studied these regulatory frameworks and their impact on bank behavior.

In the literature, two main types of risks are defined in the banking sector: systematic risks and idiosyncratic risks. Systematic risk more often than not associated with changes in the broader economy, and it is a risk type that affects every institution in the financial system and connected with economic cycles (Bernanke, 1983). By contrast, idiosyncratic risk relates to the specific operational as well as managerial risks of individual banks (Diamond and Dybvig 1983). Such base work laid the foundation for various risk measurement models like Value-at-Risk (VaR), Stress Testing, and Credit Risk Modeling that have been developed to measure the possible losses banks might face in unfavorable market circumstances.

Research methodology, ethics and timeline

Data Sources

I will combine primary and secondary sources of data to undertake a detailed investigation of bank risk management practices while also highlighting the aspects of default risk. The primary data collection comes from all available banks in China. According to the required variable indicators, these data indicators are downloaded from bankfocus. Secondary collection of data consisted of annual financial statements for global banks, risk management reports. Find the required variable indicators based on their financial statements.

Analytical Approach

Quantitative Analysis: It will include conducting statistical analysis done on financial data using tools like Stata where techniques like regression analysis would be used to determine substantial predictors of bank default risk.

To systematically address the complexities of bank default risk, this paper uses Z-score and dynamic panel regression analysis. These methods will evaluate the influence of multiple determinants identified as pivotal for understanding bank behavior. in diverse economic and regulatory contexts. The model will incorporate variables such as return on assets, total assets, total equal, ownership structure, reflecting the distribution of voting and cash flow rights, as discussed in Danisman and Tarazi (2020), bank size, which correlates with risk behavior, detailed in Laeven and Levine (2009). Non-interest income to total income, loans to total bank assets, customer loans to customer deposits, liquid assets to total assets and logarithm of bank assets(size), GDP growth, long-term interest rates, are highlighted in Kohler (2012).

Additionally, the capital adequacy variable will be assessed for its impact on risk-taking behaviors under regulatory constraints, a focus detailed in Laeven and Levine (2009). Macroeconomic factors such as GDP growth and credit expansion, examined for their effect on bank stability, are drawn from Kohler (2012). Financial inclusion, characterized by the rates of account ownership and digital payments, will be an Exploring Determinants of Bank Default Risk: An Assessment of Systemic and Idiosyncratic InfluencesPython alyzed to understand its stabilizing effects on the financial system as indicated in Danisman and Tarazi (2020). The regulatory environment, and its complex interactions with bank-specific factors, is extensively covered in Laeven and Levine (2009).

The data for this analysis will primarily be sourced from bankfocus and annual and semi-annual reports of publicly listed banks, providing a robust foundation for assessing the identified risk factors. This approach will not only isolate the individual contributions of each variable but also reveal their interdependencies, thereby offering insights crucial for enhancing regulatory frameworks and bank risk management strategies. The outcomes of this analysis are expected to provide empirical support for the hypotheses and contribute to both academic and practical understanding of bank default risks.

Assumptions and Limitations

According to the research, the analysis assumes that banks have submitted true and fair financial statements and risk disclosures that adequately represent the underlying financial health and risk couple to the bank. Second, we assume that the regulatory environment is constant over the period of study, as substantial changes in regulation can affect banks' risk management. However, one potential limitation of this study is that its sample banks are most likely to be well-governed, in such a way that plenty of the banks used the most progressive risk management practices. While the sample is field representative of even the best-governed part of the banking industry, it should be noted, that the banks' internal risk management strategies cannot be observed from the outside.

Description of proposed chapters.

Chapter 1: Introduction

The first chapter, which is the introductory chapter, portrays the problem statement in context to a comprehensive coverage. The first thing mentioned concerns risk management in banks, explaining why it is so important for economic stability and crisis prevention. This chapter outlines the purpose of the study—to identify the factors that determine the banks' default risk. The reasoning of selecting this field of study would be discussed relating to its practicability in the prevailing financial background of the recent economic recessions and changes in the laws. Then list the dissertation outline showing each consecutive chapter (a roadmap of the research journey) which also will include the structure.

Chapter 2: Literature Review

Literature review of bank risk management and risk appetite in this chapter we will submerge into a complete literature of risk appetite of banks. It will include both seminal works and the most recent research in the field and will give a sense of the evolution of risk management theories. The literature review will also consider the ways in which these models are used in practice and so will offer a critical evaluation. A review of literature and related studies and field of arguments so that any research gaps could be highlighted or which needs theoretical framework is claimed will discusses at this chapter of our dissertation.

Chapter 3: Research Methodology

The chapter provides a detailed explanation of the research methodology used in the study. It will provide a specification of the data used, using primary data (from bankfocus) and secondary data (from financial statements and risk reports). The procedures for data collection will be clearly outlined, detailing the selection criteria, data sources, and acquisition methods. The chapter will also explain the rationale behind the choice of regression analysis for quantifying relationships and thematic analysis for qualitative insights, demonstrating how these methods align with the research objectives and the nature of the data collected.

Chapter 4: Results and Discussion

Chapter Four will discuss the results of the research. It will present the results of the quantitative and qualitative analyses, and interpret these results through the lens of the theoretical framework set up in the literature review. The chapter discusses how the results relate to prior theories, and what such findings imply in terms of the current practices in risk management at banks. It will also conclude by reflecting on the implications of these findings, shedding light on how they lend themselves toward a more nuanced view of what risk management in banking actually entails.

Chapter 5: Conclusion and Recommendations

Finally, Chapter Five will conclude the study by retracing the path followed, summarising the main conclusions and answering the question of whether and in what way the objectives of bank risk management are met by this study. It considers the concrete relevance of these findings for banks and policymakers by the way of what to make of this evidence on their risk management. It will indicate the limitations of the study and suggestions for future research. The study allows the research to come to a conclusion and provides a contribution to the bank risk management, which are outlined in the latter chapter.

References

Basel Committee on Banking Supervision. (2010). Basel III: A global regulatory framework for more resilient banks and banking systems. Bank for International Settlements.

Bernanke, B. (1983). Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression. American Economic Review, 73(3), 257-276.

Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419.

Danisman, G. O., & Tarazi, A. (2020). Financial inclusion and bank stability: evidence from Europe. The European Journal of Finance, 26(18), 1842-1855.

Kohler, M. (2012). Which banks are more risky? The impact of business models on bank stability. Journal of Financial Stability, 8(3), 123-134.

Laeven, L., & Levine, R. (2009). Bank governance, regulation, and risk taking. Journal of Financial Economics, 93(2), 259-275.

Markowitz, H. (1952). Portfolio Selection. The Journal of Finance, 7(1), 77-91.

Minsky, H. P. (1974). The modeling of financial instability: An introduction. Modelling and Simulation, 5(1), 267-272.

Modigliani, F., & Miller, M. H. (1958). The Cost of Capital, Corporation Finance, and the Theory of Investment. American Economic Review, 48(3), 261-297