Can market signals improve banking supervision? An empirical study on EU financial institutions

The main focus of this thesis is anyway on the so-called market signals. A common trait of many early warning systems in the literature is that they do not consider financial markets in their risk assessment, i.e. they do not account for equity prices, bond prices, volatilities and other financial instruments like credit default swaps, options, but only on accounting based measures (capital adequacy, liquidity ratios, earnings, etc.). They only take the accounting measures as benchmark, probably because they consider markets affected by participants’ irrationality and other drawbacks. However also accounting based systems have their points of weakness. For example they don’t account for accounting frauds. The harmfulness of these is argued in various papers, as Francis (2010) and Manganaris et al. (2017), that underline how a well-established and well known permissive attitude towards frauds created a global systemic risk that contributes to the burst of an inevitable financial crisis. Therefore the hidden question that accompanies this work is: is it worth is to include market signals in off-site monitoring models? This is structured like this: Chapter 1 focuses on the definition of bank distress, posing particular attention on its main causes and risk factors and analyzing the consequence that bank failures carry along with. Chapter 2 is aimed to analyze bank distress prevention in the European Union, concentrating on the current regulation on bank supervision and the recent trends in the main banking metrics. Then, market signals are introduced, underlining theoretical advantages and disadvantages of their inclusion in early warning systems. Chapter 3 introduces market signals, highlighting the theoretical advantages and disadvantages of their inclusion in early warning systems. Finally, Chapter 4 conducts regression analysis to examine the use of market signals in bank distress prevention. This last chapter will enable a comprehensive exploration of the role of market signals in bank distress prevention, providing valuable insights into their effectiveness and offering policy recommendations for enhancing the resilience of the banking sector. In chapter 5 there are the conclusions

The main focus of this thesis is anyway on the so-called market signals. A common trait of many early warning systems in the literature is that they do not consider financial markets in their risk assessment, i.e. they do not account for equity prices, bond prices, volatilities and other financial instruments like credit default swaps, options, but only on accounting based measures (capital adequacy, liquidity ratios, earnings, etc.). They only take the accounting measures as benchmark, probably because they consider markets affected by participants’ irrationality and other drawbacks. However also accounting based systems have their points of weakness. For example they don’t account for accounting frauds. The harmfulness of these is argued in various papers, as Francis (2010) and Manganaris et al. (2017), that underline how a well-established and well known permissive attitude towards frauds created a global systemic risk that contributes to the burst of an inevitable financial crisis. Therefore the hidden question that accompanies this work is: is it worth is to include market signals in off-site monitoring models? This is structured like this: Chapter 1 focuses on the definition of bank distress, posing particular attention on its main causes and risk factors and analyzing the consequence that bank failures carry along with. Chapter 2 is aimed to analyze bank distress prevention in the European Union, concentrating on the current regulation on bank supervision and the recent trends in the main banking metrics. Then, market signals are introduced, underlining theoretical advantages and disadvantages of their inclusion in early warning systems. Chapter 3 introduces market signals, highlighting the theoretical advantages and disadvantages of their inclusion in early warning systems. Finally, Chapter 4 conducts regression analysis to examine the use of market signals in bank distress prevention. This last chapter will enable a comprehensive exploration of the role of market signals in bank distress prevention, providing valuable insights into their effectiveness and offering policy recommendations for enhancing the resilience of the banking sector. In chapter 5 there are the conclusions.