Peas in a Pod: Canadian and Australian Banks Before and During a Global Financial Crisis

7 Pages Posted: 12 Jul 2011 Last revised: 25 Jul 2011

See all articles by David E. Allen

David E. Allen

School of Mathematics and Statistics, The University of Sydney; Financial Research Network (FIRN); Department of Finance; School of Business and Law, Edith Cowan University

Ray Boffey

School of Finance and Business Economics; Financial Research Network (FIRN)

Robert J. Powell

Edith Cowan University - School of Accounting, Finance and Economics; Financial Research Network (FIRN)

Date Written: July 12, 2011

Abstract

In the aftermath of the Global Financial Crisis (GFC), the Canadian and Australian banking systems have been singled out by some commentators as having performed better than many other banking systems, particularly those in Europe, America and the United Kingdom. Banks in both Canada and Australia, for instance, have continued to report enviable earnings, sound capital levels, and high credit ratings both before and during the GFC. The G-20 and the European Union have tried to identify the features of the Canadian and Australian financial systems which have underpinned this success in order to use them in shaping a revised international regulatory framework. One area of focus has been the regulations governing “quality of capital”.

Despite these apparent successes, there is some evidence that both Canadian and Australian banks experienced considerable deterioration in the market value of their assets during the GFC. In this paper we use the KMV / Merton structural methodology, which incorporates market asset values, to examine default probabilities of 9 listed Canadian banks and 13 Australian listed banks in both a pre-GFC period (2000-2006) and a GFC period (2007-2008). We also modify the model to incorporate conditional probability of default which measures extreme credit risk.

This paper finds that bank risk was significantly similar for Australian and Canadian Banks during the GFC period. This includes an assessment of impaired assets, Value at Risk (VaR) and Distance to Default (DD), as well as the extreme measures of Conditional VaR (CVaR), and Conditional Distance to Default (CDD); metrics which confirm the two countries similarities in terms of a significant increase in credit risk between pre-GFC and GFC periods. The extent of this increase was, however, far more pronounced for Australia, which was coming off a lower base. Bank risk for both countries was found to be far lower than for global counterparts due to factors such as sound regulatory control and low levels of involvement in sub-prime lending. This could provide lessons for global banks on risk management. A key conclusion of the paper is that it is important that fluctuating market values, especially the extreme fluctuations which are measured by CVaR and CDD, are a key consideration when determining risk management criteria such as capital adequacy.

Keywords: Value at Risk, Conditional Value at Risk, Distance to Default; Probability of Default, Conditional Distance to Default, Conditional Probability of Default

JEL Classification: G01, G21, G28

Suggested Citation

Allen, David Edmund and Boffey, Ray and Powell, Robert J., Peas in a Pod: Canadian and Australian Banks Before and During a Global Financial Crisis (July 12, 2011). Available at SSRN: https://ssrn.com/abstract=1884084 or http://dx.doi.org/10.2139/ssrn.1884084

David Edmund Allen

School of Mathematics and Statistics, The University of Sydney ( email )

School of Mathematics and Statistics F07
University of Sydney
Sydney, New South Wales 2006
Australia

HOME PAGE: http://www.maths.usyd.edu.au

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Department of Finance ( email )

Taiwan
Taiwan

School of Business and Law, Edith Cowan University

100 Joondalup Drive
Joondalup, WA 6027
Australia

HOME PAGE: http://www.dallenwapty.com

Ray Boffey (Contact Author)

School of Finance and Business Economics ( email )

Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Robert J. Powell

Edith Cowan University - School of Accounting, Finance and Economics ( email )

Joondalup Campus
Perth
Joondalup 6027, WA
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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