The Formation of Hidden Negative Capital in Banking: A Product Mismatch Hypothesis

CERGE-EI Working Paper Series No. 636

ISBN 978-80-7343-443-4 (Univerzita Karlova, Centrum Pro Ekonomický výzkum a Doktorské Studium)

44 Pages Posted: 9 May 2019

See all articles by Alexander Kostrov

Alexander Kostrov

University of St. Gallen

Mikhail Mamonov

Charles University in Prague - CERGE-EI (Center for Economic Research and Graduate Education - Economics Institute)

Date Written: April 1, 2019

Abstract

This paper investigates the phenomenon of hidden negative capital (HNC) associated with bank failures and introduces a product mismatch hypothesis to explain the formation of HNC. Given that troubled banks tend to hide negative capital in financial statements from regulators to keep their licenses, we attempt to capture this gambling behavior by evaluating product mismatches reflecting disproportions between the allocation of bank assets and the sources of funding. We manually collect unique data on HNC and test our hypothesis using U.S. and Russian banking statistics for the 2004–2017 period (external validity argument). To manage the sample selection concerns, we apply the Heckman selection approach. Our results clearly indicate that product mismatch matters and works similarly in both U.S. and Russian banking systems. Specifically, an increase in mismatch has two effects: it leads to a higher probability that a bank’s capital is negative and raises the conditional size of the bank’s HNC. Further, we demonstrate that the mismatch effect is heterogeneous with respect to bank size being at least partially consistent with the informational asymmetry view. Our results may facilitate improvements in the prudential regulation of banking activities in other countries that share similar features with either the U.S. or Russian banking systems.

Keywords: Bank Failure, Hidden Negative Capital, Product Mismatch, Misreporting, Heckman Selection Model

JEL Classification: G21 G33 C34

Suggested Citation

Kostrov, Alexander and Mamonov, Mikhail, The Formation of Hidden Negative Capital in Banking: A Product Mismatch Hypothesis (April 1, 2019). CERGE-EI Working Paper Series No. 636, ISBN 978-80-7343-443-4 (Univerzita Karlova, Centrum Pro Ekonomický výzkum a Doktorské Studium), Available at SSRN: https://ssrn.com/abstract=3370499 or http://dx.doi.org/10.2139/ssrn.3370499

Alexander Kostrov (Contact Author)

University of St. Gallen ( email )

Bodanstrasse 6
St. Gallen, CH-9000
Switzerland

Mikhail Mamonov

Charles University in Prague - CERGE-EI (Center for Economic Research and Graduate Education - Economics Institute) ( email )

P.O. Box 882
7 Politickych veznu
Prague 1, 111 21
Czech Republic

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