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

Alexander Kostrov and Mikhail Mamonov

CERGE-EI Working Papers from The Center for Economic Research and Graduate Education - Economics Institute, Prague

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 (search for similar items in EconPapers)
JEL-codes: C34 G21 G33 (search for similar items in EconPapers)
Date: 2019-03
New Economics Papers: this item is included in nep-ban, nep-cis and nep-tra
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Persistent link: https://EconPapers.repec.org/RePEc:cer:papers:wp636

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