Local Bank Risk and the Regional Economic Environment: A Study of Cooperative Banks and Savings Banks in Germany

Abstract: This essay investigates the impact of a bank’s local economic environment that on its overall bank risk. Balance sheet data of Germany’s regionally-active savings banks (Sparkassen) and credit cooperatives (Kreditgenossenschaften) is matched with data from regional statistics to construct a dataset spanning the time period from 2000 until 2013. Bank risk is measured by time-varying Z-scores, an inverse measure of default risk. First, cross-sectional results are computed whilst controlling for both macroeconomic effects and time-varying bank characteristics. Second, bank-fixed effects are additionally taken into account. The results are not entirely indicative of an effect of the regional economic environment on bank risk, but do not allow to rule out a relationship either. From a policy perspective, these findings add to the ongoing discussion on the regulatory treatment of small banks. While potentially more risky, local banks in economically disadvantaged, cash-strapped regions act as important providers of funding. Consequently, policy makers face a trade-off regarding the extent of regulation that is seen as disproportionally costly and as a threat to their business by small banks.