New Economics Papers
on Banking
Issue of 2006‒08‒26
nine papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. The Anatomy of Bank Diversification By Elsas, Ralf; Hackethal, Andreas; Holzhaeuser, Markus
  2. On the Coexistence of Banks and Markets By Hans Gersbach; Harald Uhlig
  3. Default risk sharing between banks and markets: the contribution of collateralized debt obligations By Günter Franke; Jan Pieter Krahnen
  4. Underpriced Default Spread Exacerbates Market Crashes By Winston T. H. Koh; Roberto S. Mariano; Andrey Pavlov; Sock Yong Phang; Augustine H. H. Tan; Susan M. Wachter
  5. Sovereign debt crises and credit to the private sector By Carlos Arteta; Galina Hale
  6. Divergence of credit valuation in Germany - Continuous theory and discrete practice - By Weibach, Rafael; Sibbertsen, Philipp
  7. Incompatibility, Product Attributes and Consumer Welfare: Evidence from ATMs By Christopher R. Knittel; Victor Stango
  8. The Welfare Consequences of ATM Surcharges: Evidence from a Structural Entry Model By Gautam Gowrisankaran; John Krainer
  9. Financial Regulations in Developing Countries: Can they Effectively Limit the Impact of Capital Account Volatility? By Liliana Rojas-Suarez

  1. By: Elsas, Ralf; Hackethal, Andreas; Holzhaeuser, Markus
    Abstract: We use panel data from nine countries over the period 1996 to 2003 to test how revenue diversi-fication in conjunction with increasing bank size affects bank value. Using a comprehensive framework for bank performance measurement, we find no evidence for a conglomerate discount, unlike studies concerned with industrial firms. Rather, revenue diversification increases bank profitability and is associated with higher market valuation. This performance effect does not depend on whether diversification was achieved through organic growth or through M&A activity.
    Keywords: Bank diversification; organic growth; M&A
    JEL: G21
    Date: 2006–06
  2. By: Hans Gersbach; Harald Uhlig
    Abstract: We examine the coexistence of banks and financial markets, studying a credit market where the qualities of investment projects are not observable and the investment decisions of entrepreneurs are not contractible. Standard banks can alleviate moral-hazard problems by securing a portion of a repayment in the case of non-investment. Financial markets operated by investment banks and rating agencies have screening know-how and can alleviate adverse-selection problems. In competition, standard banks are forced to increase repayments, since financial markets can attract the highest-quality borrowers. This, in turn, increases the share of shirkers and may make lending unprofitable for standard banks. The coexistence of financial markets and standard banks is socially inefficient. The same inefficiency can happen with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies.
    Keywords: contract, debt contract, adverse selection, moral hazard, coexistence of financial intermediaries, regulation
    JEL: G24 G28 G32 G38 D80 D92 D43
    Date: 2006–03
  3. By: Günter Franke (Department of Economics, University of Konstanz); Jan Pieter Krahnen (Center for Financial Studies, Goethe-University Frankfurt)
    Abstract: This paper contributes to the economics of financial institutions risk management by exploring how loan securitization affects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to expand its loan business, thereby affecting systematic risk. For a sample of European CDO issues, we find an increase of the banks’ betas, but no significant stock price effect around the announcement of a CDO issue.
    Date: 2005–08–18
  4. By: Winston T. H. Koh (School of Economics and Social Sciences, Singapore Management University); Roberto S. Mariano (School of Economics and Social Sciences, Singapore Management University); Andrey Pavlov (Simon Fraser University); Sock Yong Phang (School of Economics and Social Sciences, Singapore Management University); Augustine H. H. Tan (School of Economics and Social Sciences, Singapore Management University); Susan M. Wachter (Department of Finance, The Wharton School, University of Pennsylvania)
    Abstract: In this paper, we develop a specific observable symptom of a banking system that underprices the default spread in non-recourse asset-backed lending. Using three different data sets for 18 countries and property types, we find that, following a negative demand shock, the “underpricing” economies experience far deeper asset market crashes than economies in which the put option is correctly priced. Furthermore, only one of the countries in our sample continues to exhibit the underpricing symptom following a market crash. This indicates that market crashes have a cleansing effect and eliminate underpricing at least for a period of time. This makes investing in such markets safer following a negative demand shock.
    Keywords: real estate bubble, lender optimism, disaster myopia, Asian financial crisis
    Date: 2006–03
  5. By: Carlos Arteta; Galina Hale
    Abstract: We argue that, through its effect on aggregate demand and country risk premia, sovereign debt restructuring can adversely affect the private sector's access to foreign capital markets. Using fixed effect analysis, we estimate that sovereign debt rescheduling episodes are indeed systematically accompanied by a decline in foreign credit to emerging market private firms, both during debt renegotiations and for over two years after the agreements are reached. This decline is large (over 20%), statistically significant, and robust when we control for a host of fundamentals. We find that this effect is different for financial sector firms, for exporters, and for nonfinancial firms in the non-exporting sector. We also find that the effect depends on the type of debt rescheduling agreement.
    Keywords: Debts, External ; Financial crises
    Date: 2006
  6. By: Weibach, Rafael; Sibbertsen, Philipp
    Abstract: Lending is associated with credit risk. Modelling the loss stochastically, the cost of credit risk is the expected loss. In credit business the probability that the debtor will default in payments within one year, often is the only reliable quantitative parameter. Modelling the time to default as continuous variable corresponds to an exponential distribution. We calculate the expected loss of a trade with several cash flows, even if the distribution is not exponential. Continuous rating migration data show that the exponential distribution is not adequate in general. The distribution can be calibrated using rating migrations without a parametric model. A practitioner, however, will model time as a discrete variable. We show that the expected loss in the discrete model is a linear approximation of the expected loss in the continuous model and discuss the consequences. Finally, as costs for the expected loss cannot be charged up-front, the credit spread over risk-free interest is derived.
    Keywords: Point process, credit valuation, hazard rate, kernel smoothing test
    JEL: C19 C29
    Date: 2006–08
  7. By: Christopher R. Knittel (University of California, Davis); Victor Stango (Dartmouth College)
    Abstract: Incompatibility in markets with network effects can either benefit or harm consumers. Incompatibility reduces consumers’ ability to “mix and match” components offered by different sellers, but can also be associated with changes in product attributes that might benefit consumers. In this paper, we estimate the effects of incompatibility in a classic hardware/software market: ATM cards and machines. Our empirical model allows us to measure the indirect network effect relating the value of ATM cards to ATM availability. It also allows us to measure the effects of incompatibility as measured by ATM fees. Our sample contains a relatively discrete move toward incompatibility after 1996, when banks began to impose surcharges on non-customers using their ATM machines. We provide estimates of the partial equilibrium effects of increased incompatibility on consumer welfare, finding that ATM fees ceteris paribus reduce the indirect network effect associated with other banks’ ATMs. However, a surge in ATM deployment accompanies the shift to surcharging and in many cases completely offsets the reduction in welfare associated with higher fees. This suggests that welfare analyses should consider the interaction between incompatibility and changes in product attributes.
    Date: 2004–10
  8. By: Gautam Gowrisankaran; John Krainer
    Abstract: We estimate a structural model of the market for automatic teller machines (ATMs) in order to evaluate the implications of regulating ATM surcharges on ATM entry and consumer and producer surplus. We estimate the model using data on firm and consumer locations, and identify the parameters of the model by exploiting a source of local quasi-experimental variation, that the state of Iowa banned ATM surcharges during our sample period while the state of Minnesota did not. We develop new econometric methods that allow us to estimate the parameters of equilibrium models without computing equilibria. Monte Carlo evidence shows that the estimator performs well. We find that a ban on ATM surcharges reduces ATM entry by about 12 percent, increases consumer welfare by about 35 percent and lowers producer profits by about 20 percent. Total welfare remains about the same under regimes that permit or prohibit ATM surcharges and is about 17 percent lower than the surplus maximizing level. This paper can help shed light on the theoretically ambiguous implications of free entry on consumer and producer welfare for differentiated products industries in general and ATMs in particular.
    JEL: G21 L13 L5
    Date: 2006–08
  9. By: Liliana Rojas-Suarez
    Abstract: This paper identifies two alternative forms of prudential regulation. The first set is formed by regulations that directly control financial aggregates, such as liquidity expansion and credit growth. An example is capital requirements as currently incorporated in internationally accepted standards; namely capital requirements with risk categories used in industrial countries. The second set, which can be identified as the “pricing-risk-right” approach, works by providing incentives to financial institutions to avoid excessive risk-taking activities. A key feature of this set of regulations is that they encourage financial institutions to internalize the costs associated with the particular risks of the environment where they operate. Regulations in this category include ex-ante risk-based provisioning rules and capital requirements that take into account the risk features particular to developing countries. This category also includes incentives for enhancing market discipline as a way to differentiate risk-taking behavior between financial institutions. The main finding of the paper is that the first set of regulations—the most commonly used in developing economies-- have had very limited usefulness in helping countries to contain the risks involved with more liberalized financial systems. The main reason for this disappointing result is that, by not taking into account the particular characteristics of financial markets in developing countries, these regulations cannot effectively control excessive risk taking by financial institutions. Moreover, the paper shows that, contrary to policy intentions, this set of prudential regulations can exacerbate rather than decrease financial sector fragility, especially in episodes of sudden reversal of capital flows. In contrast, the paper claims, the second set of prudential regulation can go a long way in helping developing countries achieving their goals. The paper advances suggestions for the sequencing of implementation of these regulations for different groups of countries.
    Keywords: regulation, liquidity, credit growth, pricing-risk-right, financial institutions, capital flows, developing countries
    JEL: O16 F30 F32 F33 F36 F43 H3 D81

This issue is ©2006 by Roberto J. Santillán–Salgado. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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