New Economics Papers
on Banking
Issue of 2007‒03‒17
eleven papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the U.S. Banking Sector By Rachel A. Campbell; Roman Kräussl
  2. Risk Transfer with CDOs and Systemic Risk in Banking By Jan Pieter Krahnen; Christian Wilde
  3. Tying Lending and Underwriting: Scope Economies, Incentives, and Reputation By Christian Laux; Uwe Walz
  4. Credit Cards: Facts and Theories By Carol C. Bertaut; Michael Haliassos
  5. Mark-to-Market Accounting and Liquidity Pricing By Franklin Allen; Elena Carletti
  6. Universal Banking Failure? An Analysis of the Contrasting Responses of the Amsterdamsche Bank and the Rotterdamsche Bankvereeniging to the Dutch Financial Crisis of the 1920s By Colvin, Chris
  7. Credit Risk in the Czech Economy By Petr Jakubík
  8. Stress testing of the stability of the Italian banking system: a VAR approach By Renato Filosa
  9. Russia's banking sector transition: Where to? By Vernikov , Andrei V.
  10. Sophisticated Discipline in a Nascent Deposit Market: Evidence from Post-Communist Russia By A. KARAS; W. PYLE; K. SCHOORS
  11. Quantitative approaches to fiscal sustainability analysis : a new World Bank tool applied to Turkey By Budina, Nina; van Wijnbergen, Sweder

  1. By: Rachel A. Campbell (Maastricht University); Roman Kräussl (Free University of Amsterdam and CFS)
    Abstract: We examine the empirical predictions of a real option-pricing model using a large sample of data on mergers and acquisitions in the U.S. banking sector. We provide estimates for the option value that the target bank has in waiting for a higher bid instead of accepting an initial tender offer. We find empirical support for a model that estimates the value of an option to wait in accepting an initial tender offer. Market prices reflect a premium for the option to wait to accept an offer that has a mean value of almost 12.5% for a sample of 424 mergers and acquisitions between 1997 and 2005 in the U.S. banking industry. Regression analysis reveals that the option price is related to both the price to book market and the free cash flow of target banks. We conclude that it is certainly in the shareholders best interest if subsequent offers are awaited.
    Keywords: Option-pricing Model, Mergers and Acquisitions, U.S. Banking Industry
    JEL: G34 C10
    Date: 2006–12–21
  2. By: Jan Pieter Krahnen (Center for Financial Studies and University of Frankfurt); Christian Wilde (University of Frankfurt)
    Abstract: Large banks often sell part of their loan portfolio in the form of collateralized debt obligations (CDO) to investors. In this paper we raise the question whether credit asset securitization affects the cyclicality (or commonality) of bank equity values. The commonality of bank equity values reflects a major component of systemic risks in the banking market, caused by correlated defaults of loans in the banks’ loan books. Our simulations take into account the major stylized fact of CDO transactions, the nonproportional nature of risk sharing that goes along with tranching. We provide a theoretical framework for the risk transfer through securitization that builds on a macro risk factor and an idiosyncratic risk factor, allowing an identification of the types of risk that the individual tranche holders bear. This allows conclusions about the risk positions of issuing banks after risk transfer. Building on the strict subordination of tranches, we first evaluate the correlation properties both within and across risk classes. We then determine the effect of securitization on the systematic risk of all tranches, and derive its effect on the issuing bank’s equity beta. The simulation results show that under plausible assumptions concerning bank reinvestment behaviour and capital structure choice, the issuing intermediary’s systematic risk tends to rise. We discuss the implications of our findings for financial stability supervision.
    JEL: G28
    Date: 2006–03–01
  3. By: Christian Laux (Frankfurt University and CFS); Uwe Walz (Frankfurt University and CFS)
    Abstract: Informational economies of scope between lending and underwriting are a mixed blessing for universal banks. While they can reduce the cost of raising capital for a firm, they also reduce incentives in the underwriting business. We show that tying lending and underwriting helps to overcome this dilemma. First, risky debt in tied deals works as a bond to increase underwriting incentives. Second, with limitations on contracting, tying reduces the underwriting rents as the additional incentives from debt can substitute for monetary incentives. In addition, reducing the yield on the tied debt is a means to pay for the rent in the underwriting business and to transfer informational benefits to the client. Thus, tying is a double edged sword for universal banks. It helps to compete against specialized investment banks, but it can reduce the rent to be earned in investment banking when universal banks compete against each other. We derive several empirical predictions regarding the characteristics of tied deals.
    Keywords: Tying, Investment Banking, Universal Banking
    JEL: G21 G24 D49
    Date: 2006–12–07
  4. By: Carol C. Bertaut (Board of Governors of the Federal Reserve System); Michael Haliassos (University of Frankfurt and CFS)
    Abstract: We use data from several waves of the Survey of Consumer Finances to document credit and debit card ownership and use across US demographic groups. We then present recent theoretical and empirical contributions to the study of credit and debit card behavior. Utilization rates of credit lines and portfolios of card holders present several puzzles. Credit line increases initiated by banks lead households to restore previous utilization rates. High-interest credit card debt co-exists with substantial holdings of low-interest liquid assets and with accumulation of retirement assets. Although available evidence disputes ignorance of credit card terms by card holders, credit card rates do not respond to competition. There is a rising trend in bankruptcy and delinquency, partly attributable to an increased tendency of households to declare bankruptcy associated with reduced social stigma, ease of procedures, and financial incentives. Co-existence of credit card debt with retirement assets can be explained through self-control hyperbolic discounting. Strategic default motives contribute partly to observed co-existence of credit card debt with low-interest liquid assets. A framework of “accountant-shopper” households, in which a rational accountant tries to control an impulsive shopper, seems consistent with both types of co-existence and with observed utilization of credit lines.
    Keywords: Credit Cards, Debit Cards, Revolving Debt, Consumer Credit, Portfolios
    JEL: G11 E21
    Date: 2006–09–19
  5. By: Franklin Allen (Wharton School, University of Pennsylvania); Elena Carletti (Center for Financial Studies)
    Abstract: When liquidity plays an important role as in times of financial crisis, asset prices in some markets may reflect the amount of liquidity available in the market rather than the future earning power of the asset. Mark-to-market accounting is not a desirable way to assess the solvency of a financial institution in such circumstances. We show that a shock in the insurance sector can cause the current value of banks’ assets to be less than the current value of their liabilities so the banks are insolvent. In contrast, if historic cost accounting is used, banks are allowed to continue and can meet all their future liabilities. Mark-to-market accounting can thus lead to contagion where none would occur with historic cost accounting.
    Keywords: Mark-to-market, Historical Cost, Incomplete Markets
    JEL: G21 G22 M41
    Date: 2006–08–07
  6. By: Colvin, Chris
    Abstract: Whilst in some financial systems in the early twentieth century commercial and investment banking activities were carried out by functionally separate firms, in others both kinds of operation were conducted under one roof by “universal banks”. Explaining the evolutionary paths that lead to these divergent banking structures has remained a hot topic of multidisciplinary debate for many years. So has their respective exposure to financial crises. On the one hand, universal banks – which hold both long- and short-term assets – are able to reduce information asymmetries and internalise risk. But on the other hand, their mixed asset structure arguably decreases versatility during an economic downturn and may create a “dual market for lemons” in which information asymmetries cause financially sound clients and banks to exit the market, leaving only the riskier crisis-prone ones behind. This paper analyses these debates using the case study of the Netherlands in the early 1920s. The literature argues that it is during this decade that the Netherlands experienced her one and only traditional banking crisis from 1600 to the present day, and after which her short-lived experiment with a system of universal banking came to an end. By calculating an equitydeposit ratio panel for the Big Five Dutch banks, this paper attempts to measure to what degree the sector evolved to become universal and subsequently returned to functional separation. It then conducts a matched pair comparison of two similar-sized banks operating in the Netherlands in the 1920s: the Amsterdamsche Bank and the Rotterdamsche Bankvereeniging. Whilst the first escaped the crisis relatively unscathed, the second required assistance from the Nederlandsche Bank, the Dutch central bank. A new and detailed narrative of one episode of the crisis using as yet unused primary sources is developed for this comparison. This paper finds that the Rotterdamsche Bankvereeniging was more universal than her Amsterdam rival. It concludes that it was primarily this difference that caused her to suffer during the crisis. However, it does so with caution in view of the paucity of data to hand and methodological restrictions.
    Keywords: Financial crises; Netherlands; inter-war history; universal banking
    JEL: N24 N84
    Date: 2007–03
  7. By: Petr Jakubík (Czech National Bank; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper deals with credit risk in the Czech aggregate economy. It follows structural Merton's approach. A latent factor model is employed within this framework. Estimation of this model can help to understand relation between credit risk and macroeconomic indicators. The credit risk model of the Czech aggregate economy was estimated in this manner for purpose of stress testing. The results of this study can be used for stress testing of banking sector.
    Keywords: banking, credit risk, latent factor model, default rate, stress test
    JEL: G21 G28 G33
    Date: 2007–03
  8. By: Renato Filosa
    Abstract: With the aim of contributing to the use of stress testing techniques, by now a commonly-used practice adopted by the financial community to understand the determinants of financial instability, and to measure the size of financial risk, this work represents an application of macro stress testing to the Italian banking system. The paper tries to provide an answer to two interrelated questions. Whether, and the extent to which, procyclicality is a prominent feature of banks’ soundness and whether exogenous, or policy induced, tightening of monetary conditions (sharp and sustained increases in the interest rate and/or appreciation of the exchange rate) significantly increases banks’ fragility. The task is accomplished by the estimation of three alternative VAR models each using different indicators of banks’ soundness: the ratio of non performing loans (flow and stock data) and interest margins to outstanding loans. Two main conclusions emerge. First: the behaviour of either non performing loans or interest margins is only weakly procyclical: i.e. that the solidity of Italian banks could be seriously undermined only in case of falls in output far more severe than in any previous recession since the end of the World War II. The preoccupation expressed by the literature about the dangers of financial procyclicality seems, therefore, grossly exaggerated in the case of Italy. Second: in a hypothetical scenario where monetary conditions are drastically tightened our banks’ soundness indicators exhibit little variations. In this case too the importance attached by the literature to exchange rate swings, or monetary tightening more generally, for the setting off of financial crises is vastly overstated.
    Keywords: banking crises; financial crises; procyclicality; profitability; stress testing; VAR
    JEL: E32 E44 G21
    Date: 2007–03
  9. By: Vernikov , Andrei V. (BOFIT)
    Abstract: This paper applies an analytical paradigm of institutional economics to the transition of the Russian banking sector, focusing on the interplay between ownership change and institutional change. We find that the state’s withdrawal from commercial banking has been inconsistent and limited in scope. To this day, core banks have yet to be privatized and the state has made a comeback as owner of the dominant market participants. We also look at the new institutions imported into Russia to regulate banking and finance, including rule of law, competition, deposit insurance, bankruptcy, and corporate governance. The unfortunate combination of this new institutional overlay and traditional local norms of behavior have brought Russia to an impasse – the banking sector’s ownership structure hinders further advancement of market institutions. Indeed, we may now be witnessing is a retreat from the original market.
    Keywords: banking sector reform; privatization; Russia; economic transition; institutional economics
    JEL: G21 G28 P34 P37
    Date: 2007–03–07
    Abstract: Using a database from post-communist, pre-deposit-insurance Russia, we demonstrate the presence of quantity-based sanctioning of weaker banks by both firms and households. Evidence for the standard form of price discipline, however, is weak. This combination of findings is unusual within the context of the literature on market discipline. But it is consistent with depositors interpreting the deposit rate as a complementary proxy of otherwise unobserved bank-level risk. Testing this hypothesis, we estimate the deposit supply function and show that, particularly for poorly capitalized banks, interest rate increases exhibit diminishing, and eventually negative, returns in terms of deposit attraction.
    Keywords: market discipline, deposit market, Russia
    JEL: G21 O16 P2
    Date: 2007–01
  11. By: Budina, Nina; van Wijnbergen, Sweder
    Abstract: Fiscal sustainability analysis (FSA) is an important component of macroeconomic analysis. The authors review various quantitative approaches to FSA with a major objective to bring these approaches together and to present a user-friendly tool for FSA that reflects modern developments. They combine a dynamic simulations approach with a simplified version of the steady-state consistency approach. They also incorporate two different methods to deal with uncertainty: user-defined stress tests and stochastic simulations. The tool goes further by evaluating the required fiscal adjustment as a consequence of the stochastic realizations of the exogenous variables. Furthermore, the fiscal sustainability tool incorporates an endogenous debt feedback rule for the primary surplus, a fiscal policy reaction function. Besides outlining the theoretical framework, the authors also present a case study for Turkey.
    Keywords: Economic Theory & Research,External Debt,Economic Stabilization,Banks & Banking Reform,Public Sector Economics & Finance
    Date: 2007–03–01

This issue is ©2007 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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