New Economics Papers
on Banking
Issue of 2007‒09‒09
twelve papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. The Impact of Organizational Structure and Lending Technology on Banking Competition By Degryse, Hans; Laeven, Luc; Ongena, Steven
  2. A Framework for Stress Testing Bank's Credit Risk By Jim Wong; Ka-fai Choi; Tom Fong
  3. Legal origin, creditor protection and bank lending: Evidence from emerging markets By Cole, Rebel; Turk, Rima
  4. Bank stock returns and economic growth By Cole, Rebel; Moshirian, Fari; Wu, Qionbing
  5. Determinants of the Performance of Banks in Hong Kong By Jim Wong; Tom Fong; Eric Wong; Ka-fai Choi
  6. Banking consolidation and small businessfinance : empirical evidence for Germany By Marsch, Katharina; Schmieder, Christian; Forster-van Aerssen, Katrin
  7. The Case for Financial Sector Liberalization in Ethiopia By Kozo Kiyota; Barbara Peitsch; Robert M. Stern
  8. Testing for Collusion in the Hong Kong Banking Sector By Jim Wong; Eric Wong; Tom Fong; Ka-fai Choi
  9. The Cost Efficiency of Commercial Banks in Hong Kong By Jim Wong; Tom Fong; Eric Wong; Ka-fai Choi
  10. Competition in Hong Kong's Banking Sector: A Panzar-Rosse Assessment By Jim Wong; Eric Wong; Tom Fong; Ka-fai Choi
  11. Why do banks demand excess liquidity? Evidence from Guyana By Khemraj, Tarron
  12. Can investors profit from banks’ stock recommendations? Evidence for the German DAX index By Pierdzioch, Christian; Kempa, Bernd; Hendricks, Torben

  1. By: Degryse, Hans; Laeven, Luc; Ongena, Steven
    Abstract: Recent theoretical models argue that a bank’s organizational structure reflects its lending technology. A hierarchically organized bank will employ mainly hard information, whereas a decentralized bank will rely more on soft information. We investigate theoretically and empirically how bank organization shapes banking competition. Our theoretical model illustrates how a lending bank’s geographical reach and loan pricing strategy is determined not only by its own organizational structure but also by organizational choices made by its rivals. We take our model to the data by estimating the impact of the lending and rival banks’ organization on the geographical reach and loan pricing of a singular, large bank in Belgium. We employ detailed contract information from more than 15,000 bank loans granted to small firms, comprising the entire loan portfolio of this large bank, and information on the organizational structure of all rival banks located in the vicinity of the borrower. We find that the organizational structures of both the rival banks and the lending bank matter for branch reach and loan pricing. The geographical footprint of the lending bank is smaller when rival banks are large and hierarchically organized. Such rival banks may rely more on hard information. Geographical reach increases when rival banks have inferior communication technology, have a wider span of organization, and are further removed from a decision unit with lending authority. Rival banks’ size and the number of layers to a decision unit also soften spatial pricing. We conclude that the organizational structure and technology of rival banks in the vicinity influence local banking competition.
    Keywords: authority; banking sector; competition; hierarchies; technology
    JEL: G21 L11 L14
    Date: 2007–08
  2. By: Jim Wong (Research Department, Hong Kong Monetary Authority); Ka-fai Choi (Research Department, Hong Kong Monetary Authority); Tom Fong (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper develops a framework for stress testing the credit exposures of Hong Kong's retail banks to macroeconomic shocks. It involves the construction of macroeconomic credit risk models, each consisting of a multiple regression model explaining the default rate of banks, and a set of autoregressive models explaining the macroeconomic environment estimated by the method of seemingly unrelated regression. Specifically, two macroeconomic credit risk models are built. One model is specified for the overall loan portfolios of banks and, to illustrate how the same framework can be applied for stress testing loans to different economic sectors, the other model is specified for the banks' mortgage exposures only. The empirical results suggest a significant relationship between the default rates of bank loans and key macroeconomic factors including Hong Kong¡¦s real GDP, real interest rates, real property prices and Mainland China's real GDP. Macro stress testing is then performed to assess the vulnerability and risk exposures of banks' overall loan portfolios and mortgage exposures. By using the framework, a Monte Carlo method is applied to estimate the distribution of possible credit losses conditional on an artificially introduced shock. Different shocks are individually introduced into the framework for the stress tests. The magnitudes of the shocks are specified according to those occurred during the Asian financial crisis. The result shows that even for the Value-at-Risk (VaR) at the confidence level of 90%, banks would continue to make a profit in most stressed scenarios, suggesting that the current credit risk of the banking sector is moderate. However, under the extreme case for the VaR at the confidence level of 99%, banks' credit loss would range from a maximum of 3.22% to a maximum of 5.56% of the portfolios, and if a confidence level of 99.9% is taken, it could range from a maximum of 6.08% to a maximum of 8.95%. These estimated maximum losses are very similar to what the market experienced one year after the Asian financial crisis shock. However, the probability of such losses and beyond is very low.
    Date: 2006–10
  3. By: Cole, Rebel; Turk, Rima
    Abstract: Numerous papers in the “law and finance” literature have established that countries with better functioning legal institutions enjoy better developed capital markets, and that legal origin is a fundamental determinant of legal institutions (La Porta et al. 1997, 1998, 2006; Djankov et al. 2007). In this study, we test whether banks are willing to grant more credit to the private sector when they enjoy superior legal protection. We test this hypothesis using bank-level data from 45 emerging-market countries and a random-effects model that controls for bank heterogeneity. We find that lenders allocate a significantly higher portion of their assets to loans (i) where they enjoy English legal origin rather than French or Socialist legal origin; (ii) where enforcement of debt contracts is more efficient and (iii) where banks enjoy fewer restrictions on their operations. These support our hypothesis that superior legal protection leads to more bank credit, which, in turn, should lead to higher economic growth.
    Keywords: banking; creditor rights; emerging markets; investor protection; legal origin
    JEL: O16 G34 G21
    Date: 2007–05–30
  4. By: Cole, Rebel; Moshirian, Fari; Wu, Qionbing
    Abstract: Previous research has established (i) that a country’s financial sector influence future economic growth and (ii) that stock market index returns affect future economic growth. We extend and tie together these two strands of the growth literature by analyzing the relationship between banking industry stock returns and future economic growth. Using dynamic panel techniques to analyze panel data from 18 developed and 18 emerging markets, we find a positive and significant relationship between bank stock returns and future GDP growth that is independent of the previously documented relationship between market index returns and economic growth. We also find that much of the informational content of bank stock returns is captured by country-specific and institutional characteristics, such as bank-accounting-disclosure standards, banking crises, enforcement of insider trading law and government ownership of banks.
    Keywords: Banks; Economic Growth; Emerging Markets; Financial Development
    JEL: G15 G21 O11 G14 O43
    Date: 2007–08–01
  5. By: Jim Wong (Research Department, Hong Kong Monetary Authority); Tom Fong (Research Department, Hong Kong Monetary Authority); Eric Wong (Research Department, Hong Kong Monetary Authority); Ka-fai Choi (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper develops a model to identify the major determinants of a bank's profit, and the general level of profitability of a banking market. It found that in Hong Kong's case, market structure, such as market concentration and market shares of banks, is not a major contributory factor. Cost efficiency of banks, which measures the ability of banks to optimise their input mix for producing outputs, is a major determinant of banks' profitability. Since larger banks are found to be in general more cost efficient than smaller banks in our previous study on banks' efficiency, larger banks can offer services at lower prices to compete with smaller banks, yet attaining a similar or even higher level of profits. Smaller banks may, therefore, be more vulnerable to intense competitions in the loan market than larger banks, particularly in cut-throat price wars.
    Keywords: Profitability, price, Hong Kong banking, bank efficiency, market structure
    JEL: G14 G21 G28 L11
    Date: 2007–04
  6. By: Marsch, Katharina; Schmieder, Christian; Forster-van Aerssen, Katrin
    Abstract: Since the early 1990s an unprecedented process of consolidation has taken place in the banking sector in most industrialised countries raising concern of policymakers that it may reduce access to credit for the small business sector. While most of the existing empirical studies have focused on the U.S., this paper is the first one empirically investigating the effects of banking consolidation in Germany. As small and medium sized German companies traditionally almost exclusively rely on bank credit and as they represent the vast majority of the corporate sector reduced credit availability for those companies could particularly endanger economic growth. Based on an exceptional panel dataset comprising merged data of the German credit register and balance sheet data of German firms and banks we find - contrary to public fear - that the ongoing banking consolidation in Germany does not have a significant negative impact on the financing of small and medium-sized enterprises (SME). We measure the financing opportunities of SMEs based on the bank debt/assets ratio and the logarithmized credit size and control both explicitly for bank mergers and for the increase in the average bank size in the course of the consolidation process. In addition, we observe that the concentration in the banking market is insignificant for SME financing and that there is no significant difference between commercial banks, savings banks and private banks.
    Keywords: Banking consolidation, bank mergers, SME financing
    JEL: G1 G2 G21
    Date: 2007
  7. By: Kozo Kiyota (Yokohama National University and University of Michigan, Ann Arbor); Barbara Peitsch (University of Michigan, Dearborn); Robert M. Stern (University of Michigan, Ann Arbor)
    Abstract: This paper focuses on issues of financial sector liberalization in Ethiopia, with reference in particular to the Ethiopian banking sector. We identify two factors that may constrain Ethiopia’s financial development. One is the closed nature of the Ethiopian financial sector in which there are no foreign banks, a non-competitive market structure, and strong capital controls in place. The other is the dominant role of state-owned banks. Our observations suggest that the Ethiopian economy would benefit from financial sector liberalization, especially from the entry of foreign banks and the associated privatization of state-owned banks.
    Keywords: foreign banks, state-owned banks, financial sector liberalization, Africa, Ethiopia
    JEL: G21 G32 L33 O55
    Date: 2007
  8. By: Jim Wong (Research Department, Hong Kong Monetary Authority); Eric Wong (Research Department, Hong Kong Monetary Authority); Tom Fong (Research Department, Hong Kong Monetary Authority); Ka-fai Choi (Research Department, Hong Kong Monetary Authority)
    Abstract: This working paper examines the degree of collusion in the banking sector of Hong Kong based on the conjectural variation approach. The results suggest that banks in Hong Kong operated in a competitive fashion in the loan market during the period 1991-2002 with no significant sign of collusion on pricing. The market conduct was largely maintained in subsequent years, despite significant changes in the operating conditions. While major bank consolidations in 2001-2002 have resulted in fewer banks and thus a market more conducive to develop and maintain collusions, interest rate deregulations implemented around the same time has promoted a more competitive environment. The estimation results show that while banks do not appear to have exercised any collusive pricing in either the retail market or the corporate loan market, it is relatively less likely to develop oligopolistic collusions in the corporate loan market than in the local retail market.
    Keywords: Conjectural variation, price, Hong Kong banking, market structure
    JEL: G21 G28 L13 L22
    Date: 2007–02
  9. By: Jim Wong (Research Department, Hong Kong Monetary Authority); Tom Fong (Research Department, Hong Kong Monetary Authority); Eric Wong (Research Department, Hong Kong Monetary Authority); Ka-fai Choi (Research Department, Hong Kong Monetary Authority)
    Abstract: Given banks' special role in channelling funds from savers to investors, their cost efficiency has a significant effect on the supply of credit and, in turn, on the overall economic performance. In addition, inefficiency would affect banks' earnings, thus hampering their ability to withstand shocks. The issue of banks' cost efficiency is therefore of interest to policy makers. Using the stochastic frontier approach and a panel dataset of retail banks, this paper assesses the cost efficiency of the banking sector in Hong Kong. The average cost inefficiency during the period 1992-2005 is found to be about 15% to 29% of observed total costs, which is largely in line with the experience of US and European banks. Cost efficiency is found to be correlated with macroeconomic conditions, with a significant rise in cost inefficiency triggered by the Asian financial crisis and the outbreak of SARS during the period 1998-2003, partly due to the lack of perfect flexibility by banks to adjust their factor inputs (labour, funds and capital) in response to falling outputs. Additional resources spent on risk control, new business initiatives and strengthening customer relationships may also have contributed. Nevertheless, the cost efficiency has started to improve by 2004 Q1, along with the recovery of the economy. This suggests also that the adjustments and streamlining by the banks in recent years may have begun to bear fruit. Empirical results also indicate that cost efficiency is positively correlated with bank size, suggesting large banks are on average more efficient than smaller banks. Efficiency is also observed to be sensitive to banks' business mix, with banks which focus more on lending business exhibiting a higher level of efficiency compared to banks that focus relatively less on loans. In addition, banks suffering from larger loan loss provisions are found to be less efficient, probably due to higher operational costs relating to credit risk and loan loss management.
    Date: 2006–09
  10. By: Jim Wong (Research Department, Hong Kong Monetary Authority); Eric Wong (Research Department, Hong Kong Monetary Authority); Tom Fong (Research Department, Hong Kong Monetary Authority); Ka-fai Choi (Research Department, Hong Kong Monetary Authority)
    Abstract: A re-examination of the competitive conditions of the banking industry in Hong Kong, based on the Panzar-Rosse approach and using a panel dataset with longer time-series data, reconfirms previous findings in our RM 04/2004 that the degree of competition was fairly high during the period 1992-2002. The empirical analysis also suggests that competitive pressures have been maintained in subsequent years, notwithstanding significant changes in the operating environment. The estimation results showed that competitive pressures were higher among larger banks and lower among smaller banks. This may suggest that while larger banks compete with smaller banks keenly in local retail markets on products such as mortgages and credit cards, they may be subject to even stronger pressures from other competitors at the regional or international levels in the corporate banking market, wealth management and other off-balance sheet activities, where they are more heavily involved. While relaxation of regulations and advances in technology tend to increase competition in the banking system, the effect of consolidation may depend on the prevailing market settings. To the extent that bank consolidation in recent years may have hampered competition, regulatory liberalisation and technological progress appear to have largely offset the adverse effect. The emergence of a number of larger banks through mergers and acquisitions which should be more capable of competing with existing large banks may have also contributed. Nonetheless, with bank consolidation expected to continue, how market concentration may impact on competition in the years to come needs to be closely monitored.
    Date: 2006–10
  11. By: Khemraj, Tarron
    Abstract: This paper posits two alternative hypotheses to explain why commercial banks demand non-remunerative excess liquidity. The first hypothesis holds that banks require a minimum interest rate in the loan market and the market for the domestic short-term government security. The minimum rates are mark-up interest rates owing to oligopoly power in the loan market and oligopsony power in the government security market. The second hypothesis is the existence of a foreign currency constraint, which explains why banks seemingly refuse to invest all excess funds in safe accounts abroad. The stylized facts, econometric and calibration exercises are consistent with the hypotheses.
    Keywords: oligopoly banking; excess liquidity; monetary policy; small open economies; Guyana
    JEL: O16 O10 E52 E50
    Date: 2007–06
  12. By: Pierdzioch, Christian; Kempa, Bernd; Hendricks, Torben
    Abstract: We find that banks’ buy and sell recommendations only have a minor effect on the out-of-sample predictability of daily stock returns and the market-timing ability of an investor trading in real time in the German DAX30 stock index. Banks’ stock recommendations may improve the performance of simple trading rules in real time. These improvements, however, are in general small and sensitive to the model-selection criterion being used by an investor to set up a forecasting model for stock returns.
    Keywords: Forecasting stock returns; trading rules; buy and sell recommendations by banks
    JEL: G11 E44 C53
    Date: 2007–01–09

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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