New Economics Papers
on Banking
Issue of 2007‒10‒20
fourteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. The marketability of bank assets and managerial rents: implications for financial stability By Fecht, Falko; Wagner, Wolf
  2. The quality of banking and regional growth By Hasan, Iftekhar; Koetter, Michael; Wedow, Michael
  3. A Causal Framework for Credit Default Theory By Wilson Sy
  4. Creditor Passivity: The Effects of Bank Competition and Institutions on the Strategic Use of Bankruptcy Filings By Hainz, Christa
  5. Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns By Paolo Emilio Mistrulli
  6. Bank ownership and efficiency in China: what lies ahead in the world’s largest nation? By Berger , Allen N; Hasan , Iftekhar; Zhou, Mingming
  7. Financial fragility, macroeconomic shocks and banks’ loan losses: evidence from Europe By Pesola, Jarmo
  8. Credit Risk Models for Managing Bank’s Agricultural Loan Portfolio By Bandyopadhyay, Arindam
  9. Fusões e Aquisições Bancárias no Brasil: Uma Avaliação da Eficiência Técnica e de Escala By João Adelino de Faria; Luiz Fernando de Paula; Alexandre Marinho
  10. Welfare effects of financial integration By Fecht, Falko; Grüner, Hans Peter; Hartmann, Philipp Christian Heinrich
  11. Do Universal Banks Create Value? Universal Bank Affiliation and Company Performance in Belgium, 1905-1909 By Van Overfelt W.; Annaert J.; De Ceuster M.; Deloof M.
  12. Finance and Efficiency: Do Bank Branching Regulations Matter? By Viral V. Acharya; Jean Imbs; Jason Sturgess
  13. The performance of credit rating systems in the assessment of collateral used in Eurosystem monetary policy operations By François Coppens; Fernando Gonzáles; Gerhard Winkler
  14. Applying a Structured Approach to Operational Risk Scenario Analysis in Australia By Emily Watchorn

  1. By: Fecht, Falko; Wagner, Wolf
    Abstract: Ongoing financial innovation and greater information availability increase the tradability of bank assets and reduce banks' dependence on individual bank managers as private information in the lending process declines. In this paper we argue that this has two effects on banks, with opposing implications for banking stability. First, the hold-up problem between bank managers and shareholders becomes less severe. Consequently, banks' capital structure needs to be less concerned with disciplining the management. Deposits -the most effective disciplining device- can be reduced, increasing banks' resilience to adverse return shocks. However, limiting the hold-up problem also diminishes bank managers' rents, reducing their incentives to properly monitor and screen borrowers, with adverse implications for asset quality. Thus, even though the improved marketability of bank assets allows banks to adopt a safer capital structure, the default risk of banks does not necessarily decline.
    Keywords: Marketability, Incentives, Financial Innovations, Financial Stability
    JEL: G21 G28 G32
    Date: 2007
  2. By: Hasan, Iftekhar; Koetter, Michael; Wedow, Michael
    Abstract: We test whether output growth in European economic agglomeration regions depends on financial development. To this end we suggest a relative measure of the quality of financial institutions rather than the usual quantity proxy of nancial development. In order to measure the quality of financial development we use profit efficiency derived from stochastic frontier analysis. We show that more efficient banks spur regional growth while the typically used quantity measure of financial development is negligible. Also, our results suggest an additional channel through which better banking can spur growth: the interaction of more credit with efficient banks.
    Keywords: Bank performance, regional growth, bank efficiency, Europe
    JEL: G21 O16 O47 O52
    Date: 2007
  3. By: Wilson Sy (Australian Prudential Regulatory Authority)
    Abstract: Most existing credit default theories do not link causes directly to the effect of default and are unable to evaluate credit risk in a rapidly changing market environment, as experienced in the recent mortgage and credit market crisis. Causal theories of credit default are needed to understand lending risk systematically and ultimately to measure and manage credit risk dynamically for financial system stability. Unlike existing theories, credit default is treated in this paper by a joint model with dual causal processes of delinquency and insolvency. A framework for developing causal credit default theories is introduced through the example of a new residential mortgage default theory. This theory overcomes many limitations of existing theories, solves several outstanding puzzles and integrates both micro and macroeconomic factors in a unified financial economic theory for mortgage default.
    Keywords: causal framework; credit default risk; delinquency; insolvency; mortgage defualt
    JEL: B41 C81 D14 E44 G21 G32 G33
    Date: 2007–10–01
  4. By: Hainz, Christa
    Abstract: Why do banks remain passive? In a model of bank-firm relationship we study the trade-off a bank faces when having defaulting firms declared bankrupt. First, the bank receives a payoff if a firm is liquidated. Second, it provides information about a firm’s type to its competitors. Thereby, asymmetric information between banks is reduced and bank competition intensifies. We find that the better the institutions and the more competitive the banking sector, the higher the bank’s incentive to bankrupt defaulting firms. This makes information between banks less asymmetric and thus leads to lower interest rates and less credit rationing.
    Keywords: Creditor passivity; bank competition; information sharing; institutions; bankruptcy; relationship banking
    JEL: G21 G33 K10 D82
    Date: 2007–09
  5. By: Paolo Emilio Mistrulli (Bank of Italy - Research Department)
    Abstract: Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may be a channel allowing a bank default to spread to other banks. This paper analyzes how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures. Since information on bilateral exposures was not available in most previous studies, they assumed that banks spread their lending as evenly as possible among all the other banks by maximizing the entropy of interbank linkages. Based on the data available on actual bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims. The comparison indicates that, in line with the thesis prevailing in the literature, the maximum entropy method tends to underestimate the extent of contagion. However, this does not hold in general. Under certain circumstances, depending on the structure of the interbank linkages, the recovery rates of interbank exposures and banks’ capitalization, the maximum entropy approach overestimates the scope for contagion.
    Keywords: interbank market, financial contagion, systemic risk, maximum entropy
    JEL: G21 G28
    Date: 2007–09
  6. By: Berger , Allen N (Federal Reserve Board); Hasan , Iftekhar (Lally School of Management,Rensselaer Polytechnic Institute, and Bank of Finland Research); Zhou, Mingming
    Abstract: China is reforming its banking system, partially privatizing and permitting minority foreign ownership of three of the dominant ‘big four’ state-owned banks. This paper seeks to help predict the effects of this change by analysing the efficiency of virtually all Chinese banks in the years 1994–2003. Our findings suggest the big four banks are by far the least efficient and foreign banks the most efficient while minority foreign ownership is associated with significantly improved efficiency. We present corroborating robustness checks and offer several credible mechanisms through which minority foreign owners can increase Chinese bank efficiency. These findings suggest that minority foreign ownership of the big four is likely to significantly improve performance.
    Keywords: foreign banks; efficiency; foreign ownership
    JEL: F23 G21 G28 G34
    Date: 2007–10–10
  7. By: Pesola, Jarmo (Bank of Finland Research)
    Abstract: This paper tests the hypothesis that the more fragile a banking system is, the more likely it is to experience problems when an unexpected shock hits. The empirical framework where this test is conducted is a reduced form model, where macroeconomic factors explain banks’ loan losses. The dependent variable is the ratio of net loan losses to lending in a panel comprising the banking sectors of nine sample countries. An econometric model is estimated on pooled annual data mostly covering the period from the early 1980s to 2002. There are three separate explanatory terms. Two of these include a surprise change both in incomes and real interest rates. Both form a separate cross-product term with lagged aggregate indebtedness. The lagged dependent variable is the third explanatory term possibly capturing the feedback effect from loan losses back to the real economy. The underlying macroeconomic account that this paper puts forward is that loan losses seem basically to be generated by strong adverse aggregate shocks under high exposure of banks to such shocks. The model has been used in connection with stress testing in the Bank of Finland.
    Keywords: financial fragility; unexpected macroeconomic shock; loan loss; stress test
    JEL: E44 G21
    Date: 2007–10–09
  8. By: Bandyopadhyay, Arindam
    Abstract: In this paper, we have developed a credit scoring model for agricultural loan portfolio of a large Public Sector Bank in India and suggest how such model would help the Bank to mitigate risk in Agricultural lending. The logistic model developed in this study reflects major risk characteristics of Indian agricultural sector, loans and borrowers and designed to be consistent with Basel II, including consideration given to forecasting accuracy and model applicability. In this study, we have shown how agricultural exposures are typically can be managed on a portfolio basis which will not only enable the bank to diversify the risk and optimize the profit in the business, but also will strengthen banker-borrower relationship and enables the bank to expand its reach to farmers because of transparency in loan decision making process.
    Keywords: Credit Risk Modelling; Lending; Agriculture
    JEL: G21 C53 Q14
    Date: 2007–10–12
  9. By: João Adelino de Faria; Luiz Fernando de Paula; Alexandre Marinho
    Abstract: The Brazilian banking sector experimented huge changes in the last years. This provoked a wave of banking mergers and acquisitions (M&As) and the penetration of some foreign banks in the Brazilian retail banking market. Bradesco, Itaú, Unibanco, Santander, ABN Amro and HSBC became the leaders of the private segment of banking sector. This paper aims at evaluating if M&As enhanced the efficiency of these banks. For this purpose, we use a non-parametric technique, Data Envelopment Analysis (DEA). The findings of the applied research show that there were improvements in the intermediation efficiency for all the six banks, while only two banks enhanced in the profit efficiency. Besides, there are a large range of constant returns of scale, that is between R$ 30-40 billion and R$ 100 billion.
    Date: 2006–11
  10. By: Fecht, Falko; Grüner, Hans Peter; Hartmann, Philipp Christian Heinrich
    Abstract: This paper compares four forms of inter-regional financial risk sharing: (i) segmentation, (ii) integration trough the secured interbank market, (iii) integration trough the unsecured interbank market, (iv) integration of retail markets. The secured interbank market is an optimal risk-sharing device when banks report liquidity needs truthfully. It allows diversification without the risk of cross-regional financial contagion. However, free-riding on the liquidity provision in this market restrains the achievable risk-sharing as the number of integrated regions increases. In too large an area this moral hazard problem becomes so severe that either unsecured interbank lending or, ultimately, the penetration of retail markets is preferable. Even though this deeper financial integration entails the risk of contagion it may be beneficial for large economic areas, because it can implement an efficient sharing of idiosyncratic regional shocks. Therefore, the enlargement of a monetary union, for example, extending the common interbank market might increase the benefits of also integrating retail banking markets through cross-border transactions or bank mergers.
    Keywords: Financial integration, interbank market, cross border lending, financial contagion
    JEL: D61 E44 G10 G21
    Date: 2007
  11. By: Van Overfelt W.; Annaert J.; De Ceuster M.; Deloof M.
    Abstract: We investigate the impact of universal banks on the performance and the risk of affiliated companies in an unregulated environment with booming financial markets. For a unique sample of 129 Belgian companies listed in the period 1905-1909, we find that universal bank affiliation had a positive impact on the market-to-book ratio and return-on-assets. The effect on performance was positively related to the degree of bank involvement. Universal banks significantly reduced the volatility of return-on-assets. Stock return performance, measured by the Sharpe ratio, was also significantly better for affiliated corporations.
    Date: 2007–01
  12. By: Viral V. Acharya (London Business School & CEPR); Jean Imbs (University of Lausanne - HEC, CEPR & Swiss Finance Institute); Jason Sturgess (London Business School)
    Abstract: We use portfolio theory to quantify the efficiency of state-level sectoral patterns of production in the United States. On the basis of observed growth in sectoral value added output, we calculate for each state the efficient frontier for investments in the real economy, the efficient Sharpe ratio, and the corresponding weights on investments in different industries. We study how rapidly different states converge to an efficient allocation, depending on access to finance. We find that convergence is faster - in terms of distance to the efficient frontier and improving Sharpe ratios - following intra- and (particularly) interstate liberalization of bank branching restrictions. This effect arises primarily from convergence in the volatility of state output growth, rather than in its average. The realized industry shares of output also converge faster to their efficient counterparts following liberalization, particularly for industries that are characterized by young, small and external finance dependent firms. Convergence is also faster for states that have a larger share of constrained industries, greater distance from the efficient frontier before liberalization and larger geographical area. These effects are robust to industries integrating across states and the endogeneity of liberalization dates. Overall, our results suggest that financial development has important consequences for the efficiency and specialization (or diversification) of investments, in a manner that depends crucially on the variancecovariance properties of investment returns, rather than on their average only.
    Keywords: Financial development, Growth, Sharpe ratio, Volatility, Diversification
    JEL: E44 F02 F36 O16 G11 G21 G28
    Date: 2006–11
  13. By: François Coppens (National Bank of Belgium, Microeconomic Information Department); Fernando Gonzáles (European Central Bank); Gerhard Winkler (Oesterreichische Nationalbank)
    Abstract: The aims of this paper are twofold: first, we attempt to express the threshold of a single “A” rating as issued by major international rating agencies in terms of annualised probabilities of default. We use data from Standard & Poor’s and Moody’s publicly available rating histories to construct confidence intervals for the level of probability of default to be associated with the single “A” rating. The focus on the single A rating level is not accidental, as this is the credit quality level at which the Eurosystem considers financial assets to be eligible collateral for its monetary policy operations. The second aim is to review various existing validation models for the probability of default which enable the analyst to check the ability of credit assessment systems to forecast future default events. Within this context the paper proposes a simple mechanism for the comparison of the performance of major rating agencies and that of other credit assessment systems, such as the internal ratings-based systems of commercial banks under the Basel II regime. This is done to provide a simple validation yardstick to help in the monitoring of the performance of the different credit assessment systems participating in the assessment of eligible collateral underlying Eurosystem monetary policy operations. Contrary to the widely used confidence interval approach, our proposal, based on an interpretation of p-values as frequencies, guarantees a convergence to an ex ante fixed probability of default (PD) value. Given the general characteristics of the problem considered, we consider this simple mechanism to also be applicable in other contexts.
    Keywords: credit risk, rating, probability of default (PD), performance checking, backtesting
    JEL: G20 G28 C49
    Date: 2007–09
  14. By: Emily Watchorn (Australian Prudential Regulation Authority)
    Abstract: Banks intending to apply the Advanced Measurement Approach (AMA) to Operational Risk are required to use scenario analysis as one of the key data inputs into their capital model. Scenario analysis is a forward-looking approach, and it can be used to complement the banks’ short recorded history of operational risk losses, especially for low frequency high impact events (LFHI).
    Date: 2007–09–12

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.