New Economics Papers
on Banking
Issue of 2008‒02‒16
eleven papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Indebtedness, macroeconomic conditions and banks’ loan losses: evidence from Italy By Simona Castellani; Chiara Pederzoli; Costanza Torricelli
  2. Liquidity Production in 21st Century Banking By Philip Strahan
  3. Bank core deposits and the mitigation of monetary policy By Lamont Black; Diana Hancock; Wayne Passmore
  4. Efficiency in banking: theory, practice, and evidence By Joseph P. Hughes; Loretta J. Mester
  5. Alternatives for distressed banks and the panics of the Great Depression By Mark Carlson
  6. Liquidity Risk and Syndicate Structure By Evan Gatev; Philip Strahan
  7. Banking Crisis and Borrower Productivity By KOBAYASHI Keiichiro; YANAGAWA Noriyuki
  8. Recent trends in the number and size of bank branches: an examination of likely determinants By Timothy H. Hannan; Gerald A. Hanweck
  9. Currency Denomination of Bank Loans: Evidence from Small Firms in Transition Countries By Brown, M.; Ongena, S.; Yesin, P.
  10. Democratizing Entry: Banking Deregulations, Financing Constraints, and Entrepreneurship By William Kerr; Ramana Nanda
  11. Financial Intermediation and Late Development: The Case of Meiji Japan, 1868 to 1912 By John Tang

  1. By: Simona Castellani; Chiara Pederzoli; Costanza Torricelli
    Abstract: The Basel II capital accord has fostered the debate over the financial stability of the aggregate banking sector. There is a large empirical literature focused on the effects of macroeconomic disturbances on the banking system. Specifically, loan losses are an important factor for the banking stability and a stream of research in this field aims to identify explanatory variables for this critical indicator. This paper focuses on Italian banks data over the period 1990-2007 and investigates the relationship between the ratio of non-performing loans to total loans, the business cycle and firms’ indebtedness so as to test the impact of both real and financial fragility on banks’ default losses. We use a regression model with an interaction term representing the joint effect of real and financial fragility, which to our knowledge has never been applied before to Italian default data. The results show that the impact of financial fragility on default losses is enhanced by adverse economic conditions.
    Keywords: default; GDP; financial fragility
    JEL: G21 E44
    Date: 2008–01
  2. By: Philip Strahan
    Abstract: I consider banks' role in providing funding liquidity (the ability to raise cash on demand) and market liquidity (the ability to trade assets at low cost), and how these roles have evolved. Traditional banks made illiquid loans funded with liquid deposits, thus producing funding liquidity on the liability side of the balance sheet. Deposits are less important in 21st century banks, but funding liquidity from lines of credit and loan commitments has become more important. Banks also provide market liquidity as broker-dealers and traders in securities and derivatives markets, in loan syndication and sales, and in loan securitization. Many institutions besides banks provide market liquidity in similar ways, but banks dominate in producing funding liquidity because of their comparative advantage in managing funding liquidity risk. This advantage stems from the structure of bank balance sheets as well as their access to government-guaranteed deposits and central-bank liquidity.
    JEL: G2
    Date: 2008–02
  3. By: Lamont Black; Diana Hancock; Wayne Passmore
    Abstract: We consider the business strategy of some banks that provide relationship loans (where they have loan origination and monitoring advantages relative to capital markets) with core deposit funding (where they can pass along the benefit of a sticky price on deposits). These "traditional banks" tend to lend out less than the deposits they take in, so they have a "buffer stock" of core deposits. This buffer stock of core deposits can be used to mitigate the full effect of tighter monetary policy on their bank-dependent borrowers. In this manner, the business strategy of "traditional banks" acts as a "core deposit mitigation channel" to provide funds to bank-dependent borrowers when there are monetary shocks. In effect, there is no bank lending channel of monetary policy associated with these traditional banks. ; In contrast, other banks mainly rely on managed liabilities that are priced at market rates. These banks do not have to shift from insured deposits to managed liabilities in response to tighter monetary policy. At the margin, their loans are already funded with managed liabilities. For these banks as well, there is no unique bank lending channel of monetary policy. ; The only banks that are likely to raise loan rates substantially in response to an increase in the federal funds rate are banks with a high proportion of relationship loans that are close to a loan-to-core deposit ratio of one. These banks must substitute higher cost nondeposit liabilities, which have an external finance premium, for core deposits, which do not because of deposit insurance. Some of these banks may also face higher marginal costs as their loan-to-core deposit ratio approaches one because of the costs associated with lending to default-prone relationship borrowers. It is among these banks (which we refer to as high relationship lenders), and only these banks, that we find evidence of a bank lending channel - they significantly reduce lending in response to a monetary contraction. Importantly, these banks hold only a small fraction of U.S. banking assets. Thus, in the United States, the bank lending channel seems limited in scope and importance, mainly because so few banks that specialize in relationship lending switch from core deposits to managed liabilities in response to changes in interest rates.
    Date: 2007
  4. By: Joseph P. Hughes; Loretta J. Mester
    Abstract: Great strides have been made in the theory of bank technology in terms of explaining banks’ comparative advantage in producing informationally intensive assets and financial services and in diversifying or offsetting a variety of risks. Great strides have also been made in explaining sub-par managerial performance in terms of agency theory and in applying these theories to analyze the particular environment of banking. In recent years, the empirical modeling of bank technology and the measurement of bank performance have begun to incorporate these theoretical developments and yield interesting insights that reflect the unique nature and role of banking in modern economies. This paper gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature.
    Keywords: Banks and banking - Research
    Date: 2008
  5. By: Mark Carlson
    Abstract: Several studies have explored whether the banking panics of the Great Depression caused some institutions to fail that might otherwise have survived. This paper adopts a different approach and investigates whether the panics resulted in the failure and liquidation of banks that might otherwise have been able to pursue a less disruptive resolution strategies such as merging with another institution or suspending operations and recapitalizing. Using data on individual state-chartered banks, I find that many of the banks that failed during the panics appear to have been at least as financially sound as banks that were able to use alternative resolution strategies. This result supports the idea that the disruptions caused by the banking panics may have exacerbated the economic downturn.
    Date: 2008
  6. By: Evan Gatev; Philip Strahan
    Abstract: We offer a new explanation of loan syndicate structure based on banks' comparative advantage in managing systematic liquidity risk. When a syndicated loan to a rated borrower has systematic liquidity risk, the fraction of passive participant lenders that are banks is about 8% higher than for loans without liquidity risk. In contrast, liquidity risk does not explain the share of banks as lead lenders. Using a new measure of ex-ante liquidity risk exposure, we find further evidence that syndicate participants specialize in liquidity-risk management while lead banks manage lending relationships. Links from transactions deposits to liquidity exposure are about 50% larger at participant banks than at lead arrangers.
    JEL: G2 G32
    Date: 2008–02
  7. By: KOBAYASHI Keiichiro; YANAGAWA Noriyuki
    Abstract: In this paper, we propose a theoretical model in which a banking crisis (or bank distress) causes declines in aggregate productivity. When borrowing firms need additional bank loans to continue their businesses, a high probability of bank failure discourages ex ante investments (e.g., R&D investment) by firms that enhance their productivity. In a general equilibrium setting, we also show that there may be multiple equilibria: one in which bank distress continues and borrower productivity is low, and in the other, banks are healthy and borrower productivity is high. We show that the bank capital requirement may be effective in eliminating the bad equilibrium and may lead the economy to the good equilibrium in which the productivity of borrowing firms and the aggregate output are both high and the probability of bank failure is low.
    Date: 2008–02
  8. By: Timothy H. Hannan; Gerald A. Hanweck
    Abstract: In this paper, we examine the role of market characteristics in explaining the much discussed phenomenon of growth in the number of banking institution branches over time, and the much less discussed phenomenon of decline in the size of the average branch. We note first that substitution of bank branches in the US for thrift branches accounts for much of the sharp rise observed for bank branches over time. Using a panel data set that consists of over 2,000 markets observed from 1988 to 2004, we report a number of findings regarding the market characteristics that are associated with the number of branches (of both commercial banks and savings associations) in a market and the average employment size of those branches.
    Date: 2008
  9. By: Brown, M.; Ongena, S.; Yesin, P. (Tilburg University, Center for Economic Research)
    Abstract: We examine the firm-level and country-level determinants of the currency denomination of small business loans. We introduce an information asymmetry between banks and firms in a model that also features the trade-off between the cost of debt and firm-level distress costs. Banks in our model don?t know the currency in which firms have contracted their sales. When foreign currency funds come at a lower interest rate, all foreign currency earners and those local currency earners with low distress costs choose foreign currency loans. With imperfect information in the model concerning the currency in which the firms receive their earnings, even more local earners switch to foreign currency loans as they do not bear the full cost of the corresponding credit risk. We test these implications of our model by using a 2005 survey with responses from 9,655 firms in 26 transition countries that contains reports on 3,105 recent bank loans. We find that firms with foreign currency earnings and lower distress costs borrow more in foreign currency, while opaque firms do not. Interest rate advantages on foreign currency funds do explain differences in loan dollarization across countries, but not within countries over time. The presence of foreign banks and reforms related to corporate governance also contribute to differences in foreign currency borrowing across countries. However, stronger foreign bank presence or corporate governance do not lead more local currency earners to choose foreign currency loans. Our results suggest that while the cost and risk of debt do affect the propensity of small firms to take unhedged foreign currency loans, firm opaqueness does not. Hence, we cannot confirm that information asymmetries are a key driving force of the recently observed increase in loan dollarization in Eastern European transition countries.
    Keywords: foreign currency borrowing;competition;banking sector;market structure.
    JEL: G21 G30 F34 F37
    Date: 2008
  10. By: William Kerr (Harvard Business School, Entrepreneurial Management Unit); Ramana Nanda (Harvard Business School, Entrepreneurial Management Unit)
    Abstract: We study how US branch-banking deregulations affected the entry and exit of firms in the non-financial sector using establishment-level data from the US Census Bureau's Longitudinal Business Database. The comprehensive micro-data allow us to study how the entry rate, the distribution of entry sizes, and survival rates for firms responded to changes in banking competition. We also distinguish the relative effect of the policy reforms on the entry of startups versus facility expansions by existing firms. We find that the deregulations reduced financing constraints, particularly among small startups, and improved ex ante allocative efficiency across the entire firm-size distribution. However, the US deregulations also led to a dramatic increase in 'churning' at the lower end of the size distribution, where new startups fail within the first three years following entry. This churning emphasizes a new mechanism through which financial sector reforms impact product markets. It is not exclusively better ex ante allocation of capital to qualified projects that causes creative destruction; rather banking deregulations can also 'democratize' entry by allowing many more startups to be founded. The vast majority of these new entrants fail along the way, but a few survive ex post to displace incumbents.
    Keywords: banking, financial constraints, entrepreneurship, entry, exit, creative destruction, growth, deregulation.
    JEL: E44 G21 L26 L43 M13
    Date: 2006–12
  11. By: John Tang
    Abstract: Was nineteenth century Japan an example of finance-led growth? Using a new panel dataset of startup firms from the Meiji Period (1868-1912), I test whether financial sector development influenced the emergence of modern industries. Results from multiple econometric models suggest that increased financial intermediation, particularly from banks, is associated with greater firm establishment. This corresponds with the theory of late development that industrialization requires intermediaries to mobilize and allocate financing. The effect is pronounced in the second half of the period and for heavy industries, which may be due to improved institutions and larger capital requirements, respectively.
    Keywords: Financial intermediation, late development, industrialization, Japan
    JEL: N15 N25 O16
    Date: 2008–01

This issue is ©2008 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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