New Economics Papers
on Banking
Issue of 2008‒03‒01
fifteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Life-cycle patterns of interest rate markups in small firm finance By Moshe Kim; Eirik Gaard Kristiansen; Bent Vale
  2. Market power and merger simulation in retail banking By Molnár, József
  3. What Drives the Arrangement Timetable of Bank Loan Syndication ? By Christophe J. Godlewski
  4. Consistent Quantitative Operational Risk Measurement and Regulation: Challenges of Model Specification, Data Collection, and Loss Reporting By Andreas Jobst
  5. Capital Flows and Economic Fluctuations: The Role of Commercials Banks in Transmitting Shocks By Yong Sarah Zhou
  6. Money, Intermediation, and Banking By Andolfatto, David
  7. Credit Expansion, the Prisoner´s Dilemma and Free Banking as Mechanism Design By van den Hauwe, Ludwig
  8. Islamic Banks and Financial Stability: An Empirical Analysis By Martin Cihák; Heiko Hesse
  9. Decomposing Financial Risks and Vulnerabilities in Eastern Europe By Andrea M. Maechler; Srobona Mitra; DeLisle Worrell
  10. Are Banks Procyclical? Evidence from the Italian Case (1890-1973) By Carlo Brambilla; Giandomenico Piluso
  11. Banking reform in China: Driven by international standards and Chinese specifics By Kudrna, Zdenek
  12. Convergence in Banking Efficiency Across European Countries By Laurent Weill
  13. Show Me the Money: Access to Finance for Small Borrowers in Canada By Vladimir Klyuev
  14. The reserve fulfilment path of euro area commercial banks - empirical testing using panel data. By Nuno Cassola
  15. Operational Risk--The Sting is Still in the Tail but the Poison Depends on the Dose By Andreas Jobst

  1. By: Moshe Kim (University of Haifa and Universitat Pompeu Fabra); Eirik Gaard Kristiansen (Norwegian School of Economics and Business Administration); Bent Vale (Norges Bank (Central Bank of Norway))
    Abstract: We derive empirical implications from a stylized theoretical model of bankborrower relationships. Banks’ interest rate markups are predicted to follow a life-cycle pattern over the borrowing firms’ age. Due to endogenous bank monitoring by competing banks, borrowing firms initially face a low markup, thereafter an increasing markup due to informatonal lock-in until it falls for older firms when lock-in is resolved. By applying a large sample of small unlisted firms and a new measure of asymmetric information, we find that firms with significant asymmetric information problems have a more pronounced life-cycle pattern of interest rate markups. Additionally, we examine the effects of concentrated banking markets on interest markups. Results indicate that markups are mainly driven by asymmetric information problems and not by concentration. However, we find weak evidence that bank market concentration matters for old firms.
    Keywords: Banking, loan-pricing, lock-in, asymmetric information, competition
    JEL: G21 L15
    Date: 2007–09–11
  2. By: Molnár, József (Bank of Finland Research)
    Abstract: This paper tests market power in the banking industry. Price-cost margins predicted by different oligopoly models are calculated using discrete-choice demand estimates of own-price and cross-price elasticities. These predicted price-cost margins are then compared with price-cost margins computed using observed interest rates and estimates of marginal costs. This paper is among the first to apply this methodology on a detailed, bank-level dataset from the retail banking sector. It extends on previous papers and illustrates the advantages of structural modelling by simulating a counterfactual merger experiment with a number of mergers, each of which involves two major banks, and studying the unilateral effect of the mergers on interest rates. This provides more evidence that concentration measures (such as the Herfindahl index) could be very misleading indicators of market power.
    Keywords: demand; discrete choice; product differentiation; banking; market power; merger simulation
    JEL: G21 L11 L13
    Date: 2008–02–27
  3. By: Christophe J. Godlewski (Laboratoire de Recherche en Gestion et Economie, Université Louis Pasteur)
    Abstract: We investigate the influence of loan and syndicate characteristics and information disclosure and legal environment factors on the arrangement timetable of bank loan syndications (measured as the time elapsed from the launching until the completion of the deal) from 68 countries over the 1992-2006 period. Employing accelerated failure time models from survival analysis methodology, we find that loan, syndicate, legal environment and information disclosure characteristics which reduce agency problems related to syndication reduce the arrangement timetable. Among the country level characteristics, information disclosure which reduces moral hazard due to informational frictions between syndicate members appears to be the most important driver of a faster deal arrangement timetable, while better creditor rights protection increase the arrangement timetable, consistently with recontracting risk issues.
    Keywords: Syndicated loans arrangement timetable, Agency problems, Information disclosure, Legal risk, Survival analysis, Accelerated failure time models.
    JEL: G21 C41
    Date: 2008
  4. By: Andreas Jobst
    Abstract: Amid increased size and complexity of the banking industry, operational risk has a greater potential to transpire in more harmful ways than many other sources of risk. This paper provides a succinct overview of the current regulatory framework of operational risk under the New Basel Capital Accord with a view to inform a critical debate about the influence of varying loss profiles and different methods of data collection, loss reporting, and model specification on the reliability of operational risk estimates and the consistency of risk-sensitive capital rules. The presented findings offer guidance on enhanced market practice and more effective prudential standards for operational risk measurement.
    Keywords: Risk management , Bank regulations , Globalization , Banking systems ,
    Date: 2007–11–05
  5. By: Yong Sarah Zhou
    Abstract: This paper uses a general equilibrium model to examine the central role played by commercial banks in intermediating and amplifying the capital flow shocks to the local economy in the 1997 Asia financial crisis. It finds that a sudden stop of capital inflows affects the equilibrium credit supply through two channels: first, the plunge of foreign financing decreases the loanable funds directly; and second the sudden stop drives up the cost of providing banking services, thereby additionally reducing the available bank credit to firms through a "deposit run". Empirical results from a VAR model broadly support the theoretical implications.
    Keywords: Capital flows , Bank credit , Employment , Financial crisis ,
    Date: 2008–01–29
  6. By: Andolfatto, David
    Abstract: The business of money creation is conceptually distinct from that of intermediation. Yet, these two activities are frequently---but not always---combined together in the form of a banking system. We develop a simple model to examine the question: When is banking essential? There is a role for money due to a lack of record-keeping and a role for intermediation due to the existence of private information: both money and intermediation are essential. When monitoring costs associated with intermediation are sufficiently low, the two activities can be separated from one another. However, when monitoring costs are sufficiently high, a banking system that combines these two activities is essential.
    Keywords: Money; Record-keeping; Private Information; Delegated Monitoring
    JEL: E42
    Date: 2008–02–24
  7. By: van den Hauwe, Ludwig
    Abstract: Despite the distinctive character of the Austrian approach to “microfoundations for macroeconomics”, the literature on free banking contains a number of arguments which make use of game-theoretic concepts and models such as the well-known Prisoner´s Dilemma model. While there can be no general a priori presumption against the possible usefulness of game-theoretic concepts for Austrian theorizing, in the context of the debate on free banking such concepts and models have been used with varying degrees of perspicacity. One example which is elaborated in the paper is concerned with the interaction configuration between independent banks in a fractional-reserve free banking system, which has sometimes been modeled as a One-Shot Prisoner´s Dilemma. This conceptualization does not provide a sufficient argument for the in-concert overexpansion thesis, nor for the thesis that fractional-reserve free banking will “inevitably” lead to central banking. The author drops the implicit assumption that there exists a one-to-one correspondence between the outcome matrix and the utility matrix. When it is acknowledged that banks in a fractional-reserve free banking system need not necessarily adopt a “myopic”, self-regarding perspective but may recognize the long-run harmony of interests between the banking sector and society at large, a different conceptualization and a different matrix representation emerge.
    Keywords: Free Banking; Business Cycle Theory; Prisoner´s Dilemma; Mechanism Design;
    JEL: E32 E66 E58 E42 E31 G18 E52 D01 K39
    Date: 2008–02–21
  8. By: Martin Cihák; Heiko Hesse
    Abstract: The relative financial strength of Islamic banks is assessed empirically based on evidence covering individual Islamic and commercial banks in 18 banking systems with a substantial presence of Islamic banking. We find that (i) small Islamic banks tend to be financially stronger than small commercial banks; (ii) large commercial banks tend to be financially stronger than large Islamic banks; and (iii) small Islamic banks tend to be financially stronger than large Islamic banks, which may reflect challenges of credit risk management in large Islamic banks. We also find that the market share of Islamic banks does not have a significant impact on the financial strength of other banks.
    Keywords: Islamic banking , Financial stability ,
    Date: 2008–01–30
  9. By: Andrea M. Maechler; Srobona Mitra; DeLisle Worrell
    Abstract: This paper assesses how various types of financial risk such as credit risk, market risk, and liquidity risk affect banking stability in the ten countries that joined the European Union most recently, and eight neighboring countries. It also examines how the quality of supervisory standards may have mitigated the vulnerabilities arising from these risk factors. Using panel data, the study finds substantial variation in the impacts of financial risks, the macroeconomic environment, and supervisory standards on banks' risk profile across different country clusters. Credit quality is of general concern especially in circumstances where credit growth is accelerating.
    Keywords: Working Paper , Financial risk , Europe , Bank soundness , Bank supervision , Economic models ,
    Date: 2007–10–29
  10. By: Carlo Brambilla; Giandomenico Piluso
    Abstract: Recently a number of studies on banking systems’ procyclicality have been drawn. Such an issue, often developed as a consequence of Basel 2 agreements, is related with credit crunch phenomena and financial stability. Typically, a temporary shock may produce a long term effect following or amplifying fluctuations through finance. For this reason procyclicality may significantly affect capital accumulation and long-term growth. Therefore, verifying and measuring whether a banking system is, or is not, procyclical is relevant in order to understand which effects regulatory schemes and financial architectures can produce on capital formation processes. While studies generally have a short period perspective, this paper analyses business fluctuations and banking cycles in the long run. The Italian financial history could provide useful insights because its evolutionary path experimented two different banking patterns. Universal banking prevailed until the Great Depression, whilst specialised financial institutions emerged afterwards. Economic historians have considered Italian universal banks, up to the early 1930s, a convincing example of procyclical intermediaries. Such hypothesis relies on qualitative research based on case studies, but it has not been verified in quantitative terms, yet. Thus, this paper aims to verify procyclicality of the Italian banking system in the long run applying VAR analysis on a wide set of economic and financial indicators. What emerges is that a certain cycle-smoothing effect is observed during the whole period, in spite of the major institutional shock occurred in the early 1930s (i.e. the new bank law), whilst relevant changes in banks’ asset structures suggest that central bank and government intervention had important impact on banks behaviour and policies
    Keywords: credit cycles, business cycles, procyclicality, credit crunch, financial stability, universal banking
    JEL: E32 G21 N13 N14 N23 N24
    Date: 2007–12
  11. By: Kudrna, Zdenek
    Abstract: This paper reviews the progress of banking reforms in China over the last five years. The stated goal of reform is to “transform major banks into internationally competitive joint‐stock commercial banks with appropriate corporate governance structures, adequate capital, stringent internal controls, safe and sound business operations, quality services as well as desirable profitability.” The reform strategy relies on three pillars – extensive publicly financed bailouts, implementation of the international best practices in bank governance and regulation and listing of major banks at the Hong Kong stock exchange. This strategy has been successful in stabilizing the three major banks. However, our review of academic and commercial research indicates that there is no evidence that the stabilization is sustainable. Prudential indicators of the largest banks are comparable to international averages, but this is an outcome of large bail outs and ongoing credit boom rather than fundamental change in banker’s incentives. Reforms of bank governance and regulatory framework need more time to proliferate throughout the banking and regulatory hierarchies. However, time alone would not solve the problem as the reform design retains important departures from international standards. These standards are implemented in a selective manner; those aspects that help to concentrate key powers in the center are implemented rather vigorously, whereas principles that require independence of banks’ boards and regulators are ignored. Thus the largest Chinese banks remain under the firm state control and can be used as development policy tools for the better or the worse.
    Keywords: China; banks; reform; international standards
    JEL: G28 G21 P34
    Date: 2007–10
  12. By: Laurent Weill (Laboratoire de Recherche en Gestion et Economie, Institut d'Etudes Politiques, Strasbourg)
    Abstract: Since the preparation of the Single Market program in the 80s, financial integration in Europe has been expected to provide gains in growth by favoring competition and efficiency on financial markets. Our paper aims to check whether financial integration has taken place on the banking markets, by investigating the convergence in banking efficiency for European Union countries. We measure cost efficiency of banks from 10 EU countries between 1994 and 2005 with the stochastic frontier approach. Our work then constitutes the first one to apply tests of β and σ convergence specified for panel data on banking efficiency measures. We provide evidence of cross-country differences in cost efficiency and of an improvement in cost efficiency for all EU countries. Tests of convergence support the view of a process in convergence in cost efficiency between EU countries. Robustness checks with alternative specifications confirm these findings. These results support the view that financial integration has taken place on the EU banking markets in the recent years.
    Keywords: Banking, convergence, efficiency, European integration, stochastic frontier approach.
    JEL: G21 D21 F36
    Date: 2008
  13. By: Vladimir Klyuev
    Abstract: This paper examines access to business finance by Canadian small and medium-sized enterprises (SMEs) and to housing finance by Canadian households (particularly non-prime borrowers) against the background of a fairly concentrated and protected banking industry. It finds access broadly adequate for the former group. However, given the dominance of the large banks and their fairly low risk tolerance, financing of riskier projects is a challenge. Problems with venture capital, plausibly related to the prevalence of tax-advantaged labor-sponsored funds, exacerbate the situation for the most innovative SMEs. The paper also finds the market for housing finance to be highly advanced and sophisticated. However, non-prime mortgage financing is in its infancy in Canada, and further development of that sector (while avoiding the excesses that beset the U.S. market in the last few years) would be beneficial. More broadly, despite recent innovations, options available to Canadians for financing house purchases are still somewhat limited, with scarce availability of mortgage maturities beyond five years particularly surprising. Further advances in securitization could help progress in both of these areas.
    Keywords: Bank credit , Canada , Financial risk , Financial systems ,
    Date: 2008–01–31
  14. By: Nuno Cassola (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The theory of liquidity management under uncertainty predicts that, under certain conditions, commercial banks will accumulate minimum reserve requirements linearly over the reserve maintenance period. This prediction is empirically tested using daily data (from March 2004 until February 2007) on the current accounts and minimum reserve requirements of a panel of 79 commercial banks from the euro area. The linear accumulation hypothesis is not rejected by the data with the exception of small banks which build-up excess reserves. The empirical analysis suggest that idio-syncratic liquidity uncertainty is much higher than aggregate liquidity uncertainty. Nevertheless, on the penultimate day in the reserve maintenance period, the inverse demand schedule of the representative bank is relatively flat around the middle of the interest rate corridor set by the standing facilities. This suggests that liquidity effects on the overnight inter-bank rate should be very muted on this day. Our calibration exercise suggests that the probability of an individual bank's daily overdraft in the euro area is very low (less than 1.0%). This is confirmed by the analysis of the daily recourses to the marginal lending facility by the panel banks. JEL Classification: C23, E4, E5, G2.
    Keywords: Monetary policy implementation, Reserve requirements, Rate corridor, Liquidity management, Panel data.
    Date: 2008–02
  15. By: Andreas Jobst
    Abstract: This paper investigates the generalized parametric measurement methods of aggregate operational risk in compliance with the regulatory capital standards for operational risk in the New Basel Capital Accord ("Basel II"). Operational risk is commonly defined as the risk of loss resulting from inadequate or failed internal processes and information systems, from misconduct by people or from unforeseen external events. Our analysis informs an integrated assessment of the quantification of operational risk exposure and the consistency of current capital rules on operational risk based on generalized parametric estimation.
    Keywords: Working Paper , Financial risk , Bank regulations , Risk management , Economic models ,
    Date: 2007–10–30

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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