New Economics Papers
on Banking
Issue of 2008‒04‒12
thirteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Does Competition Reduce the Risk of Bank Failure? By Martinez-Miera, David; Repullo, Rafael
  2. Does Interbank Borrowing Reduce Bank Risk? By Dinger, Valeriya; von Hagen, Jürgen
  3. The Impact of Technology and Regulation on the Geographical Scope of Banking By Hans Degryse; Steven Ongena
  4. Banking Permits: Economic Efficiency and Distributional Effects By Bosetti, Valentina; Carraro, Carlo; Massetti, Emanuele
  5. Corporate governance issues for banks. A financial stability perspective By Dirk Heremans
  6. Understanding the securitization of subprime mortgage credit By Adam B. Ashcraft; Til Schuermann
  7. Credit Booms and Lending Standards: Evidence From The Subprime Mortgage Market By Dell'Ariccia, Giovanni; Igan, Deniz; Laeven, Luc
  8. Market Power and Efficiency in the Czech Banking Sector By Anca Pruteanu-Podpiera; Laurent Weill; Franziska Schobert
  9. Impact of bank competition on the interest rate pass-through in the euro area By Michiel van Leuvensteijn; Christoffer Kok Sørensen; Jacob A. Bikker; Adrian A.R.J.M. van Rixtel
  10. Bad Luck or Bad Management? Emerging Banking Market Experience By Jiri Podpiera; Laurent Weill
  11. Location Decisions of Foreign Banks and Institutional Competitive Advantage By Stijn Claessens; Neeltje van Horen
  12. Bank Lending Rate Pass-Through and Differences in the Transmission of a Single EMU Monetary Policy. By Marie Donnay; Hans Degryse
  13. Bank Strategies in Euroland with Special Reference to the Benelux Area. By Juan-Paul Abraham

  1. By: Martinez-Miera, David; Repullo, Rafael
    Abstract: A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from non-defaulting loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains.
    Keywords: Bank competition; Bank failure; Credit risk; Default correlation; Franchise values; Loan defaults; Loan rates; Moral hazard; Net interest income; Risk-shifting
    JEL: D43 E43 G21
    Date: 2008–01
  2. By: Dinger, Valeriya; von Hagen, Jürgen
    Abstract: In this paper we investigate whether banks that borrow from other banks have lower risk levels. We concentrate on a large sample of Central and Eastern European banks which allows us to explore the impact of interbank lending when exposures are long-term and interbank borrowers are small banks. The results of the empirical analysis generally confirm the hypothesis that long-term interbank exposures result in lower risk of the borrowing banks.
    Keywords: bank risk; interbank market; market discipline; transition countries
    JEL: E53 G21
    Date: 2008–01
  3. By: Hans Degryse; Steven Ongena
    Abstract: We review how technological advances and changes in regulation may shape the (future) geographical scope of banking. We first review how both physical distance and the presence of borders currently affect bank lending conditions (loan pricing and credit availability) and market presence (branching and servicing). Next we discuss how technology and regulation have altered this impact and analyse the current state of the European banking sector. We discuss both theoretical contributions and empirical work and highlight open questions along the way. We draw three main lessons from the current theoretical and empirical literature: (1) Bank lending to small businesses in Europe may be characterized both by (local) spatial pricing and resilient (regional and/or national) market segmentation; (2) Because of informational asymmetries in the retail market, bank mergers and acquisitions seem the optimal route of entering another market, long before cross-border servicing or direct entry are economically feasible; (3) Current technological and regulatory developments may to a large extent remain impotent in further dismantling the various residual but mutually reinforcing frictions in the retail banking markets in Europe. We conclude the paper by offering pertinent policy recommendations based on these three lessons.
    Keywords: geographical scope, banking, lending relationships, technology, and regulation.
    JEL: G21 L11 L14
    Date: 2008–03
  4. By: Bosetti, Valentina; Carraro, Carlo; Massetti, Emanuele
    Abstract: Most analyses of the Kyoto flexibility mechanisms focus on the cost effectiveness of "where" flexibility (e.g. by showing that mitigation costs are lower in a global permit market than in regional markets or in permit markets confined to Annex 1 countries). Less attention has been devoted to "when" flexibility, i.e. to the benefits of allowing emission permit traders to bank their permits for future use. In the model presented in this paper, banking of carbon allowances in a global permit market is fully endogenised, i.e. agents may decide to bank permits by taking into account their present and future needs and the present and future decisions of all the other agents. It is therefore possible to identify under what conditions traders find it optimal to bank permits, when banking is socially optimal, and what are the implications for present and future permit prices. We can also explain why the equilibrium rate of growth of permit prices is likely to be larger than the equilibrium interest rate. Most importantly, this paper analyses the efficiency and distributional consequences of allowing markets to optimally allocate emission permits across regions and over time. The welfare and distributional effects of an optimal intertemporal emission trading scheme are assessed for different initial allocation rules. Finally, the impact of banking on carbon emissions, technological progress, and optimal investment decisions is quantified and the incentives that banking provides to accelerate technological innovation and diffusion are also discussed. Among the many results, we show that not only does banking reduce abatement costs, but it also increases the amount of GHG emissions abated in the short-term. It should therefore belong to all emission trading schemes under construction.
    Keywords: Banking; Climate Policy; Emission Trading; Flexibility
    JEL: C72 H23 Q25 Q28
    Date: 2008–01
  5. By: Dirk Heremans
    Date: 2008–03
  6. By: Adam B. Ashcraft; Til Schuermann
    Abstract: In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies monitor the performance of mortgage pools over time. Throughout the paper, we draw upon the example of a mortgage pool securitized by New Century Financial during 2006.
    Keywords: Subprime mortgage ; Investments - Government policy ; Investment banking ; Mortgage loans ; Mortgage-backed securities ; Predatory lending ; Credit ratings
    Date: 2008
  7. By: Dell'Ariccia, Giovanni; Igan, Deniz; Laeven, Luc
    Abstract: This paper studies the relationship between the recent boom and current delinquencies in the subprime mortgage market. Specifically, we analyze the extent to which this relationship can be explained by a decrease in lending standards that is unrelated to improvements in underlying economic fundamentals. We find evidence of a decrease in lending standards associated with substantial increases in the number of loan applications. We also find that the underlying market structure of the mortgage industry mattered, with larger declines in lending standards being associated with increases in the number of competing lenders. Finally, increased ability to securitize mortgages appears to have affected lender behaviour, with lending standards experiencing greater declines in areas with higher mortgage securitization rates. The results are consistent with theoretical predictions from recent financial accelerator models based on asymmetric information, and shed some light on the underlying causes and characteristics of the current crisis in the subprime mortgage market.
    Keywords: credit boom; financial accelerators; lending standards; moral hazard; mortgages; subprime loans
    JEL: E51 G21
    Date: 2008–02
  8. By: Anca Pruteanu-Podpiera; Laurent Weill; Franziska Schobert
    Abstract: Banking competition is expected to provide welfare gains by reducing monopoly rents and cost inefficiencies, favoring a reduction of loan rates and then investment. These expected gains are a major issue for transition countries, in which bank credit represents the largest source of external finance for companies. With the use of exhaustive quarterly data for Czech banks, this paper aims to provide evidence on the effects of banking competition in the Czech Republic. First, we measure the level and evolution of banking competition between 1994 and 2005. Competition is measured by the Lerner index on the loan market, using data on loan prices. The results do not show a clear-cut trend in the evolution of the Lerner index. Second, we investigate the relationship and causality between competition and efficiency. We perform a Granger-causality-type analysis. This supports the ‘banking specificities’ hypothesis, according to which heightened competition can lead to an increase in monitoring costs through a reduction in the length of the customer relationship and due to the presence of economies of scale in the banking sector, in this way reducing the cost efficiency of banks. Therefore, our results reject the intuitive ‘quiet life’ hypothesis and indicate a negative relationship between competition and efficiency in banking.
    Keywords: Banks, competition, efficiency, transition countries.
    JEL: G21 L12 P20
    Date: 2007–12
  9. By: Michiel van Leuvensteijn; Christoffer Kok Sørensen; Jacob A. Bikker; Adrian A.R.J.M. van Rixtel
    Abstract: This paper analyses the impact of loan market competition on the interest rates applied by euro area banks to loans and deposits during the 1994-2004 period, using a novel measure of competition called the Boone indicator. We find evidence that stronger competition implies significantly lower spreads between bank and market interest rates for most loan market products, in line with expectations. Using an error correction model (ECM) approach to measure the effect of competition on the pass-through of market rates to bank interest rates, we likewise find that banks tend to price their loans more in accordance with the market in countries where competitive pressures are stronger. Further, where loan market competition is stronger, we observe larger bank spreads (implying lower bank interest rates) on current account and time deposits. This would suggest that the competitive pressure is heavier in the loan market than in the deposit markets, so that banks under competition compensate for their reduction in loan market income by lowering their deposit rates. We observe also that bank interest rates in more competitive markets respond more strongly to changes in market interest rates. These findings have important monetary policy implications, as they suggest that measures to enhance competition in the European banking sector will tend to render the monetary policy transmission mechanism more effective.
    Keywords: Monetary transmission; banks; retail rates; competition; panel data
    JEL: D4 E50 G21 L10
    Date: 2008–04
  10. By: Jiri Podpiera; Laurent Weill
    Abstract: A large number of bank failures occurred in transition countries during the 1990s and at the beginning of the 2000s. These failures were related to increases in non-performing loans and deteriorated cost efficiency of banks. This paper addresses the question of the causality between non-performing loans and cost efficiency in order to examine whether either of these factors is the deep determinant of bank failures. We extend the Granger causality model developed by Berger and DeYoung (1997) by applying GMM dynamic panel estimators on a panel of Czech banks between 1994 and 2005. Our findings support the “bad management†hypothesis, according to which deteriorations in cost efficiency precede increases in non-performing loans, and reject the “bad luck†hypothesis, which predicts the reverse causality.
    Keywords: Bank failures, cost efficiency, non-performing loans, transition countries.
    JEL: G21 G28 D21 P20
    Date: 2007–12
  11. By: Stijn Claessens; Neeltje van Horen
    Abstract: Familiarity with working in a specific institutional environment compared to its competitors can provide a firm with a competitive advantage, making it invest in specific host countries. We examine whether this notion of institutional competitive advantage drives banks to seek out specific markets. Using detailed, bilateral data of bank ownership for a large number of countries over 1995-2006 and using a first-difference model, we find that institutional competitive advantage importantly drives banks' location decisions. Results are robust to different samples and model specifications, various econometric techniques and alternative measures of institutional quality. This finding has some policy implications, including on the increased cross-border banking among developing countries.
    Keywords: foreign direct investment; international banking; institutions
    JEL: D4 E50 G21 L10
    Date: 2008–04
  12. By: Marie Donnay; Hans Degryse
    Abstract: The pass-through from the money market rate to several bank lending rates and the government bond rate is investigated for 12 European countries over the period 1980-2000, by applying a SVAR based on the Cholesky decomposition. Simulations of a one percent point rise in the money market rate, performed for all countries, reveal divergences within and between countries in the dynamics of the lending rate pass-through. Subsequently, this pass-through is introduced in an enlarged SVAR model to account for the intermediation role of banks in the transission process of monetary policy to the real economy, for 7 European countries. The simulation results indicate a significant role for the banking sector. Moreover some asymmetries in the price of credit both within and across countries in Europe exist. The different effects on the real economy (private consumption and investment) depend on the magnitude of the lending rate pass-through.
    Keywords: Transmission of monetary policy, EMU, Bank intermediation, Lending rates, Pass-through, SVAR, Impulse response analysis
    JEL: E43 E44 E52 G21
    Date: 2008–03
  13. By: Juan-Paul Abraham
    Abstract: In its first part, the present essay focuses on one main thesis. The transition to full EMU and the introduction of the euro will have a more effect on European banking than the previous Single Market¨Project (Europe 1992). They deal directly with money, the basic material of banking, and they pave the way to more aggressive bank strategies. In conjunction with other factors, they not only induce "accomodating" reactions, mainly through cost-cutting, but also "autonomous restructurings" : less intermediation, more market activities and, most of all, external growth through M(ergers) and A(cquisitions). This significantly changes the structure and the policies of European banking. Recently important and controversial M and A have occurred in the Benelux area. In the second part of the essay, these developments are analysed in the just described framework. After a global overview two case studies are presented : ABN-AMRO, n° 1 in the Netherlands; the Generale Bank, n° 1 in Belgium. The main conclusion is that the rationale behind the recent M and A is not mere size, but also accelerated rationalisation and penetration in foreign domestic markets, which was previously hampered by defensive and ultimately self-defeating strategies of strengthening the mere national domestic base. However, at the present stage, the importance of institutional resistance, even in small neighbouring countries, should not be under-estimated. Hence, cross-border restructurings in European banking will only increase gradually.
    Keywords: EMU, euro, bankstrategies, Benelux financial systems.
    Date: 2008–03

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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