New Economics Papers
on Banking
Issue of 2008‒07‒30
thirteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Credit risk models: why they failed in the credit crisis By Wilson Sy
  2. Innovations in credit risk transfer: implications for financial stability By Darrell Duffie
  3. Credit risk and business cycle over different regimes By Juri Marcucci; Mario Quagliariello
  4. How Bankruptcy Punishment Influences the Ex-Ante Design of Debt Contracts? By Régis Blazy; Gisèle Umbhauer; Laurent Weill
  5. Exploring the Nexus between Banking Sector Reform and Performance: Evidence from Newly Acceded EU Countries By Sophocles N. Brissimis; Manthos D. Delis; Nikolaos I. Papanikolaou
  6. The Foreign Exchange Exposure of Chinese Banks By Eric Wong; Jim Wong; Phyllis Leung
  7. The Banking Sector and the Great Depression in Bulgaria, 1924 - 1938: Interlocking and Financial Sector Profitability By Kiril Danailov Kossev
  8. Environmental Factors Affecting Hong Kong Banking: A Post-Asian Financial Crisis Efficiency Analysis By Karligash Kenjegalieva; Maximilian J. B. Hall; Richard Simper
  9. Technical efficiency of the banks of the CEMAC By KAMGNA, Severin Yves; DIMOU, Leonnel
  10. Determinants of European banks‘ engagement in loan securitization By Bannier, Christina E.; Hänsel, Dennis N.
  11. Conditional Loss Estimation Using a South African Global Error Correcting Macroeconometric Model By Albert H. De Wet; Renee Van Eyden; Rangan Gupta
  12. Legacy Effects in Radical Innovation: A Study of European Internet Banking By Erik H. Schlie; Jaideep C. Prabhu; Rajesh K. Chandy
  13. Banking Transformation (1989 - 2006) in Central and Eastern Europe - With Special Reference to Balkans By Stephan Barisitz

  1. By: Wilson Sy (Australian Prudential Regulation Authority)
    Abstract: Abstract: Credit risk models are shown to play a key part in the global credit crisis. We discuss how the credit market has exposed the shortcomings of the credit risk models and we identify their main shortcomings. To overcome the shortcomings, a new causal framework is proposed to build deductive credit default models which have predictive capabilities.
    Date: 2008–07–10
  2. By: Darrell Duffie
    Abstract: Banks and other lenders often transfer credit risk to liberate capital for further loan intermediation. This paper aims to explore the design, prevalence and effectiveness of credit risk transfer (CRT). The focus is on the costs and benefits for the efficiency and stability of the financial system. After an overview of recent credit risk transfer activity, the following points are discussed: motivations for CRT by banks; risk retention; theories of CDO design; specialty finance companies. As an illustration of CLO design, an example is provided showing how the credit quality of the borrowers can deteriorate if efforts to control their default risks are costly for issuers. An appendix is provided on CDS index tranches.
    Keywords: credit derivatives, credit risk transfer, financial innovations, financial stability
    Date: 2008–07
  3. By: Juri Marcucci (Bank of Italy, Economic Research Department); Mario Quagliariello (Bank of Italy, Banking and Financial Supervision)
    Abstract: In the recent banking literature on the relationship between credit risk and the business cycle, the presence of asymmetric effects both across credit risk regimes and through the business cycle has been generally neglected. Employing threshold regression models both at the aggregate and the bank level and exploiting a unique dataset on Italian bank borrowersÂ’ default rates, this paper analyzes whether this relationship is characterized by regime switches and thus by asymmetries, determining the thresholds endogenously. Our results show that not only are the effects of the business cycle on credit risk more pronounced during downturns but also when credit risk conditions are poor.
    Keywords: Credit Risk, Panel Threshold Regression Models, Regime Switching, Default Rate, Business Cycle, Cyclicality, Basel 2
    JEL: C22 C23 G21 G28
    Date: 2008–06
  4. By: Régis Blazy (CREFI-LSF, University of Luxembourg); Gisèle Umbhauer; Laurent Weill
    Abstract: This research investigates how the legal sanctions prevailing under bankruptcy code impact on the design of debt contacts. Unlike most papers considering a passive behavior of the bank in case of default of the borrower, we assume the bank actively trades off between private renegotiation and costly bankruptcy procedure. Besides, the debtor’s investment policy – with a risk of asset substitution – and the creditor’s financial policy – endogenous interest rate – are explicitly modeled. The model focuses on three possible equilibriums. The first one encompasses situations where the firms stay with the best investment project (economic efficiency) and bankruptcy costs are avoided through private renegotiation (legal efficiency): this equilibrium requires a condition on bankruptcy costs and is independent of legal sanctions. A second equilibrium cover situations where the firms turn to the less profitable and riskiest project (economic inefficiency) and the default is still privately solved (legal efficiency): to avoid suboptimal investment, a minimal level of legal sanctions, whose threshold value depends on the interest rate, must apply. Last, we consider mixed strategies on the investment policy (partial economic efficiency): when financial distress occurs, two bargaining equilibriums prevail – pooling or separating – so costly bankruptcy may apply (legal inefficiency). Simulated results illustrate how the bank finally chooses between these equilibriums while the legal environment becomes more severe. First, as expected, when sanctions are getting higher, the probability of choosing the best project increases: simulations provide minimal levels of sanctions which guarantee the occurrence of the best equilibrium. As a result, extreme severity is not needed to ensure both economic and legal efficiency. Second, an increase of legal sanctions is likely to reduce the contractual interest rate, as the bank is more protected by the law, and cannot charge a risk premium anymore. A noteworthy consequence is that the debtor benefits in some extent of increased severity, as he is inclined to invest in the most profitable projects and, consequently, pays a lower interest rate. Third, a slight change of the legal environment may involve a drastic adjustment of financial variables, so that small changes in the law may involve financial instability.
    Keywords: Bankruptcy, Credit Lending, Interest Rate, Moral Hazard, Legal Sanctions
    JEL: G33 D82 D21
    Date: 2008
  5. By: Sophocles N. Brissimis (Bank of Greece and University of Piraeus); Manthos D. Delis (Athens University of Economics and Business); Nikolaos I. Papanikolaou (Athens University of Economics and Business)
    Abstract: The aim of this study is to examine the relationship between banking sector reform and bank performance – measured in terms of efficiency, total factor productivity growth and net interest margin – accounting for the effects through competition and bank risk-taking. To this end, we develop an empirical model of bank performance and draw on recent econometric advances to consistently estimate it. The model is applied to bank panel data from ten newly acceded EU countries. The results indicate that both banking sector reform and competition exert a positive impact on bank efficiency, while the effect of reform on total factor productivity growth is significant only toward the end of the reform process. Finally, the effect of capital and credit risk on bank performance is in most cases negative, while it seems that higher liquid assets reduce the efficiency and productivity of banks.
    Keywords: Bank performance; Banking sector reform; Competition; Risk-taking
    JEL: G21 L1 C14
    Date: 2008–06
  6. By: Eric Wong (Research Department, Hong Kong Monetary Authority); Jim Wong (Research Department, Hong Kong Monetary Authority); Phyllis Leung (Research Department, Hong Kong Monetary Authority)
    Abstract: Using the Capital Market Approach and equity-price data of 14 listed Chinese banks, this empirical study finds that there is a positive relationship between bank size and foreign-exchange exposure, which may reflect larger foreign-exchange operations and trading positions of larger Chinese banks, and their significant indirect foreign-exchange exposure arising from impacts of the renminbi exchange-rate movements on their customers. Empirical evidence also suggests that the average foreign-exchange exposures of state-owned and joint-stock commercial banks in China are higher than those of banks in Hong Kong, notwithstanding that their participation in international banking businesses is still limited compared with their Hong Kong counterparts. It is also found that negative foreign-exchange exposure is prevalent for larger Chinese banks, suggesting that an appreciation of the renminbi tends to reduce their equity values, and is therefore likely to hamper the banking sector¡¦s performance. Together with the fact that decreases in equity values generally imply higher default risk, how Chinese banks would be affected under different scenarios of renminbi appreciation should be closely monitored.
    Keywords: Foreign exchange exposure, banking, China
    JEL: E58 F31 G21 G28
    Date: 2008–06
  7. By: Kiril Danailov Kossev (Oxford University)
    Abstract: The economic narratives of Southeast Europe during the first part of the 20th century are currently being re-written. A story of failed industrialisation and delayed modernisation during the Interwar period has dominated since the pioneering work of Gerschenkron, but not enough aggregate data are available to see this as the only interpretation. In particular, virtually nothing is known about the financial system. This paper has two aims. First, it looks at the banking sector in Bulgaria in 1924- 1938. We provide new data for the 1920s rise and the 1930s decline of the Bulgarian banking sector and we evaluate its potential contribution to Bulgarian economic growth. In the second part, we discuss different explanations for the widespread collapse of commercial banks after the onset of the Great Depression. Relying on a new data set for over 100 Bulgarian commercial banks, we show that traditional explanations for the collapse of European commercial banks in the 1930s (based on the default of risky loans and falling asset prices due to deflation) need to be complemented by the pernicious effects of widespread insider lending in the Bulgarian case. We conclude that insider lending was the single most important factor behind the demise of the private banking system after the onset of the Depression.
    Keywords: Bulgarian economic development; Banking and finance; Great Depression; Insider lending
    JEL: E44 G21 G14 N24
    Date: 2008–06
  8. By: Karligash Kenjegalieva (Dept of Economics, Loughborough University); Maximilian J. B. Hall (Dept of Economics, Loughborough University); Richard Simper (Dept of Economics, Loughborough University)
    Abstract: Within the banking efficiency analysis literature there is a dearth of studies which have considered how banks have ‘survived’ the Asian financial crisis of the late 1990s. Considering the profound changes that have occurred in the region’s financial systems since then, such an analysis is both timely and warranted. This paper examines the evolution of Hong Kong’s banking industry’s efficiency and its macroeconomic determinants through the prism of two alternative approaches to banking production based on the intermediation and services-producing goals of bank management over the post-crisis period. Within this research strategy we employ Tone’s (2001) Slacks-Based Model (SBM) combining it with recent bootstrapping techniques, namely the non-parametric truncated regression analysis suggested by Simar and Wilson (2007) and Simar and Zelenyuk’s (2007) group-wise heterogeneous sub-sampling approach. We find that there was a significant negative effect on Hong Kong bank efficiency in 2001, which we ascribe to the fallout from the terrorist attacks in America in 9/11 and to the completion of deposit rate deregulation that year. However, post 2001 most banks have reported a steady increase in efficiency leading to a better ‘intermediation’ and ‘production’ of activities than in the base year of 2000, with the SARS epidemic having surprisingly little effect in 2003. It was also interesting to find that the smaller banks were more efficient than the larger banks, but the latter were also able to enjoy economies of scale. This size factor was linked to the exportability of financial services. Other environmental factors found to be significantly impacting on bank efficiency were private consumption and housing rent.
    Keywords: Finance and Banking; Productivity; Efficiency.
    JEL: C23 C52 G21
    Date: 2008–06
  9. By: KAMGNA, Severin Yves; DIMOU, Leonnel
    Abstract: In one decade, the CEMAC's countries passed from a banking crisis context to an excess systemic liquidity. In the present survey, we valued the relative levels of technical efficiency of 24 commercial banks of the CEMAC from January 2001 to December 2004 using the DEA method, and searched for the factors of the banking management susceptible to explain these evolutions. The results shows that, on average, under the hypothesis of constant scale outputs, the banks of the CEMAC only produced 36,9% of the quantity of outputs that they could have produced from their resources. While rather supposing the outputs variable, the middle level of technical efficiency settled to 0,693. Of other parts, The explanatory factors of the evolution of the technical efficiency of the banks during this period are: i) the risk of defect; ii) the importance of the Bank, identified by the proportion of the capital stocks on the assets of the banks, iii) the level of the treasury excesses, and iv) the proportion of capital stock in the total of the credits.
    Keywords: Efficacité technique; méthode DEA; rendement d’échelle; banques; CEMAC
    JEL: C69 G29 G32 G21
    Date: 2008–06–20
  10. By: Bannier, Christina E.; Hänsel, Dennis N.
    Abstract: We analyze collateralized loan obligation (CLO) transactions by European banks (1997 - 2004), trying to identify firm-specific and macroeconomic factors influencing an institution’s securitization decision. CLO issuance seems to be an appropriate funding tool for large banks with high risk and low liquidity. However, risk transfer turns out to be limited in the extremes. Controlling for fixed effects, we find that fixed costs of securitization are surmountable also for smaller institutions. Interestingly, commercial banks seem to use loan securitization to access capital-market based businesses and the associated fee income. Regulatory capital arbitrage does not appear to have driven the market. Trotz des rasanten Wachstums des Marktes für Kreditrisikotransfer sind die Motive der Banken für die Verbriefung von Kreditportfolios noch nicht vollständig geklärt. Kreditverbriefungen führen zwar zu höherer Liquidität, einer Reduktion von Kredit- und Zinsrisiken, einer Steigerung von Provisionseinkommen, möglicherweise auch einer Verbesserung der Kapitalstruktur, jedoch entscheiden sich einige Banken trotzdem gegen eine Strukturierung und Weiterreichung ihrer Kreditportfolios. Unter den Nachteilen der Verbriefung werden unter anderem die relativ hohen fixen Kosten der erstmaligen Errichtung einer Verbriefungsstruktur sowie eventuelle Steuernachteile von nicht auf der Bilanz gehaltenen Krediten genannt. Weiterhin ermöglicht das neue Basel-II Regelwerk keine „Arbitrage regulatorischen Eigenkapitals“ via Kreditverbriefung mehr, anders als die weniger risikosensitive Eigenkapitalunterlegung unter den alten Basel-Richtlinien. Unsere Studie analysiert „Collateralized Loan Obligation“ (CLO) Transaktionen von Europäischen Banken in den Jahren 1997-2004. Ziel ist es, Faktoren zu isolieren, die die Entscheidung einer Bank, Kredite zu verbriefen, beeinflusst haben. Während wir einen Einfluss regulatorischer Arbitrage nicht vollkommen ausschließen können, zeigt unsere Studie, dass die wesentlichen Bestimmungsfaktoren vielmehr individuelle Faktoren der Banken sind. So ist die Wahrscheinlichkeit, dass eine Bank Kredite verbrieft, umso höher, je größer die Bank, je geringer ihre Liquidität und je höher ihr erwartetes Kreditrisiko ist. Kreditverbriefungen werden offensichtlich als Möglichkeit des Kreditrisikotransfers genutzt. Allerdings zeigt sich, dass Banken mit dem höchsten Kreditrisiko ihre Verbriefungsaktivitäten mit zunehmendem Risiko einstellen, so dass die Risikotransferfunktion nur begrenzt zu nutzen zu sein scheint. Für am Aktienmarkt notierte Banken treffen obige Aussagen noch stärker zu. Interessanterweise zeigt sich hier sogar ein „negativer“ regulatorischer Arbitrageeffekt : Banken mit niedrigem regulatorischem Eigenkapital verbriefen weniger Kredite als Banken mit höherem Eigenkapital. Die neuen Eigenkapitalrichtlinien nach Basel II sollten daher das zukünftige Wachstum des Kreditrisikotransfermarktes nicht beeinträchtigen. Bemerkenswerterweise scheint auch die Bankengröße eine weniger wichtige Rolle zu spielen als zunächst gedacht. Auch kleinere Banken sind somit in der Lage, die mit einer Kreditverbriefung verbundenen Fixkosten zu tragen. Es ist zu vermuten, dass gerade traditionelle Kreditbanken die Verbriefung von Kreditportfolios unter anderem auch nutzen, um indirekt dem „investment-banking“ verwandte Geschäftsbereiche und die entsprechenden Provisionseinkommen zu erschließen.
    Keywords: Securitization, credit risk transfer, collateralized loan obligations
    JEL: G21
    Date: 2008
  11. By: Albert H. De Wet (FirstRand Bank, South Africa); Renee Van Eyden (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: Active credit portfolio management is becoming a central part of capital and credit management within the banking industry. Stimulated by the Basel II capital accord the estimation of risk sensitive credit and capital management is central to success in an increasingly competitive environment. If any risk mitigation or value-enhancing activity is to be pursued, a credit portfolio manager must be able to identify the interdependencies between exposures in a portfolio, but more importantly, be able to relate credit risk to tangible portfolio effects on which specific actionable items can be taken. This analysis draws on the macroeconometric vector error correcting model (VECM) developed by De Wet and Van Eyden (2007) and applies the proposed methodology of PSTW (2006) to a fictitious portfolio of corporate bank loans within the South African economy. It illustrates that it is not only possible to link macroeconomic factors to a South African specific credit portfolio, but that scenario and sensitivity analysis can also be performed within the credit portfolio model. These results can be used in credit portfolio management or standalone credit risk analytics which is ideal for practical credit portfolio management applications.
    Keywords: Credit portfolio modelling, macroeconometric correlation model, economic capital, scenario analysis, default threshold
    JEL: G32 E17
    Date: 2008–07
  12. By: Erik H. Schlie (ESMT European School of Management and Technology); Jaideep C. Prabhu (Tanaka Business School, Imperial College London); Rajesh K. Chandy (Carlson School of Management, University of Minnesota)
    Abstract: How do firms cope with the challenges of disruptive change in their industry? Numerous studies have highlighted that success with any prior technology creates a negative legacy effect for the next radical technological shift. We question the overly pessimistic view of such legacy effects and ask how quickly firms embrace technological breakthroughs by radically innovating and who wins in the longer term? In this paper, we argue that legacy is a multi-faceted construct whose diverse aspects could simultaneously have different effects on innovation speed and market performance. We identify three main types of legacy related to technology, organizational, and country-level influences. Previous research tends to focus on technological or market effects in isolation, whereas we seek to study the effects of both firm and country legacy simultaneously on speed to radical innovation and market performance over time. Based on a conceptual framework we develop six hypotheses concerning the legacy effects on initial speed radical innovation and subsequent market performance. We chose the European retail banking industry and the focal innovation of transactional Internet banking as a suitable empirical context to employ quantitative hypothesis testing. Detailed and longitudinal (1996-2001) data were collected for a sample of 123 banks from six European countries: United Kingdom, Germany, France, Sweden, Finland, and Denmark. We specified a model and used threestage least squares (3SLS) as a method to estimate simultaneous regression equations due to endogeneity of a key variable. We show that the prevailing negative view of legacies is likely to be overstated.
    Keywords: innovation, legacy, internet banking, europe
    JEL: M31
    Date: 2008–06–12
  13. By: Stephan Barisitz (Oesterreichische Nationalbank)
    Abstract: This paper provides an overview of the history of banking transition (1989-2006) in 13 CEE countries – with particular emphasis on four relatively large Balkan countries (Bulgaria, Croatia, Romania, Serbia and Montenegro). Two “banking reform waves” are distinguished, salient features of which all countries (need to) run through in order to mature. The first reform wave focuses on liberalization measures; the second wave mostly consists of restructuring/institutional adjustment. Western European FDI has come to dominate banking in most countries, including those of the Balkans. Recently, credit booms have unfolded, which, while constituting structural catchingup phenomena, are not without risks. Insufficient rule of law remains widespread.
    Keywords: Banking crisis; Banking transformation; Credit boom; FDI; Institutional reforms; Liberalization; Privatization; Structural reforms
    JEL: G21 G28 P34
    Date: 2008–06

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