New Economics Papers
on Banking
Issue of 2008‒11‒04
ten papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. The Impact of Macroeconomic Factors on Risks in the Banking Sector: A Cross-Country Empirical Assessment By Olga Bohachova
  2. How does competition affect efficiency and soundness in banking? New empirical evidence. By Klaus Schaeck; Martin ?ihák
  3. An Examination of Entry and Competitive Performance in Rural Banking Markets By Robert M. Feinberg; Kara M. Reynolds
  4. Bank Competition and Collateral: Theory and Evidence By Christa Hainz; Laurent Weill; Christophe J. Godlewski
  5. Predatory mortgage lending By Philip Bond; David K. Musto; Bilge Yilmaz
  6. Firm Default and Aggregate Fluctuations By Jacobson, Tor; Kindell, Rikard; Lindé, Jesper; Roszbach, Kasper
  7. A New Structure for Regulated Bank Lending in a Cyclical Downturn By William Wild
  8. The Effects of Collateral on SME Performance in Japan By ONO Arito; SAKAI Koji; UESUGI Iichiro
  9. Where's the smoking gun? a study of underwriting standards for US subprime mortgages By Geetesh Bhardwaj; Rajdeep Sengupta
  10. Implied Market Loss Given Default: structural-model approach By Jakub Seidler

  1. By: Olga Bohachova
    Abstract: This paper explores the links between macroeconomic conditions and individual bank risk. Using capital adequacy ratios as a broad measure of risk sustainability, a linear mixed effects model for a large international panel of banks for the years 2001-2005 is estimated. In OECD countries, banks tend to hold higher capital ratios during business cycle highs, this effect being even stronger for a subsample of EU banks. In non-OECD countries, periods of higher economic growth are associated with lower capital ratios. This indicates procyclical behavior. Banks accumulate risks more rapidly in economically good times and some of these risks materialize as asset quality deteriorates during subsequent recessions. Furthermore, higher inflation rates are associated with higher capital ratios of banks, implying that inflation-induced economic uncertainty stimulates banks to restrict credit. As far as regulatory and institutional environment is concerned, econometric estimates show that banks in non-OECD countries with deposit insurance tend to be more risky, whereas evidence of a negative relationship between concentration of the banking sector and banks’ risk taking is statistically less robust.
    Keywords: international banking, macroeconomic conditions, banking risk
    JEL: F37 F41 G21
    Date: 2008–09
  2. By: Klaus Schaeck (Bangor Business School, Hen Goleg, College Road, Bangor, LL57 2DG, UK.); Martin ?ihák (International Monetary Fund, 700 19th Street N. W. Washington, D. C. 20431, USA.)
    Abstract: A growing body of literature indicates that competition increases bank soundness. Applying an industrial organization based approach to large data sets for European and U.S. banks, we offer new empirical evidence that efficiency plays a key role in the transmission from competition to soundness. We use a twopronged approach. First, we employ Granger causality tests to establish the link between competition and measures of profit efficiency in banking, and find that competition indeed increases bank efficiency. Second, building on these results, we examine the relation between the Boone indicator [Boone, J. (2001)Intensity of competition and the incentive to innovate. IJIO, Vol. 19, pp. 705-726], an innovative measure of competition that focuses on the impact of competition on performance of efficient banks, and relate this measure to bank soundness. We find evidence that competition robustly increases bank soundness, via the efficiency channel. JEL Classification: G21, G28, L11.
    Keywords: Bank competition, efficiency, soundness, market structure, regulation.
    Date: 2008–09
  3. By: Robert M. Feinberg; Kara M. Reynolds
    Abstract: This paper explores the change in the level of competition in rural banking markets since the deregulation that occurred following passage of the Riegle Neal Act of 1994. Using an empirical model that utilizes both the number of banks and the value of deposits in a cross-section of rural markets, we decompose the impact of the entry of new banks into resulting changes in per capita demand and the costs/profits of local banks in both 1994 and 2004. We conclude that the banking market is more competitive today despite the fact that the number of banks may have declined; on average fewer banks are now needed to make rural banking markets competitive than were needed in 1994.
    Keywords: Entry, Banking
    JEL: L11
    Date: 2008–05
  4. By: Christa Hainz (University of Munich); Laurent Weill (Laboratoire de Recherche en Gestion et Economie, Institut d'Etudes Politiques, Strasbourg); Christophe J. Godlewski (Laboratoire de Recherche en Gestion et Economie, Université Louis Paster)
    Abstract: We investigate the impact of bank competition on the use of collateral in loan contracts. We develop a theoretical model incorporating information asymmetries in a spatial competition framework where banks choose between screening the borrower and asking for collateral. We show that the presence of collateral is more likely when bank competition is low. We then test this prediction empirically on a sample of bank loans from 70 countries. We perform logit regressions of the presence of collateral on bank competition, measured by the Lerner index. Our empirical tests corroborate the theoretical predictions that bank competition reduces the presence of collateral. These findings survive several robustness checks.
    Keywords: Collateral, Bank Competition, Asymmetric information.
    JEL: G21 D43 D82
    Date: 2008
  5. By: Philip Bond; David K. Musto; Bilge Yilmaz
    Abstract: Regulators express growing concern over predatory loans, which we take to mean loans that borrowers should decline. Using a model of consumer credit in which such lending is possible, we identify the circumstances in which it arises both with and without competition. We find that predatory lending is associated with highly collateralized loans, inefficient refinancing of subprime loans, lending without due regard to ability to pay, prepayment penalties, balloon payments, and poorly informed borrowers. Under most circumstances competition among lenders attenuates predatory lending. We use our model to analyze the effects of legislative interventions.
    Keywords: Predatory lending
    Date: 2008
  6. By: Jacobson, Tor (Research Department, Central Bank of Sweden); Kindell, Rikard (Svenska Handelsbanken); Lindé, Jesper (Monetary Policy Department, Central Bank of Sweden); Roszbach, Kasper (Research Department, Central Bank of Sweden)
    Abstract: This paper studies the relation between macroeconomic fluctuations and corporate defaults while conditioning on industry affiliation and an extensive set of firm-specific factors. Using a logit approach on a panel data set for all incorporated Swedish businesses over 1990- 2002, we find strong evidence for a substantial and stable impact of aggregate fluctuations. Macroeffects differ across industries in an economically intuitive way. Out-of-sample evaluations show our approach is superior to both models that exclude macro information and best fitting naive forecasting models. While firm-specific factors are useful in ranking firms’ relative riskiness, macroeconomic factors capture fluctuations in the absolute risk level.
    Keywords: Default; default-risk model; business cycles; aggregate fluctuations; microdata; logit; firm-specific variables; macroeconomic variables
    JEL: C35 C41 C52 E44 G21 G33
    Date: 2008–09–01
  7. By: William Wild
    Abstract: This paper outlines a new structure for lending by regulated banks, under which the Tier 1 capital required to support a new loan is provided by the borrower’s own equity-holders. In a downturn cyclical environment this would secure a new, motivated and informed class of bank capital provider to counter the pro-cyclicality of bank lending. The new structure would be competitive in terms of cost to borrowers, nondilutive of existing bank capital and credit risk neutral. It also has the potential to be an effective instrument of market discipline in economic upcycles and regulators might consider adopting it as a pillar in any revised bank capital regime.
    Date: 2008–10–29
  8. By: ONO Arito; SAKAI Koji; UESUGI Iichiro
    Abstract: This paper examines how collateral and personal guarantees affect firms' ex-post performance employing the propensity score matching estimation approach. Based on a unique firm-level panel data set of more than 500 small and medium-sized borrower firms in Japan, we find the following: (1) the increase in profitability and reduction in riskiness of borrowers that provide collateral to lenders are more sizeable than of borrowers that do not; (2) On the other hand, the lending attitude and monitoring frequency of borrowers' main banks do not change significantly at the time of collateral being pledged; and (3) The increase in profitability of collateralized borrowers is driven by cost reductions rather than by sales growth. These findings are consistent with the hypothesis that by providing collateral, borrowers curb their own incentives for moral hazard in order to further enhance their creditworthiness.
    Date: 2008–10
  9. By: Geetesh Bhardwaj; Rajdeep Sengupta
    Abstract: The dominant explanation for the meltdown in the US subprime mortgage market is that lending standards dramatically weakened after 2004. Using loan-level data, we examine underwriting standards on the subprime mortgage originations from 1998 to 2007. Contrary to popular belief, we find no evidence of a dramatic weakening of lending standards within the subprime market. We show that while underwriting may have weakened along some dimensions, it certainly strengthened along others. Our results indicate that (average) observable risk characteristics on mortgages underwritten post-2004 would have resulted in a significantly lower ex post default if they were to be given a loan in 2001 or 2002. We show that while it is possible that underwriting standards in this market were poor to begin with, deterioration in underwriting post-2004 cannot be the explanation for collapse of subprime mortgage market.
    Keywords: Subprime mortgage
    Date: 2008
  10. By: Jakub Seidler (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper focuses on the key credit risk parameter–Loss Given Default (LGD). We describe its general properties and determinants with respect to seniority of debt, characteristics of debtors or macroeconomic conditions. Further, we illustrate how the LGD can be extracted from market observable information with help of the adjusted Mertonian structural approach. We present a derivation of the formula for expected LGD and show its sensitivity analysis with respect to other structural parameters of the company. Finally, we estimate the 5-year expected LGDs for companies listed on Prague Stock Exchange and find out, that the average LGD for this analyzed sample is around 20%. To the author’s best knowledge, those are the first implied market estimates of LGD in the Czech Republic.
    Keywords: loss given default, credit risk, structural models
    JEL: C02 G13 G33
    Date: 2008–10

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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