New Economics Papers
on Banking
Issue of 2009‒10‒31
fifteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. The determinants of bank capital structure. By Reint Gropp; Florian Heider
  2. Accounting Discretion of Banks During a Financial Crisis By Luc Laeven; Harry Huizinga
  3. Banking: a mechanism design approach By Fabrizio Mattesini; Cyril Monnet; Randall Wright
  4. Bank regulation, capital and credit supply: Measuring the Impact of Prudential Standards By William Francis; Matthew Osborne
  5. Evidence of Regulatory Arbitrage in Cross-Border Mergers of Banks in the EU By Santiago Carbo-Valverde; Edward J. Kane; Francisco Rodriguez-Fernandez
  6. Are U.S. banks too large? By David C. Wheelock; Paul Wilson
  7. Australian Bank and Corporate Sector Vulnerabilities--An International Perspective By Patrizia Tumbarello; Elöd Takáts
  8. New Zealand Bank Vulnerabilities in International Perspective By Ray Brooks; Rodrigo Cubero
  9. The Effect of Mergers and Acquisitions on Bank Performance in Egypt By Ahmed Mohamed Badreldin; Christian Kalhoefer
  10. Efficiency of commercial banks in Bulgaria in the wake of EU accession By Kiril Tochkov; Nikolay Nenovsky
  11. BANKS RISK RACE: A SIGNALING EXPLANATION By Damien Besancenot; Radu Vranceanu
  12. Oil Prices and Bank Profitability: Evidence from Major Oil-Exporting Countries in the Middle East and North Africa By Heiko Hesse; Tigran Poghosyan
  13. Market Structure, Welfare, and Banking Reform in China By Hoy, Chun-Yu
  14. Perverse incentives at the banks? Evidence from a natural experiment By Sumit Agarwal; Faye H. Wang
  15. Banks, Financial Markets and International Consumption Risk Sharing By Markus Leibrecht; Johann Scharler

  1. By: Reint Gropp (European Business School, Wiesbaden and Centre for European Economic Research (ZEW) Mannheim, Germany.); Florian Heider (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper shows that mispriced deposit insurance and capital regulation were of second order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms’ leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks’ liability structure away from deposits towards non-deposit liabilities. We find that unobserved timeinvariant bank fixed effects are ultimately the most important determinant of banks’ capital structures and that banks’ leverage converges to bank specific, time invariant targets. JEL Classification: G32, G21.
    Keywords: bank capital, capital regulation, capital structure, leverage.
    Date: 2009–09
  2. By: Luc Laeven; Harry Huizinga
    Abstract: This paper shows that banks use accounting discretion to overstate the value of distressed assets. Banks' balance sheets overvalue real estate-related assets compared to the market value of these assets, especially during the U.S. mortgage crisis. Share prices of banks with large exposure to mortgage-backed securities also react favorably to recent changes in accounting rules that relax fair-value accounting, and these banks provision less for bad loans. Furthermore, distressed banks use discretion in the classification of mortgage-backed securities to inflate their books. Our results indicate that banks' balance sheets offer a distorted view of the financial health of the banks.
    Keywords: Accounting , Asset management , Asset prices , Bank accounting , Bank regulations , Banks , Financial crisis , Housing prices , Investment , Liquidity management , Real estate prices ,
    Date: 2009–09–28
  3. By: Fabrizio Mattesini; Cyril Monnet; Randall Wright
    Abstract: The authors study banking using the tools of mechanism design, without a priori assumptions about what banks are, who they are, or what they do. Given preferences, technologies, and certain frictions - including limited commitment and imperfect monitoring - they describe the set of incentive feasible allocations and interpret the outcomes in terms of institutions that resemble banks. The bankers in the authors' model endogenously accept deposits, and their liabilities help others in making payments. This activity is essential: if it were ruled out the set of feasible allocations would be inferior. The authors discuss how many and which agents play the role of bankers. For example, they show agents who are more connected to the market are better suited for this role since they have more to lose by reneging on obligations. The authors discuss some banking history and compare it with the predictions of their theory.
    Keywords: Banks and banking
    Date: 2009
  4. By: William Francis (Financial Services Authority); Matthew Osborne (Financial Services Authority)
    Abstract: The existence of a “bank capital channel”, where shocks to a bank’s capital affect the level and composition of its assets, implies that changes in bank capital regulation have implications for macroeconomic outcomes, since profit-maximising banks may respond by altering credit supply or making other changes to their asset mix. The existence of such a channel requires (i) that banks do not have excess capital with which to insulate credit supply from regulatory changes, (ii) raising capital is costly for banks, and (iii) firms and consumers in the economy are to some extent dependent on banks for credit. This study investigates evidence on the existence of a bank capital channel in the UK lending market. We estimate a long-run internal target risk-weighted capital ratio for each bank in the UK which is found to be a function of the capital requirements set for individual banks by the FSA and the Bank of England as the previous supervisor (Although within the FSA’s regulatory capital framework the FSA’s view of the capital that an individual bank should hold is given to the firm through individual capital guidance, for reasons of simplicity/consistency this paper refers throughout to “capital requirements”). We further find that in the period 1996-2007, banks with surpluses (deficits) of capital relative to this target tend to have higher (lower) growth in credit and other on- and off-balance sheet asset measures, and lower (higher) growth in regulatory capital and tier 1 capital. These findings have important implications for the assessment of changes to the design and calibration of capital requirements, since while tighter standards may produce significant benefits such as greater financial stability and a lower probability of crisis events, our results suggest that they may also have costs in terms of reduced loan supply. We find that a single percentage point increase in 2002 would have reduced lending by 1.2% and total risk weighted assets by 2.4% after four years. We also simulate the impact of a countercyclical capital requirement imposing three one-point rises in capital requirements in 1997, 2001 and 2003. By the end of 2007, these might have reduced the stock of lending by 5.2% and total risk-weighted assets by 10.2%.
    Keywords: bank, capital, financial regulation, prudential policy, credit, lending
    Date: 2009–09
  5. By: Santiago Carbo-Valverde; Edward J. Kane; Francisco Rodriguez-Fernandez
    Abstract: Banks are in the business of taking calculated risks. Expanding the geographic footprint of an organization’s profit-making activities changes the geographic pattern of its exposure to loss in ways that are hard for regulators and supervisors to observe. This paper tests and confirms the hypothesis that differences in the character of safety-net benefits that are available to banks in individual EU countries help to explain the nature of cross-border merger activity. If they wish to protect taxpayers from potentially destabilizing regulatory arbitrage, central bankers need to develop statistical procedures for assessing supervisory strength and weakness in partner countries. We believe that the methods and models used here can help in this task.
    JEL: F3 G2 K2
    Date: 2009–10
  6. By: David C. Wheelock; Paul Wilson
    Abstract: The substantial consolidation of the U.S. banking industry since the mid-1980s has brought a large increase in average (and median) bank size, which along with concerns about banks that are "too-big-to-fail," has led many analysts to wonder whether banks are "too large." This paper presents new estimates of ray-scale and expansion-path scale economies for U.S. banks based on nonparametric, local linear estimation of a model of bank costs. We employ a dimension-reduction technique to reduce estimation error, and bootstrap methods for inference. Our estimates indicate that as recently as 2006, most U.S. banks faced increasing returns to scale, suggesting that industry consolidation and increasing scale are likely to continue unless checked by government intervention.
    Keywords: Banks and banking ; Economies of scale ; Bank failures
    Date: 2009
  7. By: Patrizia Tumbarello; Elöd Takáts
    Abstract: This paper focuses on how the exposure to the corporate sector may impact the health of the Australian banking system. It also compares Australian banks with their international peers. Finally, it investigates banks' exposure to credit risk using the new Basel II Pillar 3 disclosure data. The analysis shows that Australian banks have remained very sound by international standards, despite the global financial turmoil. While the international downturn points to several vulnerabilities, the risks from the corporate and household sectors appear to be manageable.
    Keywords: Australia , Banking sector , Banks , Corporate sector , Credit risk , Cross country analysis , Financial assets , Financial soundness indicators , Loans , Private sector , Risk management ,
    Date: 2009–10–14
  8. By: Ray Brooks; Rodrigo Cubero
    Abstract: The global financial crisis is creating stress on banking systems across the world through funding and asset quality shocks. This paper combines different stress scenarios, as well as cross-country analysis, to assess New Zealand bank vulnerabilities to the global crisis and the domestic recession. It finds that a sharp worsening of asset quality would be required to reduce bank capital below the regulatory minimum. On the funding side, a disruption to banks' offshore funding may put pressure on the exchange rate, but would not trigger a systemic liquidity problem.
    Keywords: Banking sector , Banks , Corporate sector , Credit risk , Cross country analysis , Financial assets , Financial crisis , Financial soundness indicators , Household credit , Housing prices , New Zealand , Private sector , Risk management ,
    Date: 2009–10–14
  9. By: Ahmed Mohamed Badreldin (Faculty of Management Technology, The German University in Cairo); Christian Kalhoefer (Faculty of Business Administration, British University in Egypt)
    Abstract: Recent economic reforms in Egypt have significantly improved its macroeconomic indicators and financial sector. Banks have witnessed significant merger and acquisition activity as a result of these reforms in attempts to privatize and strengthen the banking sector. This study measures the performance of Egyptian banks that have undergone mergers or acquisitions during the period 2002-2007. This is done by calculating their return on equity using the Basic ROE Scheme in order to determine the degree of success of banking reforms in strengthening and consolidating the Egyptian banking sector. Our findings indicate that not all banks that have undergone deals of mergers or acquisitions have shown significant improvements in performance and return on equity when compared to their performance before the deals. Furthermore, extensive analysis was performed yielding the same results. It was concluded that mergers and acquisitions have not had a clear effect on the profitability of banks in the Egyptian banking sector. They were only found to have minor positive effects on the credit risk position. These findings do not support the current process of financial consolidation and banking reforms observed in Egypt, and provide weak evidence to support their constructive role in improved bank profitability and economic restructure.
    Keywords: Mergers and Acquisitions, Egypt, Banks, ROE, Performance Measurement, Reforms, ROA
    JEL: G21 G34
    Date: 2009–10
  10. By: Kiril Tochkov; Nikolay Nenovsky
    Abstract: The paper examines the efficiency of Bulgarian banks and its determinants over the period 1999- 2007. The levels of technical, allocative, and cost efficiency are first estimated using a nonparametric methodology and then regressed upon a number of bank-specific, institutional, and EU-related factors. The findings indicate that foreign banks were more efficient than domestic private banks, although the gap between them narrowed over time. State-owned banks ranked last on average but their privatization resulted in efficiency gains. Capitalization, liquid ity, and enterprise restructuring enhanced bank efficiency, while banking reforms had an adverse effect. The Treaty of Accession and EU membership were associated with significant efficiency improvements.
    Keywords: Transition economies; Banking sector; Efficiency; EU accession
    JEL: C14 G21 P20
    Date: 2009–10
  11. By: Damien Besancenot (CEPN - Centre d'économie de l'Université de Paris Nord - CNRS : UMR7115 - Université Paris-Nord - Paris XIII); Radu Vranceanu (Department of Economics - ESSEC)
    Abstract: Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 …nancial turmoil. But what could have pushed banks to engage in such a risk race? The answer brought by this paper builds on the classical signaling model by Spence. If banks' returns can be observed while risk cannot, less efficient banks can hide their type by taking more risks and paying the same returns as the efficient banks. The latter can signal themselves by taking even higher risks and delivering bigger returns. The game presents several equilibria that are all characterized by excessive risk taking as compared to the perfect information case.
    Keywords: Banking sector, Risk strategy, Risk/return tradeoff, Signaling, Imperfect information.
    Date: 2009–10–14
  12. By: Heiko Hesse; Tigran Poghosyan
    Abstract: This paper analyzes the relationship between oil price shocks and bank profitability. Using data on 145 banks in 11 oil-exporting MENA countries for 1994-2008, we test hypotheses of direct and indirect effects of oil price shocks on bank profitability. Our results indicate that oil price shocks have indirect effect on bank profitability, channeled through country-specific macroeconomic and institutional variables, while the direct effect is insignificant. Investment banks appear to be the most affected ones compared to Islamic and commercial banks. Our findings highlight systemic implications of oil price shocks on bank performance and underscore their importance for macroprudential regulation purposes in MENA countries.
    Keywords: Banks , Commodity price fluctuations , External shocks , Middle East , North Africa , Oil exporting countries , Oil exports , Oil prices , Oil sector , Profit margins , Profits ,
    Date: 2009–10–09
  13. By: Hoy, Chun-Yu (BOFIT)
    Abstract: This paper examines the effects of market deregulation on consumers and state commercial banks in China, a large developing country. I jointly estimate a system of differentiated product demand and pricing equations under alternative market structures. While China's banking reforms overall have achieved mixed results, the consumer surplus of the deposit market has increased. The welfare effects from reforms are unevenly distributed, with losses skewed toward inland provinces and certain consumer groups. There is no clear evidence that the pricing of banking services has become more competitive after the reform, and such pricing remains subject to government intervention. Encouragingly, the price-cost margins of some state commercial banks have fallen over time.
    Keywords: banking reform; banks in China; demand estimation; market structure
    JEL: G21 L11
    Date: 2009–10–21
  14. By: Sumit Agarwal; Faye H. Wang
    Abstract: Incentive provision is a central question in modern economic theory. During the run up to the financial crisis, many banks attempted to encourage loan underwriting by giving out incentive packages to loan officers. Using a unique data set on small business loan officer compensation from a major commercial bank, we test the model’s predictions that incentive compensation increases loan origination, but may induce the loan officers to book more risky loans. We find that the incentive package amounts to a 47% increase in loan approval rate, and a 24% increase in default rate. Overall, we find that the bank loses money by switching to incentive pay. We further test the effects of incentive pay on other loan characteristics using a multivariate difference-in-difference analysis.
    Date: 2009
  15. By: Markus Leibrecht; Johann Scharler
    Abstract: In this paper we empirically explore how characteristics of the domestic financial system influence the international allocation of consumption risk using a sample of OECD countries. Our results show that the extent of risk sharing achieved does not depend on the overall development of the domestic financial system per se. Rather, it depends on how the financial system is organized. Specifically, we find that coun- tries characterized by developed financial markets are less exposed to idiosyncratic risk, whereas the development of the banking sector contributes little to the inter- national diversification of consumption risk.
    Keywords: International Risk Sharing, Financial Development, Financial System
    JEL: F36 F41
    Date: 2009–10

This issue is ©2009 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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