New Economics Papers
on Banking
Issue of 2009‒11‒14
fifteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Credit Risk Transfer and Bank Competition By Hendrik Hakenes; Isabel Schnabel
  2. Why Did Some Banks Perform Better during the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation By Beltratti, Andrea; Stulz, Rene M.
  3. The effect of board size and composition on bank efficiency By Agoraki, Maria-Eleni; Delis, Manthos D; Staikouras, Panagiotis
  4. Bank CEO Incentives and the Credit Crisis By Fahlenbach, Rudiger; Stulz, Rene M.
  5. Banks’ risk race: a signaling explanation By Besancenot, Damien; Vranceanu, Radu
  6. The Role of the Securitization Process in the Expansion of Subprime Credit By Nadauld, Taylor D.; Sherlund, Shane M.
  7. Risk, Leverage, and Regulation of Financial Intermediaries By Tianxi Wang
  8. Bank Capital Buffer and Risk Adjustment Decisions By Jokipii, Terhi; Milne, Alistair
  9. Interaction between market and credit risk: Focus on the endogeneity of aggregate risk By Sokolov, Yuri
  10. A Tale of Two Policies: Prudential Regulation and Monetary Policy with Fragile Banks By Ignazio Angeloni; Ester Faia
  11. The Bonus-Driven “Rainmaker” Financial Firm: How These Firms Enrich Top Employees, Destroy Shareholder Value and Create Systemic Financial Instability By James Crotty
  12. Quantifying and explaining parameter heterogeneity in the capital regulation-bank risk nexus By Delis, Manthos D; Tran , Kien; Tsionas, Efthymios
  13. Investigating the Determinants of Banking Coexceedances in Europe in the Summer of 2008 By Brian Lucey* School of Business and Institute for International Integration Studies,Trinity College Dublin Aleksandar Ševic, School of Business, Trinity College Dublin
  14. Russia’s Long and Winding Road to a more Efficient and Resilient Banking Sector By Geoff Barnard
  15. Resource Reallocation and Zombie Lending in Japan in the '90s By KWON Hyeog Ug; NARITA Futoshi; NARITA Machiko

  1. By: Hendrik Hakenes (Institute of Financial Economics, Leibniz University of Hannover); Isabel Schnabel (Department of Law and Economics, Johannes Gutenberg University Mainz)
    Abstract: We present a banking model with imperfect competition in which borrowers’ access to credit is improved when banks are able to transfer credit risks. However, the market for credit risk transfer (CRT) works smoothly only if the quality of loans is public information. If the quality of loans is private information, banks have an incentive to grant unprofitable loans in order to transfer them to other parties, leading to an increase in aggregate risk. Nevertheless, the introduction of CRT generally increases welfare in our setup. However, under private information, higher competition induces an expansion of loans to unprofitable firms, which in the limit offsets the welfare gains from CRT completely.
    Keywords: access to credit, bank competition, credit derivatives, Credit risk transfer, public and private information
    JEL: G13 G21 L11
    Date: 2009–10
  2. By: Beltratti, Andrea (Bocconi University); Stulz, Rene M. (Ohio State University and ECGI)
    Abstract: Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities.
    Date: 2009–07
  3. By: Agoraki, Maria-Eleni; Delis, Manthos D; Staikouras, Panagiotis
    Abstract: This paper analyzes the relationship between board structure, in terms of board size and composition, and bank performance. Unlike previous studies, the present analysis is carried out within a stochastic frontier framework. To this end, bank performance is proxied by both cost and profit efficiency, measures that present considerable advantages over simple accounting ratios. The empirical framework formed is applied to a panel of large European banks operating during the period 2002-2006. We find that board size negatively affects banks’ cost and profit efficiency, while the impact of board composition on profit efficiency is non-linear. Finally, introducing risk-taking (credit risk) as an interaction component of board size and composition does not affect the robustness of the results.
    Keywords: Corporate governance; Board size and composition; Bank cost and profit efficiency; Stochastic frontier analysis
    JEL: C23 G34 K23 G21
    Date: 2009–10–08
  4. By: Fahlenbach, Rudiger (Ecole Polytechnique Federale de Lausanne); Stulz, Rene M. (Ohio State University and ECGI)
    Abstract: We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.
    JEL: G21 G32
    Date: 2009–07
  5. By: Besancenot, Damien (University Paris 13 and CEPN (Centre d'Economie de l'université Paris Nord)); Vranceanu, Radu (ESSEC Business School, Department of Economics)
    Abstract: Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 financial 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; Imperfect Information; Risk Strategy; Risk/return Tradeoff; Signaling
    JEL: D82 G21 G32
    Date: 2009–10
  6. By: Nadauld, Taylor D. (Ohio State University); Sherlund, Shane M. (Federal Reserve Board)
    Abstract: We analyze the structure and attributes of subprime mortgage-backed securitization deals originated between 1997 and 2007. Our data set allows us to link loan-level data for over 6.7 million subprime loans to the securitization deals into which the loans were sold. We show that the securitization process, including the assignment of credit ratings, provided incentives for securitizing banks to purchase loans of poor credit quality in areas with high rates of house price appreciation. Increased demand from the secondary mortgage market for these types of loans appears to have facilitated easier credit in the primary mortgage market. To test this hypothesis, we identify an event which represents an external shock to the relative demand for subprime mortgages in the secondary market. We show that following the SEC's adoption of rules reducing capital requirements on certain broker dealers in 2004, five large deal underwriters disproportionately increased their purchasing activity relative to competing underwriters in ZIP codes with the highest realized rates of house price appreciation but lower average credit quality. We show that these loans subsequently defaulted at marginally higher rates. Finally, using the event as an instrument, we demonstrate a causal link between the demand for mortgages in the secondary mortgage market and the supply of subprime credit in the primary mortgage market.
    JEL: G21 G24
    Date: 2009–04
  7. By: Tianxi Wang
    Abstract: This paper presents a model on the leverage of financial intermediaries, where debt are held by risk averse agents and equity by the risk neutral. The paper shows that in an unregulated competitive market, financial intermediaries choose to be leveraged over the social best level. This is because the leverage of one intermediary imposes a negative externality upon others by reducing their profit margins. The paper thus founds capital adequacy regulation upon the market failure and suggests that this regulation should bind not only commercial banks, but all financial intermediaries, including private equities and hedge funds.
    Date: 2009–11–03
  8. By: Jokipii, Terhi (Swiss National Bank); Milne, Alistair (Cass Business School)
    Abstract: Building an unbalanced panel of United States (US) bank holding company (BHC) and commercial bank balance sheet data from 1986 to 2006, we examine the relationship between short-term capital buffer and portfolio risk adjustments. Our estimations indicate that the relationship over the sample period is a positive two-way relationship. Moreover, we show that the management of such adjustments is dependent on the degree of bank capitalization. Further investigation through time-varying analysis reveals a cyclical pattern in the uncovered relationship: negative after the 1991/1992 crisis, and positive before 1991 and after 1997.
    Keywords: Bank capital; Portfolio Risk; Regulation
    JEL: G21 G28 G32
    Date: 2009–10–01
  9. By: Sokolov, Yuri
    Abstract: As shown in the recent BCBS papers market and credit risks could reinforce each other in certain circumstances, meaning the sum of the parts might be less than an estimate of risk that takes into account the interactions between the two. Market risk factors have an ambiguous impact on the firms' repayment conditions because depreciation of domestic currency for instance favors exporters and harms importers. Within the task of a ‘top-down’ aggregation of market and credit risks this contribution presents a general framework to economic capital measurement and active portfolio management splitting exogenous risk factor influence throw different channels. The approach implies an exploiting of banks information about the clients' trade and cash flows related to global economic activity. The way to single out exposures to counterparties belonging to the same pattern of behavioural reactions to the market factors are considered as the bedrock of Factor endogenous behaviour aggregation (FEBA) approach.
    Keywords: integrated analysis of market and credit risk; risk management; endogenous behaviour; concentration risk.
    JEL: G28 G32 G30 E37 G21 E47 G20
    Date: 2009–11–08
  10. By: Ignazio Angeloni; Ester Faia
    Abstract: We introduce banks, modeled as in Diamond and Rajan (JoF 2000 or JPE 2001), into a standard DSGE model and use this framework to study the role of banks in the transmission of shocks, the effects of monetary policy when banks are exposed to runs, and the interplay between monetary policy and Basel-like capital ratios. In equilibrium, bank leverage depends positively on the uncertainty of projects and on the bank’s "relationship lender" skills, and negatively on short term interest rates. A monetary restriction reduces leverage, while a productivity or asset price boom increases it. Procyclical capital ratios are destabilising; monetary policy can only partly offset this effect. The best policy combination includes mildly anticyclical capital ratios and a response of monetary policy to asset prices or leverage
    Keywords: capital requirements, leverage, bank runs, combination policy, market liquidity
    Date: 2009–10
  11. By: James Crotty
    Abstract: <p>We recently experienced a global financial crisis so severe that only massive rescue operations by governments around the world prevented a total financial market meltdown and perhaps another global Great Depression. One necessary precondition for the crisis was the perverse, bonus-driven compensation structure employed in important financial institutions such as investment banks. This structure provided the rational incentive for key decision makers in these firms (who I call “rainmakers”) to take the excessive risk and employ the excessive leverage in the bubble that created the preconditions for the crisis. This paper presents and evaluates extensive data on compensation practices in investment banks and other important financial institutions. These data show that rainmaker compensation has been rising rapidly, is very large, and has asymmetric properties that induce reckless risk-taking. Since boom-period bonuses do not have to be returned if rainmaker decisions eventually lead to losses for their firms, and since large bonuses continue to be paid even when firms in fact suffer large losses, it is rational for rainmakers to use unsustainable leverage to invest in recklessly risky assets in the bubble. A review of the modest literature on financial firm compensation practices in general and those of investment banks in particular demonstrates that the giant bonuses of the recent past are not efficient returns to human capital – they are unjustified rents. The paper discusses possible answers to the challenging questions: what is the source of rainmaker rents and how are they sustained over time? Answers to these questions can help guide debates over the appropriate regulation of financial markets. They are also necessary inputs to the development of an adequate theory of the “rainmaker” financial firm that can help us understand how these firms were able to maximize the compensation of their key employees through policies that destroyed shareholder value and created systemic financial fragility. To my knowledge, no such theory currently exists.</p>
    Keywords: bonuses; investment banks; leverage; financial crisis; perverse incentives
    JEL: G24 G10
    Date: 2009
  12. By: Delis, Manthos D; Tran , Kien; Tsionas, Efthymios
    Abstract: By examining the impact of capital regulation on bank risk-taking using a local estimation technique, we are able to quantify the heterogeneous response of banks towards this type of regulation in banking sectors of western-type economies. Subsequently, using this information on the bank-level responses to capital regulation, we examine the sources of heterogeneity. The findings suggest that the impact of capital regulation on bank risk is very heterogeneous across banks and the sources of this heterogeneity can be traced into both bank and industry characteristics, as well as into the macroeconomic conditions. Therefore, the present analysis has important implications on the way bank regulation is conducted, as it suggests that common capital regulatory umbrellas may not be sufficient to promote financial stability. On the basis of our findings, we contend that Basel guidelines may have to be reoriented towards more flexible, country-specific policy proposals that focus on the restraint of excess risk-taking by banks.
    Keywords: Capital regulation; risk-taking of banks; local generalized method of moments
    JEL: C14 G38 G32 C33 G21
    Date: 2009–11–10
  13. By: Brian Lucey* School of Business and Institute for International Integration Studies,Trinity College Dublin Aleksandar Ševic, School of Business, Trinity College Dublin
    Abstract: We examine the nature, extent and possible causes of bank contagion in a high frequency setting. Looking at six major European banks in the summer and autumn of 2008, we model the lower coexceedances of these banks returns. We find that market microstructure, volatility (measured by range based measures) and limited general market conditions are key determinants of these coexceedances. We find some evidence that herding occurred.
    Date: 2009–09–30
  14. By: Geoff Barnard
    Abstract: In the decade following the 1998 financial crisis Russia’s banking system grew much larger and stronger – indeed, growth rates were dangerously high – but even before the onset of the current global crisis it continued to play a limited role in intermediating savings and investment, especially for small and medium-sized enterprises. Moreover, despite important improvements, some weaknesses in prudential supervision remained, and the Russian banking sector continued to have too many very small banks doing little if any banking business. This paper discusses the policy imperatives in the short term, in the face of the ongoing economic crisis, and reforms that could be implemented over the longer term to improve the efficiency and resilience of the financial system and raise Russia’s potential growth rate. While the current crisis is painful for the banking sector as well as the broader economy, it may facilitate a restructuring of the system that will be positive in the long run, as well as new approaches to regulation that will make banking less crisis-prone.<P>Vers un secteur bancaire russe plus efficace et résilient en Russie<BR>Pendant la décennie après la crise de 1998 le système bancaire russe est devenu beaucoup plus grand et fort – les taux de croissance étaient même inquiétants – mais même avant le début de la crise mondiale actuelle il a continué à jouer un rôle limité dans l’intermédiation de l’épargne et l’investissement, surtout pour les petites et moyennes entreprises. D’ailleurs, malgré des pas en avant importants, il restait des faiblesses dans la surveillance prudentielle, et le secteur bancaire avait toujours trop de banques minuscules qui avaient très peu de vraies activités bancaires. Cette étude aborde les principaux défis pour la politique envers les banques à court terme étant donné le contexte de crise économique, et les réformes qui pourraient être mises en œuvre à plus long terme afin d’augmenter l’efficacité et la stabilité du secteur bancaire et de hausser le taux de croissance de la production potentielle. La crise actuelle, tout en étant douloureuse pour le secteur bancaire et l’économie, pourrait faciliter une restructuration du système qui serait positive à long terme, ainsi que des nouvelles approches à la réglementation qui aideront à diminuer la vulnérabilité du système aux crises.
    Keywords: corruption, transition, transition, transparency, transparence, assurance, banking, deposit insurance, banque, assurance des dépôts, Russia, economy, state ownership, Russie, économie, prudential supervision, international financial reporting standards, Sberbank, surveillance prudentielle, comptabilité, norme comptable internationale, corruption, Sberbank, accountability, propriété de l’État
    JEL: E58 G21 G28 O52 P29
    Date: 2009–11–03
  15. By: KWON Hyeog Ug; NARITA Futoshi; NARITA Machiko
    Abstract: We investigate the efficiency of resource reallocation in Japan during the 1990s, a decade of economic recession, by measuring aggregate productivity growth (APG) using a plant-level data set of manufacturers from 1981-2000. We find that resource reallocation contributed negatively to APG, mainly due to inefficient labor reallocation. A possible reason for the inefficient labor reallocation is misdirected bank lending or "zombie lending" to otherwise defunct plants. To quantify its impact, we develop a model with plant-level heterogeneity, calibrate it based on the results of plant-level productivity estimation, and conduct a counterfactual exercise. The results show that 37% of the actual decline in APG due to inefficient labor reallocation in Japan in the '90s is attributable to "zombie lending."
    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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