New Economics Papers
on Banking
Issue of 2009‒12‒11
eighteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Bank safety under Basel II capital requirements By Vauhkonen, Jukka
  2. Inferring market power from retail deposit interest rates in the euro area By Vajanne, Laura
  3. A model of stigma in the fed funds market By Humberto M. Ennis; John A. Weinberg
  4. Financial crises and bank failures: a review of prediction methods By Demyanyk , Yuliya; Hasan, Iftekhar
  5. Crisis Resolution and Bank Liquidity By Viral V. Acharya; Hyun Song Shin; Tanju Yorulmazer
  6. It Pays to Violate: How Effective are the Basel Accord Penalties? By Veiga, B. da; Chan, F.; McAleer, M.
  7. Transmission of macro shocks to loan losses in a deep crisis: the case of Finland By Jokivuolle, Esa; Viren , Matti; Vähämaa, Oskari
  8. A factor analysis approch to measuring European loan and bond market integration By Wagenvoort, Rien; Ebner, André; Morgese Borys, Magdalena
  9. A New Auction for Substitutes: Central-Bank Liquidity Auctions, “Toxic Asset” Auctions, and Variable Product-Mix Auctions By Paul Klemperer
  10. Mortgage Loan Modifications: Program Incentives and Restructuring Design By Dan Magder
  11. The Real Effects of Financial Constraints: Evidence from a Financial Crisis By Murillo Campello; John Graham; Campbell R. Harvey
  12. Financial Dependence, Formal Credit, and Informal Jobs: New Evidence from Brazilian Household Data By Catão, Luis A. V.; Pagés, Carmen; Rosales, Maria Fernanda
  13. Risk-adjusted measures of value creation in financial institutions By Milne, Alistair; Onorato, Mario
  14. Comparing univariate and multivariate models to forecast portfolio value-at-risk By Andre A. P.; Francisco J. Nogales; Esther Ruiz
  15. About Some Applications of Kolmogorov Equations to the Simulation of Financial Institutions Activity By Mikhail I. Rumyantsev
  16. Exports and Financial Shocks By Mary Amiti; David E. Weinstein
  17. A Banking Explanation of the US Velocity of Money: 1919-2004 By Szilard Benk; Max Gillman; Michal Kejak
  18. A new algorithm for the loss distribution function with applications to Operational Risk Management By Dominique Guegan; Bertrand Hassani

  1. By: Vauhkonen, Jukka (Bank of Finland Research)
    Abstract: We consider the impact of mandatory information disclosure on bank safety in a spatial model of banking competition in which a bank’s probability of success depends on the quality of its risk measurement and management systems. Under Basel II capital requirements, this quality is either fully or partially disclosed to market participants by the Pillar 3 disclosures. We show that, under stringent Pillar 3 disclosure requirements, banks’ equilibrium probability of success and total welfare may be higher under a simple Basel II standardized approach than under the more sophisticated internal ratings-based (IRB) approach.
    Keywords: Basel II; capital requirements; information disclosure; market discipline; moral hazard
    JEL: D43 D82 G14 G21 G28
    Date: 2009–11–03
  2. By: Vajanne, Laura (Bank of Finland Research)
    Abstract: This paper tests for the existence of market power in banking, using data on demand deposit rates of households and corresponding market rates in five euro area countries. An implicit measure for market power is based on a partial adjustment model that also allows for an asymmetric response of deposit rates to changes in market rates. The period covers the ten years since introduction of the euro. The analysis indicates that banks are exercising major market power within the euro area. In addition to general sluggishness, bank deposit rates’ reactions are clearly asymmetric: flexible when market rates are decreasing and rigid when rates are increasing. The degree of asymmetric behaviour can be interpreted as a further indication of the market power banks exercise. Despite country differences, a general pattern of interest rate adjustment in demand deposit pricing is observable.
    Keywords: competition; banking industry; retail interest rates
    JEL: G21 L11 L13
    Date: 2009–11–02
  3. By: Humberto M. Ennis; John A. Weinberg
    Abstract: It is often the case that banks in the US are willing to borrow in the fed funds market (the interbank market for funds) at higher rates than the ones they could obtain by borrowing at the Fed's discount window. This phenomenon is commonly explained as the consequence of the existence of a stigma effect attached to borrowing from the window. Most policymakers and empirical researchers consider the stigma hypothesis plausible. Yet, no formal treatment of the issue has ever been provided in the literature. In this paper, we fill that gap by studying a model of interbank credit where: (1) banks benefit from engaging in intertemporal trade with other banks and with outside investors; and (2) informational frictions limit those trade opportunities. In our model, banks obtain loans in an over-the-counter market (involving search, bilateral matching, and negotiations over the terms of the loan) and hold assets of heterogeneous qualities which in turn determine their ability to repay those loans. When asset quality is not perfectly unobservable by outside investors, information about the actions taken by a bank in the credit market may influence the price at which it can sell its asset. In particular, under some conditions, discount window borrowing may be regarded as a negative signal about the quality of the borrower's assets. In such cases, some of the banks in our model, just as in the data, are willing to accept loans in the interbank market at higher rates than the ones they could obtain at the discount window.
    Keywords: Interbank market, Private information, Signaling, Banking
    JEL: G21 E50 E42
    Date: 2009–09
  4. By: Demyanyk , Yuliya (Federal Reserve Bank of Cleveland); Hasan, Iftekhar (Rensselaer Polytechnic Institute, USA and Bank of Finland)
    Abstract: In this article we provide a summary of empirical results obtained in several economics and operations research papers that attempt to explain, predict, or suggest remedies for financial crises or banking defaults, as well as outlines of the methodologies used. We analyze financial and economic circumstances associated with the US subprime mortgage crisis and the global financial turmoil that has led to severe crises in many countries. The intent of the article is to promote future empirical research that might help to prevent bank failures and financial crises.
    Keywords: financial crises; banking failures; operations research; early warning methods; leading indicators; subprime markets
    JEL: C44 C45 C53 G21
    Date: 2009–12–01
  5. By: Viral V. Acharya; Hyun Song Shin; Tanju Yorulmazer
    Abstract: What is the effect of financial crises and their resolution on banks’ choice of liquid asset holdings? When risky assets have limited pledgeability and banks have relative expertise in employing risky assets, the market for these assets clears only at fire-sale prices following a large number of bank failures. The gains from acquiring assets at fire-sale prices make it attractive for banks to hold liquid assets. We show that the resulting choice of bank liquidity is counter-cyclical, inefficiently low during economic booms but excessively high during crises, and present and discuss evidence consistent with these predictions. Since inefficient users may enter asset markets when prices fall sufficiently, interventions to resolve banking crises may be desirable ex post. However, policies aimed at resolving crises affect ex-ante bank liquidity in subtle ways: while liquidity support to failed banks or unconditional support to surviving banks in acquiring failed banks give banks incentives to hold less liquidity, support to surviving banks that is conditional on their liquid asset holdings creates incentives for banks to hold more liquidity.
    JEL: D62 E58 G21 G28 G38
    Date: 2009–12
  6. By: Veiga, B. da; Chan, F.; McAleer, M. (Erasmus Econometric Institute)
    Abstract: The internal models amendment to the Basel Accord allows banks to use internal models to forecast Value-at-Risk (VaR) thresholds, which are used to calculate the required capital that banks must hold in reserve as a protection against negative changes in the value of their trading portfolios. As capital reserves lead to an opportunity cost to banks, it is likely that banks could be tempted to use models that underpredict risk, and hence lead to low capital charges. In order to avoid this problem the Basel Accord introduced a backtesting procedure, whereby banks using models that led to excessive violations are penalised through higher capital charges. This paper investigates the performance of five popular volatility models that can be used to forecast VaR thresholds under a variety of distributional assumptions. The results suggest that, within the current constraints and the penalty structure of the Basel Accord, the lowest capital charges arise when using models that lead to excessive violations, thereby suggesting the current penalty structure is not severe enough to control risk management. In addition, this paper suggests an alternative penalty structure that is more effective at aligning the interests of banks and regulators.
    Keywords: Value-at-Risk (VaR);GARCH;risk management;violations;forecasting;simulations;Basel accord penalties
    Date: 2009–11–24
  7. By: Jokivuolle, Esa (Bank of Finland Research); Viren , Matti (Bank of Finland Research and University of Turku); Vähämaa, Oskari (Bank of Finland Research)
    Abstract: Building on the work of Sorge and Virolainen (2006), we revisit the data on aggregate Finnish bank loan losses from the corporate sector, which covers the ‘Big Five’ crisis in Finland in the early 1990s. Several extensions to the empirical model are considered. These extensions are then used in the simulations of the aggregate loan loss distribution. The simulation results provide some guidance as to what might be the most important dimensions in which to improve the basic model. We found that making the average LGD depend on the business cycle seems to be the most important improvement. We also compare the empirical fit of the annual expected losses over a long period. In scenario-based analyses we find that a prolonged deep recession (as well as simultaneity of various macro shocks) has a convex effect on cumulative loan losses. This emphasizes the importance of an early policy response to a looming crisis. Finally, a comparison of the loan loss distribution on the eve of the 1990s crisis with the most recent distribution demonstrates the greatly elevated risk level prior to the 1990s crisis.
    Keywords: credit risk; bank loan losses; banking crisis; macro shocks; default rates; stress testing
    JEL: C15 E37 G21 G32 G33
    Date: 2009–11–02
  8. By: Wagenvoort, Rien; Ebner, André; Morgese Borys, Magdalena
    Abstract: By using an existing and a new convergence measure, this paper assesses whether bank loan and bond interest rates are converging for the non-financial corporate sector across the euro area. Whilst we find evidence for complete bond market integration, the market for bank loans remains segmented, albeit to various degrees depending on the type and size of the loan. Factor analysis reveals that rates on large loans and small loans with long rate fixation periods have weakly converged in the sense that, up to a fixed effect, their evolution is driven by common factors only. In contrast, the price evolution of small loans with short rate fixation periods is still affected by country-specific dynamic factors. There are few signs that bank loan rates are becoming more uniform with time.
    Keywords: financial market integration; corporate loan; corporate bond; panel unit root test; factor analysis
    JEL: C12 C23 G12 G2
    Date: 2009–11
  9. By: Paul Klemperer (Nuffield College, University of Oxford, Oxford)
    Abstract: I describe a new static (sealed-bid) auction for multiple substitute goods. As in a two-sided simultaneous multiple round auction (SMRA), bidders bid on multiple assets simultaneously, and bid-takers choose supply functions across assets. The auction yields more efficiency, revenue, information, and trade than running multiple separate auctions, but is often simpler to use and understand, and less vulnerable to collusion, than a SMRA. I designed it after the 2007 Northern Rock bank run to help the Bank of England fight the credit crunch; in 2008 the U.S. Treasury planned (but later cancelled) using a related design to buy “toxic assets”.
    Keywords: multi-object auction, TARP, central banking, simultaneous ascending auction, treasury auction, term auction, toxic assets.
    JEL: D44 E58
    Date: 2009–07–01
  10. By: Dan Magder (Lone Star Funds)
    Abstract: Mortgage defaults and home foreclosures remain a growing problem that undermines the nascent US economic recovery. Delinquencies continue to skyrocket, up 300 percent since the beginning of the crisis, and the contagion has spread to prime loans where delinquencies have risen to over 11 percent of outstanding loans. The resulting foreclosures have broad consequences: Individuals lose their homes, banks take losses on the loans, neighbors suffer as area prices go down, and localities lose on property taxes. The economics of modifying loans to avoid defaults appear strong: Lenders lose an average of $145,000 during a foreclosure compared with less than $24,000 on a modified loan. Yet the track record of modification programs has been surprisingly poor. Potential lawsuits over modifying loans in securitization trusts may be a less important obstacle than many claim. More significant are misaligned incentives that put mortgage servicers in opposition to both investors and borrowers, conflicts between investors holding different tranches of mortgage-backed securities (MBS), operational impediments, and problems in loan modification design that contribute to redefaults. Policymakers should improve reporting metrics to highlight servicers’ conflicts of interest, shift the emphasis of loan modifications from short-term fixes to making the new loans more sustainable, and use government resources to drive operational/capacity improvements in the industry.
    Keywords: Mortgage Loan Modifications, Restructuring, Credit Crisis, HAMP
    JEL: E60 G18 G21
    Date: 2009–11
  11. By: Murillo Campello; John Graham; Campbell R. Harvey
    Abstract: We survey 1,050 CFOs in the U.S., Europe, and Asia to assess whether their firms are credit constrained during the global credit crisis of 2008. We study whether corporate spending plans differ conditional on this measure of financial constraint. Our evidence indicates that constrained firms planned deeper cuts in tech spending, employment, and capital spending. Constrained firms also burned through more cash, drew more heavily on lines of credit for fear banks would restrict access in the future, and sold more assets to fund their operations. We also find that the inability to borrow externally causes many firms to bypass attractive investment opportunities, with 86% of constrained U.S. CFOs saying their investment in attractive projects was restricted during the credit crisis of 2008. More than half of the respondents say they will cancel or postpone their planned investment. Our results also hold in Europe and Asia, and in many cases are stronger in those economies.
    JEL: G31
    Date: 2009–12
  12. By: Catão, Luis A. V. (Inter-American Development Bank); Pagés, Carmen (Inter-American Development Bank); Rosales, Maria Fernanda (University of Chicago)
    Abstract: This paper examines a much overlooked link between credit markets and formalization: since access to bank credit typically requires compliance with tax and employment legislation, firms are more likely to incur such formalization costs once bank credit is more widely available at lower cost; if so, well-functioning credit markets help foster formal employment at the expense of informal jobs. We gauge the relevance of this credit channel using the Rajan-Zingales measure of financial dependence and a difference-in-differences approach applied to household survey data from Brazil – a large emerging market where substantial changes in banking system depth and formalization ratios have taken place and for which consistent data exists. Our results show that formalization rates increase with financial deepening and the more so in sectors where firms are typically more dependent on external finance. We also decompose shifts in aggregate formalization into those within each firm size category and those associated with changes in firm size, and find that financial deepening significantly explains the former but not so much the latter.
    Keywords: credit markets, financial dependence, informality, Brazil
    JEL: E26 G21 O4 O16
    Date: 2009–12
  13. By: Milne, Alistair (Faculty of Finance, Cass Business School, City University, London and Bank of Finland Research); Onorato, Mario (Algorithmics Inc & Faculty of Finance, Cass Business School, City University, London)
    Abstract: Measuring value creation by comparing the RAROC of an exposure (the return on risk capital) with a single institution-wide hurdle rate is inconsistent with the standard theory of financial valuation. We use asset pricing theory to determine the appropriate hurdle rate for such a RAROC performance measure. We find that this hurdle rate varies with the skewness of asset returns. Thus the RAROC hurdle rate should differ substantially between equity which has a right skew and debt which has a pronounced left skew and also between different qualities of debt exposure. We discuss implications for financial institution risk management and supervision.
    Keywords: asset pricing; banking; capital allocation; capital budgeting; capital management; corporate finance; downside risk; economic capital; performance measurement; RAROC; risk management; value creation; hurdle rate; value at risk
    JEL: G22 G31
    Date: 2009–11–02
  14. By: Andre A. P.; Francisco J. Nogales; Esther Ruiz
    Abstract: This article addresses the problem of forecasting portfolio value-at-risk (VaR) with multivariate GARCH models vis-à-vis univariate models. Existing literature has tried to answer this question by analyzing only small portfolios and using a testing framework not appropriate for ranking VaR models. In this work we provide a more comprehensive look at the problem of portfolio VaR forecasting by using more appropriate statistical tests of comparative predictive ability. Moreover, we compare univariate vs. multivariate VaR models in the context of diversified portfolios containing a large number of assets and also provide evidence based on Monte Carlo experiments. We conclude that, if the sample size is moderately large, multivariate models outperform univariate counterparts on an out-of-sample basis.
    Keywords: Market risk, Backtesting, Conditional predictive ability, GARCH, Volatility, Capital requirements, Basel II
    Date: 2009–11
  15. By: Mikhail I. Rumyantsev
    Abstract: The goal of this article is to describe the concepts of system dynamics and its applications to the simulation modeling of financial institutions daily activity. The hybrid method of the re-engineering of banking business processes based upon combination of system dynamics, queuing theory and tools of ordinary differential equations (Kolmogorov equations) is offered.
    Date: 2009–12
  16. By: Mary Amiti; David E. Weinstein
    Abstract: A striking feature of many financial crises is the collapse of exports relative to output. In the 2008 financial crisis, real world exports plunged 17 percent while GDP fell 5 percent. This paper examines whether the drying up of trade finance can help explain the large drops in exports relative to output. This paper is the first to establish a causal link between the health of banks providing trade finance and growth in a firm’s exports relative to its domestic sales. We overcome measurement and endogeneity issues by using a unique data set, covering the Japanese financial crises of the 1990s, which enables us to match exporters with the main bank that provides them with trade finance. Our point estimates are economically and statistically significant, suggesting that trade finance accounts for about one-third of the decline in Japanese exports in the financial crises of the 1990s.
    JEL: E32 E44 F40 G21
    Date: 2009–12
  17. By: Szilard Benk (Hungarian Central Bank); Max Gillman (Institute of Economics - Hungarian Academy of Sciences); Michal Kejak (The Center for Economic Research and Graduate Education of Charles University (CERGE EI))
    Abstract: The paper shows that US GDP velocity of M1 money has exhibited long cycles around a 1.25% per year upward trend, during the 1919-2004 period. It explains the velocity cycles through shocks constructed from a DSGE model and annual time series data (Ingram et al., 1994). Model velocity is stable along the balanced growth path, which features endogenous growth and decentralized banking that produces exchange credit. Positive shocks to credit productivity and money supply increase velocity, as money demand falls, while a positive goods productivity shock raises temporary output and velocity. The paper explains such velocity volatility at both business cycle and long run frequencies. With filtered velocity turning negative, starting during the 1930s and the 1987 crashes, and again around 2003, results suggest that the money and credit shocks appear to be more important for velocity during less stable times and the goods productivity shock more important during stable times.
    Keywords: business cycle, credit shocks, velocity and volatility
    JEL: E13 E32 E44
    Date: 2009–11
  18. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Bertrand Hassani (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: Operational risks inside banks and insurance companies is currently an important task. The computation of a risk measure associated to these risks lies on the knowledge of the so-called Loss Distribution Function. Traditionally this distribution function is computed via the Panjer algorithm which is an iterative algorithm. In this paper, we propose an adaptation of this last algorithm in order to improve the computation of convolutions between Panjer class distributions and continuous distributions. This new approach permits to reduce drastically the variance of the estimated VAR associated to the operational risks.
    Keywords: Operational risk, Panjer algorithm, Kernel, numerical integration, convolution.
    Date: 2009–11

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