New Economics Papers
on Banking
Issue of 2010‒01‒10
twenty-one papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Too much right can make a wrong: Setting the stage for the financial crisis By Richard J. Rosen
  2. When liquidity risk becomes a macro-prudential issue: Empirical evidence of bank behaviour By Jan Willem van den End; Mostafa Tabbae
  3. Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk. By Florian Heider; Marie Hoerova; Cornelia Holthausen
  4. Balance Sheet Interlinkages and Macro-Financial Risk Analysis in the Euro Area. By Olli Castrén; Ilja Kristian Kavonius
  5. The Janus-Headed Salvation: Sovereign and Bank Credit Risk Premia during 2008-09. By Jacob W. Ejsing; Wolfgang Lemke
  6. Back to basics By Patrick Barron
  7. Optimal Lending Contracts with Asymmetric Information and Two-sided Limited Commitment or Impatient Entrepreneur By Shuyun May Li
  8. How much did banks pay to become too-big-to-fail and to become systemically important? By Elijah Brewer, III; Julapa Jagtiani
  9. Are bank lending shocks important for economic fluctuations? By Jørn Inge Halvorsen; Dag Henning Jacobsen
  10. Credit availability in the crisis: the European investment bank group By Alessandro Fedele; Francesco Liucci; Andrea Mantovani
  11. Did easy credit lead to economic peril?: home equity borrowing and household behavior in the early 2000s By Daniel Cooper
  12. Financial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis By D. Sornette; R. Woodard
  13. Multiple defaults and contagion risks By Ying Jiao
  14. Repayment versus Investment Conditions and Exclusivity in Lending Contracts By Bougheas, Spiros; Dasgupta, Indraneel; Morrissey, Oliver
  15. International Financial competition and bank risk-taking in emerging economies By Arnaud Bourgain; Patrice Pieretti; Skerdilajda Zanaj
  16. Does Finance Bolster Superstar Companies? Banks, Venture Capital, and Firm Size in Local U.S. Markets. By Alexander Popov
  17. The information content of market liquidity: An empirical analysis of liquidity at the Oslo Stock Exchange By Skjeltorp, Johannes; Ødegaard, Bernt Arne
  18. Credit risk analysis in microcredit: How does gender matter? By Helena Marrez; Mathias Schmit
  19. Entrepreneurial Finance in France: The Persistent Role of Banks By Cieply, S.; Dejardin, M.A.F.G.
  20. Directional and non-directional risk exposures in Hedge Fund returns By Marie Lambert; George Hübner; Marie Lambert
  21. Debts on debts By Joao Ricardo Faria; Le Wang; Zhongmin Wu

  1. By: Richard J. Rosen
    Abstract: The financial crisis that started in 2007 exposed a number of flaws in the financial system. Many of these flaws were associated with financial instruments that were issued by the shadow banking system, especially securitized assets. The volume and complexity of securitized assets grew rapidly during runup to the financial crisis that began in 2007. The paper discusses how the financial crisis can be viewed as a possible but logical outcome of a system where investors are overconfident, busy, and investing other peoples’ money and intermediaries are set up to take advantage of investors’ tendencies. The investor-intermediary risk cycle in this crisis is common to other crises. However, there are a number of factors that may have made the 2007 crisis more severe. Among them are the length of the pre-crisis period, the shift from financial intermediaries to the shadow banking system, the increasing interconnectedness among financial firms, and the increased leverage at some financial firms.
    Date: 2009
  2. By: Jan Willem van den End; Mostafa Tabbae
    Abstract: This paper provides empirical evidence of behavioural responses by banks and their contribution to system-wide liquidity stress. Using firm-specific balance sheet data, we construct aggregate indicators of macro-prudential risk. Measures of size and herding show that balance sheet adjustments have been pro-cyclical in the crisis, while responses became increasingly dependent across banks and concentrated on certain market segments. Banks' reactions were shaped by decreased risk tolerance and limited flexibility in risk management. Regression analysis confirms that their behaviour contributed to financial sector stress. The behavioural measures are useful tools for monetary and macro prudential analyses and can improve the micro foundations of financial stability models. 
    Keywords: banking; financial stability; stress-tests; liquidity risk.
    JEL: C15 E44 G21 G32
    Date: 2009–12
  3. By: Florian Heider (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marie Hoerova (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Cornelia Holthausen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We study the functioning and possible breakdown of the interbank market in the presence of counterparty risk. We allow banks to have private information about the risk of their assets. We show how banks’ asset risk affects funding liquidity in the interbank market. Several interbank market regimes can arise: i) normal state with low interest rates; ii) turmoil state with adverse selection and elevated rates; and iii) market breakdown with liquidity hoarding. We provide an explanation for observed developments in the interbank market before and during the 2007-09 financial crisis (dramatic increases of unsecured rates and excess reserves banks hold, as well as the inability of massive liquidity injections by central banks to restore interbank activity). We use the model to discuss various policy responses. JEL Classification: G01, G21, D82.
    Keywords: Financial crisis, Interbank market, Liquidity, Counterparty risk, Asymmetric information.
    Date: 2009–12
  4. By: Olli Castrén (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Ilja Kristian Kavonius (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The financial crisis has highlighted the need for models that can identify counterparty risk exposures and shock transmission processes at the systemic level. We use the euro area financial accounts (flow of funds) data to construct a sector-level network of bilateral balance sheet exposures and show how local shocks can propagate throughout the network and affect the balance sheets in other, even seemingly remote, parts of the financial system. We then use the contingent claims approach to extend this accounting-based network of interlinked exposures to risk-based balance sheets which are sensitive to changes in leverage and asset volatility. We conclude that the bilateral cross-sector exposures in the euro area financial system constitute important channels through which local risk exposures and balance sheet dislocations can be transmitted, with the financial intermediaries playing a key role in the processes. High financial leverage and high asset volatility are found to increase a sector’s vulnerability to shocks and contagion. JEL Classification: C22, E01, E21, E44, F36, G01, G12, G14.
    Keywords: Balance sheet contagion, financial accounts, network models, contingent claims analysis, systemic risk, macro-prudential analysis.
    Date: 2009–12
  5. By: Jacob W. Ejsing (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Wolfgang Lemke (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: As the global banking crisis intensified in the fall of 2008, governments announced comprehensive rescue packages for financial institutions. In this paper, we put the joint response of euro area bank and sovereign CDS premia under the microscope. We find that the bank rescue packages led to a clear structural break in these premia's comovement, which had been rather tight and stable in the weeks preceding the in-tensification of the crisis. Firstly, the packages induced a decrease in risk spreads for banks at the expense of a marked increase in risk spreads for governments. Secondly, we show that in addition to this one-off jump in the levels of CDS spreads, the packages strongly increased the sensitivity of sovereign risk spreads to any further aggravation of the crisis. At the same time, the sensitivity of bank credit risk premia declined and became more sovereign-like, reflecting the extensive government guarantees of banking sector liabilities. JEL Classification: G15, G21.
    Keywords: Financial crisis, risk transfer, credit default swaps.
    Date: 2009–12
  6. By: Patrick Barron
    Abstract: Remarks at the Georgia Bankers Association's Annual Convention, Atlanta, Georgia, June 15, 2009
    Keywords: Banks and banking ; Economic stabilization ; Economic development
    Date: 2009
  7. By: Shuyun May Li
    Abstract: This paper discusses two ways to amend the optimal lending contract under asymmetric information studied in Clementi and Hopenhayn (2006) to change its long-run implications so that firm growth and exit driven by borrowing constraints exist in the long run. One way assumes that the entrepreneur has a lower discount factor than the bank, and the other assumes the bank has limited commitment. The optimal lending contracts under each variation closely resemble each other.
    Keywords: Optimal lending contract; Borrowing constraints; Asymmetric information; Limited commitment; Impatient entrepreneur
    JEL: G3 L2 D21
    Date: 2009
  8. By: Elijah Brewer, III; Julapa Jagtiani
    Abstract: This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991-2004, the authors find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. They estimate at least $14 billion in added premiums for the eight merger deals that brought the organizations to over $100 billion in assets. In addition, the authors find that both the stock and bond markets reacted positively to these deals. Their estimated TBTF subsidy is large enough to create serious concern, since recent assisted mergers have allowed TBTF organizations to become even bigger and for nonbanks to become part of TBTF banking organizations, thus extending the TBTF subsidy beyond banking.
    Keywords: Bank failures ; Bank size ; Bank mergers ; Systemic risk
    Date: 2009
  9. By: Jørn Inge Halvorsen (Norges Bank and Norwegian School of Management (BI)); Dag Henning Jacobsen (Norges Bank (Central Bank of Norway))
    Abstract: We analyze the importance of bank lending shocks on real activity in Norway and the UK, using structural VARs and based on quarterly data for the past 21 years. The VARs are identified using a combination of sign and short-term zero restrictions, allowing for simultaneous interaction between various variables. We find that a negative bank lending shock causes output to contract. The significance of bank lending shocks seems evident as they explain a substantial share of output gap variability. This suggests that the banking sector is an important source of shocks. The empirical analysis comprises the Norwegian banking crisis (1988-1993) and the recent period of banking failures and recession in the UK. The results are clearly non-negligible also when omitting periods of systemic banking distress from the sample.
    Keywords: Identification, VAR, Monetary Policy, Bank lending.
    Date: 2009–12
  10. By: Alessandro Fedele; Francesco Liucci; Andrea Mantovani
    Abstract: In this paper we propose a moral hazard model to illustrate a credit crunch scenario. A firm is denied the access to bank funding due to high informational or monitoring costs that the bank must pay to induce the firm to behave. This is likely to happen in periods of recession, when trust between economic actors is limited. We then examine the activity carried out by the European Investment Bank Group (EIBG), with special attention to the provision of (1) credit lines to banks to help them to finance small and medium-sized enterprises (SMEs) and (2) guarantees for portfolios of SMEs' loans. We show that such services are extremely helpful to overcome the credit crunch as they mitigate the moral hazard problem without resorting to informational or monitoring expenses.
    Date: 2009
  11. By: Daniel Cooper
    Abstract: Using data from the Panel Study of Income Dynamics, this paper examines how households' home equity extraction during 2001-to-2003 and 2003-to-2005 affected their spending and saving behavior. The results show that a one-dollar increase in equity extraction led to ninety-five or ninety-eight cents higher consumption expenditures. Nearly all of this spending increase was reversed in the subsequent period. A fair amount of these expenditures went toward home improvements and repairs. In addition, households used home equity to help finance their purchases of used cars. Equity extraction also led to some household balance sheet reshuffling. In particular, households who extracted equity were somewhat more likely than other households to pay down their higher-cost credit card debt and to invest in other real estate and businesses. Overall, the results in this paper are consistent with households' extracting equity during the first half of this decade to fund one-time durable good consumption needs.
    Keywords: Home equity loans ; Consumer behavior
    Date: 2009
  12. By: D. Sornette; R. Woodard
    Abstract: The financial crisis of 2008, which started with an initially well-defined epicenter focused on mortgage backed securities (MBS), has been cascading into a global economic recession, whose increasing severity and uncertain duration has led and is continuing to lead to massive losses and damage for billions of people. Heavy central bank interventions and government spending programs have been launched worldwide and especially in the USA and Europe, with the hope to unfreeze credit and boltster consumption. Here, we present evidence and articulate a general framework that allows one to diagnose the fundamental cause of the unfolding financial and economic crisis: the accumulation of several bubbles and their interplay and mutual reinforcement has led to an illusion of a ``perpetual money machine'' allowing financial institutions to extract wealth from an unsustainable artificial process. Taking stock of this diagnostic, we conclude that many of the interventions to address the so-called liquidity crisis and to encourage more consumption are ill-advised and even dangerous, given that precautionary reserves were not accumulated in the ``good times'' but that huge liabilities were. The most ``interesting'' present times constitute unique opportunities but also great challenges, for which we offer a few recommendations.
    Keywords: Financial crisis, bubbles, real estate bubble, derivatives, super-exponential
    JEL: O16
    Date: 2009–05–02
  13. By: Ying Jiao (PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII)
    Abstract: We study multiple defaults where the global market information is modelled as progressive enlargement of filtrations. We shall provide a general pricing formula by establishing a relationship between the enlarged filtration and the reference default-free filtration in the random measure framework. On each default scenario, the formula can be interpreted as a Radon-Nikodym derivative of random measures. The contagion risks are studied in the multi-defaults setting where we consider the optimal investment problem in a contagion risk model and show that the optimization can be effectuated in a recursive manner with respect to the default-free filtration.
    Date: 2009–12–16
  14. By: Bougheas, Spiros (University of Nottingham); Dasgupta, Indraneel (University of Durham); Morrissey, Oliver (University of Nottingham)
    Abstract: Lenders condition future loans on some index of past performance. Typically, banks condition future loans on repayments of earlier obligations whilst international organizations (official lenders) condition future loans on the implementation of some policy action (‘investment’). We build an agency model that accounts for these tendencies. The optimal conditionality contract depends on exclusivity – the likelihood that a borrower who has been denied funds from the original lenders can access funds from other lenders.
    Keywords: repayment conditions, investment conditions, long-term loans, exclusivity
    JEL: G21 F34
    Date: 2009–11
  15. By: Arnaud Bourgain; Patrice Pieretti; Skerdilajda Zanaj (CREA, University of Luxembourg)
    Abstract: In this paper, we analyze the risk taking behavior of banks in emerging economies, in a context of international bank competition. In the spirit of Vives (2002 and 2006) who has developed the notion of "external market discipline", our paper introduces a new channel through which depositors can exercise pressure to control risk taking. They can reallocate their savings away from their home country to a more protective system of a developed economy. In such a frame- work, we show that there is no univoque relationship between the information disclosure of risk management and excessive risk taking. This relationship depends on the degree of financial openness of the emergent country, which ultimately defines how e¤ective the market discipline is. Furthermore, we analyze the risk taking choice of banks in emergent economies in presence of deposit insurance. We find no monotone relationship between the likeliness of excessive risk taking of banks in the emerging country and the level of deposit insurance.
    JEL: G21 G28 F39 L60
    Date: 2009
  16. By: Alexander Popov (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We study the relative effect of venture capital and bank finance on large manufacturing firms in local U.S. markets. Theory predicts that with venture capital, the firm size distribution should become more stretched-out to the right, but it’s ambiguous on the effect of banks on large firms. The empirical evidence suggests that while the average size of firms in the top bin of the firm size distribution has remained unaffected by banking sector developments, it has increased with venture capital investment. We argue that this is due to the emergence of new corporate giants rather than the growth of existing ones. JEL Classification: G24, J24, L11.
    Keywords: venture capital, banking, firm size.
    Date: 2009–12
  17. By: Skjeltorp, Johannes (Norges Bank); Ødegaard, Bernt Arne (University of Stavanger)
    Abstract: We investigate the information content of aggregate stock market liquidity and ask whether it may be a useful realtime indicator, both for financial stress, and real economic activity in Norway. We describe the development in a set of liquidity proxies at the Oslo Stock Exchange (OSE) for the period 1980-2008, with particular focus on crisis period 2007 through 2008, showing how market liquidity and trading activity changed for the whole market as well as for individual industry sectors. We also evaluate the predictive power of market liquidity for economic growth both in-sample and out-of-sample.
    Keywords: Liquidity; Business Cycles; Financial crisis; Economic Activity
    JEL: G10 G20
    Date: 2009–12–03
  18. By: Helena Marrez (Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussels); Mathias Schmit (Centre Emile Bernheim, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussels)
    Abstract: This paper is the first to analyze the credit risk of a microfinance institution based on the loan portfolio of a leading Maghrebian microfinance institution, both in terms of number of clients served and of portfolio size. This allows us to work with a proprietary data set of 1,144,770 contracts issued between 1997 and 2007. Using a resampling technique, we estimate the probability density function of losses and value-at-risk measures for a portfolio of loans granted to female and male microfinance clients separately. Results show that loss rates are higher for a male client population than for a female client population, both on average as for percentiles 95 to 99.99. We find that this difference is due to lower default probabilities for female clients, while recovery rates for male and female clients are similar. We also analyze diversification effects, where we find that the proportion of diversifiable risk in total risk is bigger for portfolios of loans granted to female clients than for portfolios of loans granted to male clients. Finally we show that capital requirements determined by the 99.9 percentile remain below those required by the Basel 2 Accords, which opens perspectives for a specific treatment of microfinance if financial regulation becomes applicable to the sector.
    Keywords: Microfinance; Credit risk; Gender study; Bank regulation; Capital requirement
    JEL: G21 G28 O16
    Date: 2009–04
  19. By: Cieply, S.; Dejardin, M.A.F.G. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: We study financial constraints new firms suffer from in France during the mid-nineties. Three types of constraints are distinguished: the classic and well-known weak and strong credit rationing and the new concept of self-rationing bound to the theory of discouraged borrowers. We look for these constraints on a sample of new firms which survived at least 3 years during the mid-nineties. Empirical findings show credit constraints as a whole concern 41.96% of the sample and a very low proportion of new firms suffer from credit rationing “à la Stiglitz-Weissâ€. Weak credit rationing and self-rationing, caused by discouragement, are more widespread among French new firms. We highlight moreover the role of banks during the post-start up stage even if firms have suffered from credit rationing at the beginning of their life. Results not only suggest the absence of firms’ path of exclusion on the credit market but the rent expropriation by banks.
    Keywords: credit rationing;self-rationing;discouragement;banks
    Date: 2009–12–01
  20. By: Marie Lambert (Luxembourg School of Finance, University of Luxembourg); George Hübner (HEC Management School, University of Liège); Marie Lambert (HEC Montreal.)
    Abstract: This paper re-examines the ability of the factor model approach to evaluate the performance of hedge funds. The analysis incorporates traditional asset based factors as well as an array of new and previously studied option based factors and instrumental variables. As hedge fund returns are not normally distributed, higher order moments play a significant role in maximizing the investors’ expected utility. As a result, hedge fund performance evaluation should assign a premium to higher order asset co-moments of hedge fund returns with the aggregate market in order to consistently capture the sources of hedge fund returns. We provide evidence that there is still much information embedded in option prices, particularly in the implied higher moments, which has not previously been exploited. These new option based factors increase the explanatory power of the models across all the hedge fund strategies.
    Keywords: Hedge funds, style, higher-moment, option-based factors, conditional factors
    JEL: G12 C32
    Date: 2009
  21. By: Joao Ricardo Faria; Le Wang; Zhongmin Wu
    Abstract: This paper studies the impact of mortgages on consumer debt and on debt on durable goods. We first present a stylized model in which an outstanding debt, representing mortgages, affects positively consumer debt, and debt on durable goods. The model is empirically tested for the U.S. using PSID 2005 wave. Our results are striking. First, we find strong evidence supporting a positive association between mortgage loans and consumer debts, regardless of the measures used, the control variables used, and the methods used. Second, we find that the effects of mortgages on the debt on durable goods are in general smaller than the effects of mortgages on consumer debt. Third, our distributional analysis reveals that the effects monotonically decrease as the quantile increases. Finally, our results are also confirmed by the results using the U.K. data.
    Keywords: Consumer expenditure, housing, credit, censored regressions
    JEL: G21 E44 R21 R31
    Date: 2009–12

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