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on Banking |
| By: | Sheri Markose; Simone Giansante; Mateusz Gatkowski; Ali Rais Shaghaghi |
| Abstract: | Credit default swaps (CDS) which constitute up to 98% of credit derivatives have had a unique, endemic and pernicious role to play in the current financial crisis. However, there are few in depth empirical studies of the financial network interconnections among banks and between banks and nonbanks involved as CDS protection buyers and protection sellers. The ongoing problems related to technical insolvency of US commercial banks is not just confined to the so called legacy/toxic RMBS assets on balance sheets but also because of their credit risk exposures from SPVs (Special Purpose Vehicles) and the CDS markets. The dominance of a few big players in the chains of insurance and reinsurance for CDS credit risk mitigation for banks’ assets has led to the idea of “too interconnected to fail” resulting, as in the case of AIG, of having to maintain the fiction of non-failure in order to avert a credit event that can bring down the CDS pyramid and the financial system. This paper also includes a brief discussion of the complex system Agent-based Computational Economics (ACE) approach to financial network modeling for systemic risk assessment. Quantitative analysis is confined to the empirical reconstruction of the US CDS network based on the FDIC Q4 2008 data in order to conduct a series of stress tests that investigate the consequences of the fact that top 5 US banks account for 92% of the US bank activity in the $34 tn global gross notional value of CDS for Q4 2008 (see, BIS and DTCC). The May-Wigner stability condition for networks is considered for the hub like dominance of a few financial entities in the US CDS structures to understand the lack of robustness. We provide a Systemic Risk Ratio and an implementation of concentration risk in CDS settlement for major US banks in terms of the loss of aggregate core capital. We also compare our stress test results with those provided by SCAP (Supervisory Capital Assessment Program). Finally, in the context of the Basel II credit risk transfer and synthetic securitization framework, there is little evidence that the CDS market predicated on a system of offsets to minimize final settlement can provide the credit risk mitigation sought by banks for reference assets in the case of a significant credit event. The large negative externalities that arise from a lack of robustness of the CDS financial network from the demise of a big CDS seller undermines the justification in Basel II that banks be permitted to reduce capital on assets that have CDS guarantees. We recommend that the Basel II provision for capital reduction on bank assets that have CDS cover should be discontinued. |
| Date: | 2010–02–02 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:683&r=ban |
| By: | Jan Kregel |
| Abstract: | The purpose of the 1933 Banking Act--aka Glass-Steagall--was to prevent the exposure of commercial banks to the risks of investment banking and to ensure stability of the financial system. A proposed solution to the current financial crisis is to return to the basic tenets of this New Deal legislation. Senior Scholar Jan Kregel provides an in-depth account of the Act, including the premises leading up to its adoption, its influence on the design of the financial system, and the subsequent collapse of the Act's restrictions on securities trading (deregulation). He concludes that a return to the Act's simple structure and strict segregation between (regulated) commercial and (unregulated) investment banking is unwarranted in light of ongoing questions about the commercial banks' ability to compete with other financial institutions. Moreover, fundamental reform--the conflicting relationship between state and national charters and regulation--was bypassed by the Act. |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:lev:levppb:ppb_107&r=ban |
| By: | Bulow, Jeremy; Klemperer, Paul |
| Abstract: | Fixing the banks is an absolute priority in G7 nations. Doing this by buying toxic assets is costly, inefficient, and risky. Governments should focus on which liabilities, rather than which assets, they need to support. This column proposes creating “bridge†banks as a way of re-establishing a healthy banking system. |
| Date: | 2009–03–21 |
| URL: | http://d.repec.org/n?u=RePEc:ner:oxford:http://economics.ouls.ox.ac.uk/14324/&r=ban |
| By: | Whelan, Karl |
| Abstract: | Systemic risk refers to the risk of financial system breakdown due to linkages between institutions. This risk cannot be assessed by looking at how individual institutions manage risks but instead requires a full understanding of how the system as a whole operates. At present, the data available to central banks and financial regulators are not at all adequate for the task of assessing systemic risk and the new European Systemic Risk Board needs to address this issue. There is a lot of exciting ongoing research devoted to measuring systemic risk and providing signals to regulators as to when and where they should intervene. However, the tools being developed are still limited in their usefulness. Perhaps more pressing than the development of these tools is the implementation of policy measures to make the financial system more robust. These measures should include higher capital ratios, limits on non-core funding and redesigning financial systems to be less complex. |
| Keywords: | Financial institutions--Management; Risk--Europe; Financial institutions--Law and legislation--Europe; Financial crises--Prevention; |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:ner:ucddub:urn:hdl:10197/1672&r=ban |
| By: | Andrew Ellul; Vijay Yerramilli |
| Abstract: | In this paper, we investigate whether U.S. bank holding companies (BHCs) with strong and independent risk management functions had lower aggregate risk and downside risk. We hand-collect information on the organization structure of the 75 largest publicly-listed BHCs, and use this information to construct a Risk Management Index (RMI) that measures the strength of organizational risk controls at these institutions. We find that BHCs with a high RMI in the year 2006, i.e., before the onset of the financial crisis, had lower exposures to mortgage-backed securities and risky trading assets, were less active in trading off-balance sheet derivatives, and generally fared better in terms of operating performance and lower downside risk during the crisis years (2007 and 2008). In a panel spanning 8 years, we find that BHCs with higher RMIs had lower aggregate risk and downside risk, and higher stock returns, after controlling for size, profitability, a variety of risk characteristics, corporate governance, executive compensation, and BHC fixed effects. This result holds even after controlling for any simultaneity bias. Overall, these results suggest that strong internal risk controls are effective in lowering risk at banking institutions. |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp646&r=ban |
| By: | Celine Gauthier; Alfred Lehar; Moez Souissi |
| Abstract: | In the aftermath of the financial crisis, there is interest in reforming bank regulation such that capital requirements are more closely linked to a bank's contribution to the overall risk of the financial system. In our paper we compare alternative mechanisms for allocating the overall risk of a banking system to its member banks. Overall risk is estimated using a model that explicitly incorporates contagion externalities present in the financial system. We have access to a unique data set of the Canadian banking system, which includes individual banks' risk exposures as well as detailed information on interbank linkages including OTC derivatives. We find that systemic capital allocations can differ by as much as 50% from 2008Q2 capital levels and are not related in a simple way to bank size or individual bank default probability. Systemic capital allocation mechanisms reduce default probabilities of individual banks as well as the probability of a systemic crisis by about 25%. Our results suggest that financial stability can be enhanced substantially by implementing a systemic perspective on bank regulation. |
| Keywords: | Financial stability |
| JEL: | G21 C15 C81 E44 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:10-4&r=ban |
| By: | Elena-Ivona Dumitrescu (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Hurlin (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Bertrand Candelon (Laboratoire d'Economie d'Orléans - Université d'Orléans - CNRS : FRE2783) |
| Abstract: | This paper proposes a new statistical framework originating from the traditional credit- scoring literature, to evaluate currency crises Early Warning Systems (EWS). Based on an assessment of the predictive power of panel logit and Markov frameworks, the panel logit model is outperforming the Markov switching specifications. Furthermore, the introduction of forward-looking variables clearly improves the forecasting properties of the EWS. This improvement confirms the adequacy of the second generation crisis models in explaining the occurrence of crises. |
| Keywords: | currency crisis; Early Warning System; credit-scoring |
| Date: | 2010–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00450050_v1&r=ban |
| By: | Yushi Yoshida (Faculty of Economics, Kyushu Sangyo University) |
| Abstract: | The recent sub-prime financial crisis initially affected the Asian economy to a degree comparable to that of the downturn in the Asian financial crisis; however, the recovery in Asia took place at a much faster pace than during the Asian financial crisis. We investigate whether the effects of sub-prime financial crisis on 13 Asian economies are similar to those of the previous crisis, by examining stock markets for volatility spillovers and causality directions between the US and Asia as well as for the degree of regional integration. The empirical evidence indicates stark differences between these two crises. First, the decline in volatility spillovers during the period of financial turmoil was more pervasive for the Asian financial crisis. Second, the estimated point of transition in correlation is indicative of market participants’ awareness of the upcoming stock market crash in September 2008. Third, the causality from the epicenter of crises is intensified during crisis. Fourth, regional integration was strengthened after the financial turmoil of the recent sub-prime financial crisis but not after the Asian financial crisis. |
| Keywords: | Asia, Contagion, Financial crisis, Spillover, Stock market integration. |
| JEL: | F31 F36 G15 |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:kyu:dpaper:40&r=ban |
| By: | Ojo, Marianne |
| Abstract: | The primary argument of this paper is, namely, that the International Accounting Standards Board (IASB), is in need of an enforcement mechanism. In drawing attention to this argument, the paper not only proposes considerations which are to be taken into account if such a mechanism is to be implemented, but also considers areas in which the regulation of accounting standards, and auditing standards in particular, have contributed to the recent global financial crisis. The impact of such standards on pro cyclicality, the level of success achieved by the IASB and other international standard setters such as the Basel Committee on Banking Supervision, relates to how effectively the accounting and audit standard setting is implemented. As well as identifying the importance of convergence in contributing towards high quality audits and the consistent application of auditing and accounting standards, this paper also acknowledges the difficulties and challenges encountered in attempting to achieve a convergent framework. Furthermore, through a discussion of recommendations aimed at consolidating transparency and accounting, as proposed by the G20, ways in which accounting standards, and consequently the IASB, could contribute further to the improvement of transparency and accountability of the framework for fair value measurements and evaluation, are considered. The absence of enforcement mechanisms, the fact that enforcement actions are carried out at national level in various EU member states, present sources of obstacles to attempts to realise the proposals put forward by the G20. This paper not only attempts to address such factors, but also to suggest ways in which the IASB, to an extent, could realise its goals. Through a consideration of two enforcement regimes in Europe, namely, Germany and the UK, two related standards which govern enforcement in Europe, principles on which harmonisation of the institutional oversight systems in Europe may be achieved , and the vital contribution made by CESR and EFRAG (the European Financial Reporting Advisory Group), this paper will consider how enforcement could be implemented by the IASB at European level. |
| Keywords: | Audit; FASB; IASB; regulation; Financial Crisis; standards |
| JEL: | K2 G2 G3 M4 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:20330&r=ban |
| By: | Petra Benešová (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Petr Teply (EEIP, a.s; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic) |
| Abstract: | As a result of the 2008 financial crisis, the world credit markets stalled significantly and raised the doubts of market participants and policymakers about the proper and fair valuation of financial derivatives and structured products such as collateralized debt obligations (CDOs). The aim of the paper is to contribute to the understanding of CDOs and shed light on CDO valuation based on data before and during the current financial upheaval. We present the One Factor Model based on a Gaussian Copula and test five hypothesizes. Based on the results we discovered four main deficiencies of the CDO market. For our modelling we used data of the CDX NA IG 5Y V3 index from 20 September 2007 until 27 February 2009 and its quotes we appropriately transform into CDO quotes. Based on the results we discovered four main deficiencies of the CDO market: i) an insufficient analysis of underlying assets by both investors and rating agencies; ii) the valuation model was usually based only on expected cash-flows when neglecting other factors such mark-to-market losses or correlation risk; iii) mispriced correlation; and finally iv) the mark-to-market valuation obligation for financial institutions should be reviewed. Based on the mentioned recommendations we conclude that the CDO market has a chance to be regenerated. However, the future CDO market would then be more conscious, driven by smarter motives rather than by poor understanding of risks involved in CDOs. |
| Keywords: | collateralized debt obligations, Gaussian Copula, valuation, securitization |
| JEL: | G32 C63 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2010_01&r=ban |
| By: | Arturo Galindo; Alejandro Izquierdo; Liliana Rojas-Suarez |
| Abstract: | This paper explores the impact of international financial integration on credit markets in Latin America, using a cross-country dataset covering 17 countries between 1996 and 2008. It is found that financial integration amplifies the impact of international financial shocks on aggregate credit and interest rate fluctuations. Nonetheless, the net impact of integration on deepening credit markets dominates for the large majority of states of nature. The paper also uses a detailed bank-level dataset that covers more than 500 banks for a similar time period to explore the role of financial integration—captured through the participation of foreign banks—in propagating external shocks. It is found that interest rates charged and loans supplied by foreign-owned banks respond more to external financial shocks than those supplied by domestically owned banks. This does not hold for all foreign banks. Spanish banks in the sample behave more like domestic banks and do not amplify the impact of foreign shocks on credit and interest rates. |
| Keywords: | Foreign Banks, Credit, Interest Rates, Financial Shocks |
| JEL: | F36 G0 G21 |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:idb:wpaper:4651&r=ban |
| By: | Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Diana Dorobantu (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Areski Cousin (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429) |
| Abstract: | The present paper provides a multi-period contagion model in the credit risk field. Our model is an extension of Davis and Lo's infectious default model. We consider an economy of n firms which may default directly or may be infected by other defaulting firms (a domino effect being also possible). The spontaneous default without external influence and the infections are described by not necessarily independent Bernoulli-type random variables. Moreover, several contaminations could be required to infect another firm. In this paper we compute the probability distribution function of the total number of defaults in a dependency context. We also give a simple recursive algorithm to compute this distribution in an exchangeability context. Numerical applications illustrate the impact of exchangeability among direct defaults and among contaminations, on different indicators calculated from the law of the total number of defaults. We then examine the calibration of the model on iTraxx data before and during the crisis. The dynamic feature together with the contagion effect seem to have a significant impact on the model performance, especially during the recent distressed period. |
| Keywords: | credit risk; contagion model; dependent defaults; default distribution; exchangeability; CDO tranches |
| Date: | 2009–04–08 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00374367_v2&r=ban |
| By: | Jenkinson, Tim; Jones, Howard |
| Abstract: | Competition between investment banks for lead underwriter mandates in IPOs is fierce, but having committed to a particular bank, the power of the issuer is greatly reduced. Although information revelation theories justify giving the underwriters influence over pricing and allocation, this creates the potential for conflicts of interest. In this clinical paper we analyse an interesting innovation that has been used in recent European IPOs whereby issuers separate the preparation and distribution roles of investment banks, and keep competitive pressure on the banks throughout the issue process. These ‘competitive IPOs’ allow the issuer greater control and facilitate more contingent fee structures that help to mitigate against ‘bait and switch’. But unlike more radical departures from traditional bookbuilding - such as auctions - the competitive IPO is an incremental market-based response to potential conflicts of interest that retains many of the advantages of investment banks’ active involvement in issues. |
| JEL: | G3 G24 |
| Date: | 2009–09 |
| URL: | http://d.repec.org/n?u=RePEc:ner:oxford:http://economics.ouls.ox.ac.uk/14297/&r=ban |
| By: | Wilco Bolt; Heiko Schmiedel |
| Abstract: | This paper analyzes the welfare implications of creating a Single Euro Payments Area. We study the effects of increased network compatibility and payment scale economies on consumer and merchant card fees and its impact on card usage. In particular, we model competition among debit cards and between debit and credit cards. We show that competitive pressures dampen merchant fees and increase total card acceptance. The paper argues that there is room for multilateral interchange fee arrangements to achieve optimal consumer and merchant fees, taking safety, income uncertainty, default risk, merchant's pricing power, and the avoided cost of cash at the retailers side into account. Consumers and merchants are likely to benefit the most from the creation of SEPA when sufficient payment card competition alleviates potential monopolistic tendencies. Key Words: SEPA, card network competition, optimal pricing, economic welfare |
| Keywords: | SEPA; card network competition; optimal pricing; economic welfare |
| JEL: | L11 G21 D53 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:239&r=ban |
| By: | Teodora Paligorova |
| Abstract: | This paper investigates the determinants of corporate risk taking. Shareholders with substantial equity ownership in a single company may advocate conservative investment policies due to greater exposure to firm risk. Using a large cross-country sample, I find a positive relationship between corporate risk taking and equity ownership of the largest shareholder. This result is entirely driven by investors holding the largest equity stakes in more than one company. Family shareholders avoid corporate risk taking as their ownership increases unlike mutual funds, banks, financial and industrial companies. Stronger legal protection of shareholder rights is associated with more risk taking, while stronger legal protection of creditor rights reduces risk taking. |
| Keywords: | Financial markets; International topics |
| JEL: | G34 G31 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:10-3&r=ban |
| By: | Jenkinson, Tim; Jones, Howard |
| Abstract: | Despite the central importance of investors to all initial public offering (IPO) theories, relatively little is known about their role in practice. This article is based on a survey of how institutional investors assess IPOs, what information they provide to the investment banking syndicate, and the factors they believe influence allocations. We find that investor characteristics, in particular brokerage relationships with the bookrunner, are perceived to be the most important factors influencing allocations, which supports the view that IPO allocations are part of implicit quid pro quo deals with investment banks. The survey raises doubts as to the extent of information production or revelation. |
| JEL: | G24 G23 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:ner:oxford:http://economics.ouls.ox.ac.uk/14296/&r=ban |
| By: | Marc Labie (Centre Emile Bernheim, CERMi, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussels and Faculté Warocqué, Université Mons-Hainaut.); Pierre-Guillaume Méon (Centre Emile Bernheim, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussels and DULBEA, Université Libre de Bruxelles, Brussels.); Roy Mersland (University of Agder, Norway and Centre Emile Bernheim, CERMi, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussels.); Ariane Szafarz (Centre Emile Bernheim, CERMi, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussels and DULBEA, Université Libre de Bruxelles, Brussels.) |
| Abstract: | This paper studies the relationship between a microfinance institution and its credit officers when the latter are biased against a subgroup of the clientele. Using survey data from Uganda, we provide evidence that credit officers are more biased against disabled borrowers than other employees. In line with the evidence, we then build an agency model of a non-profit MFI and a discriminatory credit officer. Since incentives are costly, and the MFI’s budget is limited, even a non discriminating welfare-maximizing MFI may prefer paying smaller incentives, and letting its credit officer discriminate to some extent. |
| Keywords: | Microfinance, Discrimination, Credit Officers, Incentives. |
| JEL: | G21 O16 J33 L3 |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:sol:wpaper:10-007&r=ban |