New Economics Papers
on Banking
Issue of 2010‒04‒11
twenty-two papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Illiquidity and all its friends By Jean Tirole
  2. Financial intermediation and the post-crisis financial system By Hyun Song Shin
  3. Fear of fire sales and the credit freeze By Douglas W Diamond
  4. Executive compensation and business policy choices at U.S. commercial banks By Robert DeYoung; Emma Y. Peng; Meng Yan
  5. The failure mechanics of dealer banks By Darrell Duffie
  6. How Does Competition Impact Bank Risk-Taking? By Gabriel Jiménez; Jose A. Lopez; Jesús Saurina
  7. Credit demand and supply in Italy during the financial crisis By Fabio Panetta; Federico M. Signoretti
  8. What explains the low profitability of Chinese Banks? By Alicia García-Herrero; Sergio Gavilá; Daniel Santabárbara
  9. Shocks to bank capital: evidence from UK banks at home and away By Mora, Nada; Logan, Andrew
  10. Stressed, not frozen: the Federal Funds market in the financial crisis By Gara Afonso; Anna Kovner; Antoinette Schoar
  11. Does monetary policy affect bank risk-taking? By Yener Altunbas; Leonardo Gambacorta; David Marqués-Ibáñez
  12. Credit and recessions. By Fabrizio Coricelli; Isabelle Roland
  13. The U.S. and Irish Credit Crises: Their Distinctive Differences and Common Features By Gregory Connor; Thomas Flavin; Brian O’Kelly
  14. Financial Shocks and Optimal Policy By Dellas, H.; Diba, B.; Loisel, O.
  15. Portfolio optimization in a defaults model under full/partial information By Thomas Lim; Marie-Claire Quenez
  16. Chained Credit Contracts and Financial Accelerators By Naohisa Hirakata; Nao Sudo; Kozo Ueda
  17. What explains differences in foreclosure rates?: a response to Piskorski, Seru, and Vig By Manuel Adelino; Kristopher Gerardi; Paul S. Willen
  18. Does the Current Account Balance Help to Predict Banking Crises in OECD Countries? By Ray Barrell; E. Philip Davis; Iana Liadze; D, Karim
  19. Measuring financial access around the world By Kendall, Jake; Mylenko, Nataliya; Ponce, Alejandro
  20. The euro area Bank Lending Survey matters - empirical evidence for credit and output growth By Gabe de Bondt; Angela Maddaloni; José-Luis Peydró; Silvia Scopel
  21. Credit Derivatives By Giandomenico, Rossano
  22. In the wake of the crisis: dealing with distressed debt across the transition region By Ralph De Haas; Stephan Knobloch

  1. By: Jean Tirole
    Abstract: The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macro-prudential policies.
    Keywords: liquidity, contagion, bailouts, regulation
    Date: 2010–03
  2. By: Hyun Song Shin
    Abstract: Securitization was meant to disperse credit risk to those who were better able to bear it. In practice, securitization appears to have concentrated the risks in the financial intermediary sector itself. This paper outlines an accounting framework for the financial system for assessing the impact of securitization on financial stability. If securitization leads to the lengthening of intermediation chains, then risks becomes concentrated in the intermediary sector with damaging consequences for financial stability. Covered bonds are one form of securitization that do not fall foul of this principle. I discuss the role of countercyclial capital requirements and the Spanish-style statistical provisioning in mitigating the harmful effects of lengthening intermediation chains.
    Keywords: leverage, financial intermediation chains, financial stability
    Date: 2010–03
  3. By: Douglas W Diamond
    Abstract: Is there any need to “clean” up a banking system in the midst of a crisis, by closing or recapitalizing weak banks and taking bad assets off bank balance sheets, or can one wait till the crisis is over? We argue that an “overhang” of impaired banks that may be forced to sell assets soon can reduce the current price of illiquid assets sufficiently that weak banks have no interest in selling them. Anticipating a potential future fire sale, cash rich buyers have high expected returns to holding cash, which also reduces their incentive to lock up money in term loans. The potential for a worse fire sale than necessary, as well as the associated decline in credit origination, could make the crisis worse, which is one reason it may make sense to clean up the system even in the midst of the crisis. We discuss alternative ways of cleaning up the system, and the associated costs and benefits.
    Keywords: fire sales, illiquid securities, bank fragility, prudential policy
    Date: 2010–03
  4. By: Robert DeYoung; Emma Y. Peng; Meng Yan
    Abstract: This study examines whether and how the terms of CEO compensation contracts at large commercial banks between 1994 and 2006 influenced, or were influenced by, the risky business policy decisions made by these firms. We find strong evidence that bank CEOs responded to contractual risk-taking incentives by taking more risk; bank boards altered CEO compensation to encourage executives to exploit new growth opportunities; and bank boards set CEO incentives in a manner designed to moderate excessive risk-taking. These relationships are strongest during the second half of our sample, after deregulation and technological change had expanded banks' capacities for risk-taking.
    Date: 2010
  5. By: Darrell Duffie
    Abstract: I explain the key failure mechanics of large dealer banks, and some policy implications. This is not a review of the financial crisis of 2007–2009. Systemic risk is considered only in passing. Both the financial crisis and the systemic importance of large dealer banks are nevertheless obvious and important motivations.
    Keywords: liquidity, dealer banks, OTC markets, financial crisis
    Date: 2010–03
  6. By: Gabriel Jiménez (Banco de España); Jose A. Lopez (Federal Reserve Bank Of San Francisco); Jesús Saurina (Banco de España)
    Abstract: A common assumption in the academic literature is that franchise value plays a key role in limiting bank risk-taking. As market power is the primary source of franchise value, reduced competition in banking markets has been seen as promoting banking stability. We test this hypothesis using data for the Spanish banking system. We find that standard measures of market concentration do not affect bank risk-taking. However, we find a negative relationship between market power measured using Lerner indexes based on bank-specific interest rates and bank risk. Our results support the franchise value paradigm.
    Keywords: bank competition, franchise value, Lerner index, credit risk, financial stability.
    JEL: G21 L11
    Date: 2010–03
  7. By: Fabio Panetta (Banca d'Italia); Federico M. Signoretti (Banca d'Italia)
    Abstract: The paper analyzes developments in bank lending in Italy during the financial crisis, assessing the relative contribution of demand and supply factors to lending deceleration. We find that the slowdown in lending was mainly due to a reduction in demand. For households, this can be attributed to the weakness of the real estate market and to the fall in consumption; for firms, a diminution in financing needs, due in turn to the sharp contraction of investment. Credit market indicators and empirical studies suggest that lending growth may also have been curbed by tensions in credit supply. These tensions mainly reflected the increase in borrower risk, as well as the impact of the crisis – especially in its first phase – on banks’ capital, liquidity, and ability to access external funding. Econometric analyses corroborate these indications, suggesting that the overall impact of banks’ conditions on the lending slowdown was modest. Over the next few months, supply tensions could persist, but the risk of a limitation of credit will be moderated by the economic recovery and the consequent reduction in borrower default risk. There will also be support from public interventions, which have provided financial support to firms, improving their creditworthiness, and strengthened banks’ capital and liquidity position.
    Keywords: credit demand and supply, financial crisis, Italian economy.
    JEL: E51 E58 E65
    Date: 2010–04
  8. By: Alicia García-Herrero; Sergio Gavilá; Daniel Santabárbara
    Abstract: This paper analyzes empirically what explains the low profitability of Chinese banks for the period 1997-2004. We find that better capitalized banks tend to be more profitable. The same is true for banks with a relatively larger share of deposits and for more X-efficient banks. In addition, a less concentrated banking system increases banks profitability, which basically reflects that the four state-owned commercial banks –China’s largest banks- have been the main drag for system’s profitability. We find the same negative influence for China’s development banks (so called Policy Banks), which are fully state-owned. Instead, more market oriented banks, such as joint-stock commercial banks, tend to be more profitable, which again points to the influence of government intervention in explaining bank performance in China. These findings should not come as a surprise for a banking system which has long been functioning as a mechanism for transferring huge savings to meet public policy goals.
    Keywords: China; Bank profitability; Bank reform
    JEL: G21 G28
    Date: 2009–04
  9. By: Mora, Nada (Federal Reserve Bank of Kansas City); Logan, Andrew (Oxford Economics)
    Abstract: This paper assesses how shocks to bank capital may influence a bank’s portfolio behaviour using novel evidence from a UK bank panel data set from a period that pre-dates the recent financial crisis. Focusing on the behaviour of bank loans, we extract the dynamic response of a bank to innovations in its capital and in its regulatory capital buffer. We find that innovations in a bank’s capital in this (pre-crisis) sample period were coupled with a loan response that lasted up to three years. Banks also responded to scarce regulatory capital by raising their deposit rate to attract funds. The international presence of UK banks allows us to identify a specific driver of capital shocks in our data, independent of bank lending to UK residents. Specifically, we use write-offs on loans to non-residents to instrument bank capital’s impact on UK resident lending. A fall in capital brought about a significant drop in lending in particular, to private non-financial corporations. In contrast, household lending increased when capital fell, which may indicate that – in this pre-crisis period – banks substituted into less risky assets when capital was short.
    Keywords: Bank capital; bank lending
    JEL: E44 F34 G21
    Date: 2010–03–31
  10. By: Gara Afonso; Anna Kovner; Antoinette Schoar
    Abstract: This paper examines the impact of the financial crisis of 2008, specifically the bankruptcy of Lehman Brothers, on the federal funds market. Rather than a complete collapse of lending in the presence of a market-wide shock, we see that banks became more restrictive in their choice of counterparties. Following the Lehman bankruptcy, we find that amounts and spreads became more sensitive to a borrowing bank's characteristics. While the market did not contract dramatically, lending rates increased. Further, the market did not seem to expand to meet the increased demand predicted by the drop in other bank funding markets. We examine discount window borrowing as a proxy for unmet fed funds demand and find that the fed funds market is not indiscriminate. As expected, borrowers who access the discount window have a lower return on assets. On the lender side, we do not find that the characteristics of the lending bank significantly affect the amount of interbank loans it makes. In particular, we do not find that worse performing banks began hoarding liquidity and indiscriminately reducing their lending.
    Keywords: Federal funds ; Financial crises ; Bank liquidity ; Interbank market ; Discount window
    Date: 2010
  11. By: Yener Altunbas (Centre for Banking and Financial Studies, Bangor University, Bangor, Gwynedd LL57 2DG, United Kingdom.); Leonardo Gambacorta (Bank for International Settlements, Monetary and Economics Department, Centralbahnplatz 2, CH-4002 Basel, Switzerland.); David Marqués-Ibáñez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper investigates the relationship between short-term interest rates and bank risk. Using a unique database that includes quarterly balance sheet information for listed banks operating in the European Union and the United States in the last decade, we find evidence that unusually low interest rates over an extended period of time contributed to an increase in banks' risk. This result holds for a wide range of measures of risk, as well as macroeconomic and institutional controls. JEL Classification: E44, E55, G21.
    Keywords: bank risk, monetary policy, credit crisis.
    Date: 2010–03
  12. By: Fabrizio Coricelli (Centre d'Economie de la Sorbonne and CEPR); Isabelle Roland (LSE)
    Abstract: The paper develops a simple model on the asymmetric role of credit markets in output fluctuations. When credit markets are underdeveloped and enterprise activity is financed by trade credit, shocks may induce a break-up of credit and production chains, leading to sudden and sharp contractions. The development of a banking sector can reduce the probability of such collapses and hence plays a crucial role in softening output declines. However, the banking sector becomes a shock amplifier when shocks originate in the financial sector. Using industry-level data across a large cross-section of countries, we provide evidence in support of the model's predictions.
    Keywords: Credit chains, trade credit, recessions, financial development.
    JEL: O40 F30
    Date: 2010–01
  13. By: Gregory Connor (Economics,Finance and Accounting, National University of Ireland, Maynooth); Thomas Flavin (Economics,Finance and Accounting, National University of Ireland,Maynooth); Brian O’Kelly (Dublin City University)
    Abstract: Abstract: Although the US credit crisis precipitated it, the Irish credit crisis is an identifiably separate one, which might have occurred in the absence of the U.S. crash. The distinctive differences between them are notable. Almost all the apparent causal factors of the U.S. crisis are missing in the Irish case; and the same applies vice-versa. At a deeper level, we identify four common features of the two credit crises: capital bonanzas, irrational exuberance, regulatory imprudence, and moral hazard. The particular manifestations of these four “deep” common features are quite different in the two cases.
    Date: 2010
  14. By: Dellas, H.; Diba, B.; Loisel, O.
    Abstract: This paper incorporates banks as well as frictions in the market for bank capital into a standard New Keynesian model and considers the positive and normative implications of various financial shocks. It shows that the frictions matter significantly for the effects of the shocks and the properties of optimal monetary and fiscal policy. For instance, for shocks that increase banks' demand for liquidity, optimal monetary policy accepts an output contraction while it would not in the absence of the frictions (or under suitably conducted fiscal policy). We find that optimal monetary policy can be approximated by a simple interest-rate rule targeting inflation; and it also allows large adjustments in the money supply, a property reminiscent of Poole's analysis.
    Keywords: Financial frictions, banking, optimal policy
    JEL: E2 E4
    Date: 2010
  15. By: Thomas Lim (PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII); Marie-Claire Quenez (PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII)
    Abstract: In this paper, we consider a financial market with assets exposed to some risks inducing jumps in the asset prices, and which can still be traded after default times. We use a default-intensity modeling approach, and address in this incomplete market context the problem of maximization of expected utility from terminal wealth for logarithmic, power and exponential utility functions. We study this problem as a stochastic control problem both under full and partial information. Our contribution consists in showing that the optimal strategy can be obtained by a direct approach for the logarithmic utility function, and the value function for the power utility function can be determined as the minimal solution of a backward stochastic differential equation. For the partial information case, we show how the problem can be divided into two problems: a filtering problem and an optimization problem. We also study the indifference pricing approach to evaluate the price of a contingent claim in an incomplete market and the information price for an agent with insider information.
    Keywords: Optimal investment, default time, default intensity, filtering, dynamic programming principle, backward stochastic differential equation, indifference price, information pricing, logarithmic utility, power utility, exponential utility.
    Date: 2010–03–29
  16. By: Naohisa Hirakata (Deputy Director, Research and Statistics Department, Bank of Japan. (E-mail:; Nao Sudo (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:; Kozo Ueda (Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:
    Abstract: Based on the financial accelerator model of Bernanke et al. (1999), we develop a dynamic general equilibrium model for a chain of credit contracts in which financial intermediaries (hereafter FIs) as well as entrepreneurs are subject to credit constraints. Financial intermediation takes place through chained-credit contracts, lending from the market to FIs, and from FIs to entrepreneurs. Calibrated to U.S. data, our model shows that the chained credit contracts enhance the financial accelerator effect, depending on the net worth distribution across sectors: (1) our model reinforces the effects of the net worth shock and the technology shock, compared with a model that omits the FIs' credit friction a la Bernanke et al. (1999); (2) the sectoral shock to FIs has a greater impact than the sectoral shock to entrepreneurs; and (3) the redistribution of net worth from entrepreneurs to FIs reduces the amplification of the technology shock. The key features of the results arise from the asymmetry of the two borrowing sectors: smaller net worth and larger bankruptcy costs of FIs relative to those of entrepreneurs.
    Keywords: Chain of Credit Contracts, Net Worth of Financial Intermediaries, Cross-sectional Net Worth Distribution, Financial Accelerator effect
    JEL: E22 E44
    Date: 2009–11
  17. By: Manuel Adelino; Kristopher Gerardi; Paul S. Willen
    Abstract: In this note we discuss the findings in Piskorski, Seru, and Vig (2010), as well as the authors' interpretation of their results. First, we find that small changes to the set of covariates used by PSV significantly reduce the magnitude of the differences in foreclosure rates between securitized and nonsecuritized loans. Second, we argue that early payment defaults (EPD) are not a valid instrument for the securitization status of the loans and that the empirical implementation chosen by the authors for using EPD is not a valid instrumental variables approach. Finally, we discuss the use of foreclosure rates as a measure of renegotiation and argue that explicitly using modification rates of delinquent mortgages is a better way of studying renegotiation activity. On balance, the evidence in PSV indicates that there are at most small differences in the outcomes of delinquent loans, but whether those differences reflect accounting issues, willingness to renegotiate, or unobserved heterogeneity remains an open question.
    Keywords: Foreclosure ; Mortgage-backed securities ; Mortgage loans
    Date: 2010
  18. By: Ray Barrell; E. Philip Davis; Iana Liadze; D, Karim
    Abstract: Given the magnitude of “global imbalances” in the run-up to the subprime crisis, we test for an impact of the current account balance on the probability of banking crises in OECD countries since 1980. This variable has been neglected in most early warning models to date, despite its prominence in theory and in case studies of crises. We find that a current account variable is significant in a parsimonious logit model also featuring bank capital adequacy, liquidity and changes in house prices, thus showing the patterns immediately preceding the subprime crisis were not unprecedented. Our model, even if estimated over an earlier period such as 1980-2003, could have helped authorities to forecast the subprime crisis accurately and take appropriate regulatory measures to reduce its impact.
    Date: 2010–03
  19. By: Kendall, Jake; Mylenko, Nataliya; Ponce, Alejandro
    Abstract: This paper introduces a new set of financial access indicators for 139 countries across the globe and describes the results of a preliminary analysis of this data set. The new data set builds on previous work using a similar methodology. The new data set features broader country coverage and greater disaggregation by type of financial product and by type of institution supplying the product -- commercial banks, specialized state run savings and development banks, banks with mutual ownership structure (such as cooperatives), and microfinance institutions. The authors use the data set to conduct a rough estimation of the number of bank accounts in the world (6.2 billion) as well as the number of banked and unbanked individuals. In developed countries, they estimate 3.2 accounts per adult and 81 percent of adults banked. By contrast, in developing countries, they estimate only 0.9 accounts per adult and 28 percent banked. In regression analysis, they find that measures of development and physical infrastructure are positively associated with the indicators of deposit account, loan, and branch penetration.
    Keywords: Access to Finance,Banks&Banking Reform,Debt Markets,Emerging Markets,E-Business
    Date: 2010–03–01
  20. By: Gabe de Bondt (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Angela Maddaloni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); José-Luis Peydró (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Silvia Scopel (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This study examines empirically the information content of the euro area Bank Lending Survey for aggregate credit and output growth. The responses of the lending survey, especially those related to loans to enterprises, are a significant leading indicator for euro area bank credit and real GDP growth. Notwithstanding the short history of the survey, the findings are robust across various specifications, including “horse races” with other well-known leading financial indicators. Our results are supportive of the existence of a bank lending, balance sheet, and risk-taking channel of monetary policy. They also suggest that price as well as non-price conditions and terms of credit standards do matter for credit and business cycles. Finally, we discuss the implications for the 2007/2009 financial and economic crisis. JEL Classification: C23, E32, E51, E52, G21, G28.
    Keywords: bank lending survey, credit cycle, business cycle, monetary policy transmission, euro area.
    Date: 2010–02
  21. By: Giandomenico, Rossano
    Abstract: The article presents a survey of the principal quantitative tools adopted by the major financial institutions in the credit market, pointing out their limits and new directions.
    Keywords: Implied Default Probability; Implied Correlation; Implied Time to Default
    JEL: G13
    Date: 2010–02–21
  22. By: Ralph De Haas (European Bank of Reconstruction and Development); Stephan Knobloch (European Bank of Reconstruction and Development)
    Abstract: This paper reviews the origin and spread of the distressed debt problem in the transition region. We argue that while the crisis was triggered abroad, the current high level of distressed debt in various transition countries mainly reflects home-grown vulnerabilities. As in the West, the root causes of the debt problem were abundant and cheap funding and a gradual relaxation of banks’ lending standards – in particular an excessive reliance on rising real estate values.
    Keywords: distressed debt, insolvemcy, financial crisis
    JEL: F34 F36 G21 G28 G33 K0
    Date: 2010–02

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