New Economics Papers
on Banking
Issue of 2010‒05‒02
39 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Basel Core Principles and Bank Risk: Does Compliance Matter? By Enrica Detragiache; Asli Demirgüç-Kunt
  2. The Procyclical Effects of Bank Capital Regulation By Repullo, R.; Suarez, J.
  3. Changing Perceptions of Maturity Mismatch in the US Banking System: Evidence from Equity Markets By Andrew T. Young; Travis Wiseman; Thomas L. Hogan
  4. Too Interconnected To Fail: Financial Contagion and Systemic Risk In Network Model of CDS and Other Credit Enhancement Obligations of US Banks By Sheri Markose; Simone Giansante; Mateusz Gatkowski; Ali Rais Shaghaghi
  5. Crisis Management and Resolution for a European Banking System By Alessandro Giustiniani; Wim Fonteyne; Wouter Bossu; Alessandro Gullo; Sean Kerr; Daniel C. L. Hardy; Luis Cortavarria
  6. Credit Ratings and Bank Monitoring Ability By Nakamura, L.I.; Roszbach, K.
  7. Market Structure, Welfare, and Banking Reform in China By Chun-Yu Ho
  8. What do premiums paid for bank M&As reflect? The case of the European Union By Jens Hagendorff; Ignacio Hernando; María J. Nieto; Larry D. Wall
  9. The GCC Banking Sector: Topography and Analysis By Abdullah Al-Hassan; Nada Oulidi; May Y. Khamis
  10. A revenue-based frontier measure of banking competition By Santiago Carbó; David Humphrey; Francisco Rodríguez
  11. Information Sharing and Credit Rationing: Evidence from the Introduction of a Public Credit Registry By Cheng, X.; Degryse, H.A.
  12. Credit supply: Identifying balance-sheet channels with loan applications and granted loans By Gabriel Jiménez; Steven Ongena; José-Luis Peydró; Jesús Saurina
  13. Bank Efficiency Amid Foreign Entry: Evidence from the Central American Region By Torsten Wezel
  15. The Lender of Last Resort: Liquidity Provision Versus the Possibility of Bail-out By Nijskens, R.G.M.; Eijffinger, S.C.W.
  16. Regulatory Capital Charges for Too-Connected-to-Fail Institutions: A Practical Proposal By Jorge A. Chan-Lau
  17. Bank Window Dressing: A Re-Assessment and a Puzzle By Shanshan Yang; Sherrill Shaffer
  18. Bank Liquidity, Interbank markets, and Monetary Policy By Freixas, X.; Martin, A.; Skeie, D.
  19. Banking sector output measurement in the euro area – a modified approach By Inklaar, R.; Colangelo, A.
  20. Rational Cost Inefficiency in Chinese Banks By Kent Matthews; Zhiguo Xiao; Xu Zhang
  21. The simple analytics of oligopoly banking in developing economies By Khemraj, Tarron
  22. Collateral, Netting and Systemic Risk in the OTC Derivatives Market By Manmohan Singh
  23. The EU Financial Supervision in the Aftermath of the 2008 Crisis: an Appraisal By Georges Caravelis
  24. Credit Conditions and Recoveries from Recessions Associated with Financial Crises By Prakash Kannan
  25. The International Diversification of Banks and the Value of their Cross-Border M&A Advice By Jong, A. de; Ongena, S.; Poel, M. van der
  26. Discriminatory Power and Predictions of Defaults of Structural Credit Risk Models By T. C. Wong; C. H. Hui; C. F. Lo
  27. How did a domestic housing slump turn into a global financial crisis? By Steven B. Kamin; Laurie Pounder DeMarco
  28. Financial statistics for the United States and the crisis: what did they get right, what did they miss, and how should they change? By Matthew J. Eichner; Donald L. Kohn; Michael G. Palumbo
  29. Distortionary effects of anti-crisis measures and how to limit them, DNB Occasional Studies By W.A van den End; S.A.M. Verkaart; K.A. van Dijkhuizen
  30. Asset Securitization and Optimal Retention By John Kiff; Michael Kisser
  31. Insurance regulation and the credit crisis. What’s new? By Ferro, Gustavo
  32. What Discourages Small Businesses from Asking for Loans? The International Evidence on Borrower Discouragement By Sugato Chakravarty; Meifang Xiang
  33. Financial literacy and subprime mortgage delinquency: evidence from a survey matched to administrative data By Kristopher Gerardi; Lorenz Goette; Stephan Meier
  34. Monetary Policy and Excessive Bank Risk Taking By Agur, I.; Demertzis, M.
  35. To what extent is the financial crisis a governance crisis? From diagnosis to possible remedies By Van den Berghe, L.
  36. Repo Runs By Martin, A.; Skeie, D.; Thadden, E.L. von
  37. The Global Crisis: Why Regulators Resist Reforms By Leo F. Goodstadt
  38. Interest on excess reserves as a monetary policy instrument: the experience of foreign central banks By David Bowman; Etienne Gagnon; Mike Leahy
  39. Toward a Uniform Functional Model of Payment and Securities Settlement Systems By Ron Berndsen

  1. By: Enrica Detragiache; Asli Demirgüç-Kunt
    Abstract: This paper studies whether compliance with the Basel Core Principles for effective banking supervision (BCPs) is associated with bank soundness. Using data for over 3,000 banks in 86countries, we find that neither the overall index of BCP compliance nor its individual components are robustly associated with bank risk measured by Z-scores. We also fail to find a relationship between BCP compliance and systemic risk measured by a system-wide Zscore.
    Keywords: Bank reforms , Bank regulations , Bank soundness , Bank supervision , Banks , Basel Core Principles , Credit risk , Cross country analysis , Financial risk ,
    Date: 2010–03–29
  2. By: Repullo, R.; Suarez, J. (Tilburg University, Center for Economic Research)
    Abstract: We assess the procyclical effects of bank capital regulation in a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that under cyclically-varying risk-based capital requirements (e.g. Basel II) banks hold larger buffers in expansions than in recessions. Yet, these buffers are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level underlying Basel II can reduce its procyclical effects on the supply of credit without compromising banks’ long-run solvency targets.
    Keywords: Banking regulation;Basel II;Business cycles;Capital requirements;Credit crunch;Loan defaults;Relationship banking.
    JEL: G21 G28 E44
    Date: 2010
  3. By: Andrew T. Young (Department of Economics, West Virginia University); Travis Wiseman (Department of Economics, West Virginia University); Thomas L. Hogan (Department of Economics, George Mason University)
    Abstract: US banks are thought to have become increasingly fragile and exposed during the lead-up to the recent financial crisis. However, commercial bank leverage actually decreased during this period. To resolve this discrepancy, we explore another dimension of bank balance sheets: the effective maturity mismatch between assets and liabilities. Although banks assets are generally longer in term than their liabilities, we find evidence of a structural break in the mid-1990s when equity markets begin pricing banks as relatively longer-funded. Categories of bank assets such as real estate loans (i.e., mortgages and MBSs) and consumer loans were perceived as having become effectively shorter-term.
    Keywords: maturity mismatch, effective maturity, commercial banks, GSEs, Fannie and Freddie
    JEL: G21 E44
    Date: 2010
  4. 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.
    Keywords: Credit Default Swaps; Financial Networks; Systemic Risk; Agent Based; Credit Default Swaps, Financial Networks, Systemic Risk, Agent Based Models, Complex Systems, Stress Testing
    Date: 2010–04–21
  5. By: Alessandro Giustiniani; Wim Fonteyne; Wouter Bossu; Alessandro Gullo; Sean Kerr; Daniel C. L. Hardy; Luis Cortavarria
    Abstract: This paper proposes an integrated crisis management and resolution framework for the EU's single banking market. It comprises a European Resolution Authority (ERA), armed with the mandate and the tools to deal cost-effectively with failing systemic cross-border banks, and is designed to address many fundamental operational and incentive problems. It also seeks to reduce moral hazard and better protect countries against the risk of twin fiscal-financial crises by detaching banks from government budgets. The ERA would be most effective if it were twinned or combined with a European Deposit Insurance and Resolution Fund.
    Keywords: Bank reforms , Bank resolution , Bank supervision , Banking crisis , Banking systems , Economic integration , European Monetary System , Financial crisis , Financial stability , Global Financial Crisis 2008-2009 , Risk management ,
    Date: 2010–03–19
  6. By: Nakamura, L.I.; Roszbach, K. (Tilburg University, Center for Economic Research)
    Abstract: In this paper we use credit rating data from two Swedish banks to elicit evidence on these banks’ loan monitoring ability. We do so by comparing the ability of bank ratings to predict loan defaults relative to that of public ratings from the Swedish credit bureau. We test the banks’ abilility to forecast the credit bureau’s ratings and vice versa. We show that one of the banks has a superior predictive ability relative to the credit bureau. This is evidence that bank credit ratings do contain valuable private information and suggests they may be be a reasonable basis for risk management. However, public ratings are also found to have predictive ability for future bank ratings, indicating that risk analysis should be based on both public and bank ratings. The methods we use represent a new basket of straightforward techniques that enable both financial institutions and regulators to assess the performance of credit ratings systems.
    Keywords: Monitoring;banks;credit bureau;private information;ratings;regulation;supervision.
    JEL: D82 G18 G21 G24 G32 G33
    Date: 2010
  7. By: Chun-Yu Ho (Georgia Institute of Technology, Hong Kong Institute for Monetary Research)
    Abstract: This paper examines the effects of market deregulation on consumers and state commercial banks in China, a large developing country. I jointly estimate a system of differentiated product demand and pricing equations under alternative market structures. While China's banking reforms overall have achieved mixed results, the consumer surplus of the deposit market has increased. The welfare effects from reforms are unevenly distributed, with losses skewed toward inland provinces and certain consumer groups. There is no clear evidence that the pricing of banking services has become more competitive after the reform, and such pricing remains subject to government intervention. Encouragingly, the price-cost margins of some state commercial banks have fallen over time.
    Keywords: Banking Reform, Banks in China, Demand Estimation, Market Structure
    JEL: G21 L11
    Date: 2009–09
  8. By: Jens Hagendorff (University of Leeds); Ignacio Hernando (Banco de España); María J. Nieto (Banco de España); Larry D. Wall (Federal Reserve Bank of Atlanta)
    Abstract: We analyze the takeover premiums paid for a sample of European bank mergers between 1997 and 2007. We find that acquiring banks value profitable, high-growth and low risk targets. We also find that the strength of bank regulation and supervision as well as deposit insurance regimes in Europe have measurable effects on takeover pricing. Stricter bank regulatory regimes and stronger deposit insurance schemes lower the takeover premiums paid by acquiring banks. This result, presumably in anticipation of higher compliance costs, is mainly driven by domestic deals. Also, we find no conclusive evidence that bidders seek to extract benefits from regulators either by paying a premium for deals in less regulated regimes or by becoming "too big to fail".
    Keywords: banks, mergers, premiums, European Union
    JEL: G21 G34 G28
    Date: 2010–04
  9. By: Abdullah Al-Hassan; Nada Oulidi; May Y. Khamis
    Abstract: In this paper, we analyze the evolution of the Gulf Cooperation Council (GCC) banking sectors in the six member countries including ownership, concentration, cross-border linkages, balance sheet exposures and risks, recent trends in credit growth, and financial soundness. We identify risks to the banking sector's financial stability in the context of the current global crisis and their mitigating factors.
    Keywords: Asset management , Bank soundness , Banking sector , Capital , Cooperation Council for the Arab States of the Gulf , Credit expansion , Credit risk , Cross country analysis , Household credit , Liquidity , Loans , Profit margins ,
    Date: 2010–04–02
  10. By: Santiago Carbó; David Humphrey; Francisco Rodríguez
    Abstract: Measuring banking competition using the HHI, Lerner index, or H-statistic can give conflicting results. Borrowing from frontier analysis, the authors provide an alternative approach and apply it to Spain over 1992-2005. Controlling for differences in asset composition, productivity, scale economies, risk, and business cycle influences, they find no differences in competition between commercial and savings banks nor between large and small institutions, but the authors conclude that competition weakened after 2000. This appears related to strong loan demand where real loan-deposit rate spreads rose and fees were stable for activities where scale economies should have been realized.
    Keywords: Bank competition
    Date: 2010
  11. By: Cheng, X.; Degryse, H.A. (Tilburg University, Center for Economic Research)
    Abstract: We provide the first evidence on how the introduction of information sharing via a public credit registry affects banks’ lending decisions. We employ a unique dataset containing detailed information on credit card applications and decisions from one of the leading banks in China. While we do not find that information sharing decreases credit rationing on average, the distribution of granted credit among borrowers with shared information has a unique pattern. In particular, compared to those with information reported only by this bank, borrowers with extra information shared by other banks receive higher credit card lines. While positive information shared by other banks augments lending of this bank, the effect of negative information shared by other banks is not significant. In addition, the availability of shared information through the Public Registry has mixed effects on how the bank utilizes internally produced information. Last, information sharing alleviates informational barriers in China’s credit card market, but not completely.
    Keywords: information sharing;credit availability;credit rationing;credit card
    JEL: G21 G32
    Date: 2010
  12. By: Gabriel Jiménez (Banco de España, PO Box 28014, Alcalá 48, Madrid, Spain.); Steven Ongena (CentER - Tilburg University and CEPR, PO Box 90153, NL 5000 LE Tilburg, The Netherlands.); José-Luis Peydró (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Jesús Saurina (Banco de España, PO Box 28014, Alcalá 48, Madrid, Spain.)
    Abstract: To identify credit availability we analyze the extensive and intensive margins of lending with loan applications and all loans granted in Spain. We find that during the period analyzed both worse economic and tighter monetary conditions reduce loan granting, especially to firms or from banks with lower capital or liquidity ratios. Moreover, responding to applications for the same loan, weak banks are less likely to grant the loan. Our results suggest that firms cannot offset the resultant credit restriction by turning to other banks. Importantly the bank-lending channel is notably stronger when we account for unobserved time-varying firm heterogeneity in loan demand and quality. JEL Classification: E32, E44, E5, G21, G28.
    Keywords: non-financial and financial borrower balance-sheet channels, financial accelerator, firm borrowing capacity, credit supply, business cycle, monetary policy, credit channel, net worth, capital, liquidity, 2007-09 crisis.
    Date: 2010–04
  13. By: Torsten Wezel
    Abstract: This paper investigates the efficiency of domestic and foreign banks in the Central American region during 2002-07. Using two main empirical approaches, Data Envelopment Analysis and Stochastic Frontier Analysis, the paper finds that foreign banks are not necessarily more efficient than their domestic counterparts. If anything, the regional banks that were acquired by global banks in a wave of acquisitions during 2005-07 can keep up with the local institutions. The efficiency of these acquired banks, however, is shown to have dropped during the acquisition year, recovering only slightly thereafter. Finally, it is important to account for the environment in which banks operate, as country-, sector- and firm-specific characteristics are found to have a considerable influence on bank efficiency.
    Keywords: Banks , Central America , Cross country analysis , Foreign direct investment , International banking , Productivity ,
    Date: 2010–03–16
  14. By: Sherrill Shaffer
    Abstract: Economic theory predicts that reciprocal brokered deposits, by facilitating an extension of deposit insurance coverage, may exacerbate moral hazard and reduce market discipline for banks, permitting them to take more risk in various dimensions. Using a newly available dataset, this note explores empirical evidence related to that hypothesis.
    JEL: G21
    Date: 2010–04
  15. By: Nijskens, R.G.M.; Eijffinger, S.C.W. (Tilburg University, Center for Economic Research)
    Abstract: Banking regulation has proven to be inadequate to guard systemic stability in the recent financial crisis. Central banks have provided liquidity and ministries of finance have set up rescue programmes to restore confidence and stability. Using a model of a systemic bank suffering from liquidity shocks, we find that the unregulated bank keeps too much liquidity and takes excessive risk compared to the social optimum. A Lender of Last Resort can alleviate the liquidity problem, but induces moral hazard. Therefore, we introduce a fiscal authority that is able to bail out the bank by injecting capital. This authority faces a trade-off: when it imposes strict bailout conditions, investment increases but moral hazard ensues. Milder bailout conditions reduce excessive risk taking at the expense of investment. This resembles the current situation on financial markets, in which banks take less risk but also provide less credit to the economy.
    Keywords: Bank Regulation;Lender of Last Resort;Liquidity;Capital;Bailout
    JEL: E58 G21 G28
    Date: 2010
  16. By: Jorge A. Chan-Lau
    Abstract: The recent financial crisis has highlighted once more that interconnectedness in the financial system is a major source of systemic risk. I suggest a practical way to levy regulatory capital charges based on the degree of interconnectedness among financial institutions. Namely, the charges are based on the institution’s incremental contribution to systemic risk. The imposition of such capital charges could go a long way towards internalizing the negative externalities associated with too-connected-to-fail institutions and providing managerial incentives to strengthen an institution’s solvency position, and avoid too much homogeneity and excessive reliance on the same counterparties in the financial industry.
    Keywords: Bank regulations , Banking sector , Capital , Credit risk , Financial crisis , Financial institutions , Financial risk , Financial stability , Global Financial Crisis 2008-2009 , Globalization , International financial system ,
    Date: 2010–04–09
  17. By: Shanshan Yang; Sherrill Shaffer
    Abstract: Expanded public availability of U.S. banking data has prompted a need to reexamine end-of-quarter window dressing. We find substantial heterogeneity in the pattern of window dressing across banks and products, not all of which can be explained as customerinitiated, and some of which is consistent with theoretical predictions in the absence of publicly available data. These findings call into question the efficacy of financial disclosure in constraining banks’ behavior, and raise new issues for further research.
    JEL: G2 G21 G28
    Date: 2010–02
  18. By: Freixas, X.; Martin, A.; Skeie, D. (Tilburg University, Center for Economic Research)
    Abstract: A major lesson of the recent financial crisis is that the interbank lending market is crucial for banks facing large uncertainty regarding their liquidity needs. This paper studies the efficiency of the interbank lending market in allocating funds. We consider two different types of liquidity shocks leading to di¤erent implications for optimal policy by the central bank. We show that, when confronted with a distribu- tional liquidity-shock crisis that causes a large disparity in the liquidity held among banks, the central bank should lower the interbank rate. This view implies that the traditional tenet prescribing the separation between prudential regulation and mon- etary policy should be abandoned. In addition, we show that, during an aggregate liquidity crisis, central banks should manage the aggregate volume of liquidity. Two di¤erent instruments, interest rates and liquidity injection, are therefore required to cope with the two di¤erent types of liquidity shocks. Finally, we show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.
    Keywords: bank liquidity;interbank markets;central bank policy;financial fragility;bank runs
    JEL: G21 E43 E44 E52 E58
    Date: 2010
  19. By: Inklaar, R.; Colangelo, A. (Groningen University)
    Abstract: Banks do not charge explicit fees for many of the services they provide but the service payment is bundled with the offered interest rates. This output therefore has to be imputed using estimates of the opportunity cost of funds. We argue that rather than using the single short-term, low-risk interest rate as in current official statistics, reference rates should more closely match the risk characteristics of loans and deposits. For the euro area, imputed bank output is, on average, 24 to 40 percent lower than according to current methodology. This implies an average downward adjustment of euro area GDP (at current prices) between 0.16 and 0.27 percent.
    Date: 2010
  20. By: Kent Matthews (Cardiff University, Hong Kong Institute for Monetary Research); Zhiguo Xiao (Fudan University,); Xu Zhang (Citigroup (China), Cardiff University)
    Abstract: According to a frequently cited finding by Berger et al (1993), X-inefficiency contributes 20% to cost-inefficiency in western banks. Empirical studies of Chinese banks tend to place cost-inefficiency in the region of 50%. Such estimates would suggest that Chinese banks suffer from gross cost inefficiency. Using a non-parametric bootstrapping method, this study decomposes cost-inefficiency in Chinese banks into X-inefficiency and allocative-inefficiency. It argues that allocative inefficiency is the optimal outcome of input resource allocation subject to enforced employment constraints. The resulting analysis suggests that allowing for rational allocative inefficiency; Chinese banks are no better or worse than their western counterparts.
    Keywords: Bank Efficiency, China, X-inefficiency, DEA, Bootstrapping
    JEL: D23 G21 G28
    Date: 2009–09
  21. By: Khemraj, Tarron
    Abstract: Previous studies have documented the tendency for the commercial banking sector of many developing economies to be highly liquid and be characterised by a persistently high interest rate spread. This paper embeds these stylised facts in an oligopoly model of the banking firm. The paper derives both the loan and deposit rates as a mark up rate over a relatively safe foreign interest rate. Then, using a diagrammatic framework, the paper provides an analysis of: (i) the distribution of financial surplus among savers, business borrowers and banks; (ii) exogenous deposit shocks; (iii) exogenous loan demand shocks; and (iv) the impact of interest rate control on financial intermediation.
    Keywords: Oligopoly; commercial banks; developing economies; distribution
    JEL: D30 E40 G21
    Date: 2010–01
  22. By: Manmohan Singh
    Abstract: To mitigate systemic risk, some regulators have advocated the greater use of centralized counterparties (CCPs) to clear Over-The-Counter (OTC) derivatives trades. Regulators should be cognizant that large banks active in the OTC derivatives market do not hold collateral against all the positions in their trading book and the paper proves an estimate of this under-collateralization. Whatever collateral is held by banks is allowed to be rehypothecated (or re-used) to others. Since CCPs would require all positions to have collateral against them, off-loading a significant portion of OTC derivatives transactions to central counterparties (CCPs) would require large increases in posted collateral, possibly requiring large banks to raise more capital. These costs suggest that most large banks will be reluctant to offload their positions to CCPs, and the paper proposes an appropriate capital levy on remaining positions to encourage the transition.
    Keywords: Asset management , Banks , Capital , Capital markets , Credit risk , Financial institutions , Financial instruments , Financial risk , Securities regulations ,
    Date: 2010–04–09
  23. By: Georges Caravelis
    Abstract: We appraise the new EU supervisory architecture presented by the Commission in a package of five 'draft legislative acts'. Two would establish a European Systemic Risk Board (ESRB) to undertake macro-prudential issues. Three would establish the system of European Supervisory Authorities (ESAs): Banking, Securities and Insurance.. . The theoretical case for this package of 'draft legislative acts' has been made by the High-Level Group on Financial Supervision in the EU. The ' package ' has been examined by the ECOFIN of 2 December 2009, which agreed on a 'general approach'; it has introduced changes to the Commission's three draft legislative acts concerning the European Supervisory Authorities (ESAs). We examine the theoretical approach underlying the draft legislative acts, which is based on the State theory of money. We find it incomplete in the case of the ESRB because the mission of ECB in 'mitigating system risks within the financial system' cannot be attained without real powers and tools; it is in essence a Macro-economic phenomenon.. . We also arrive at another conclusion relating to the three proposals on the ESAs. The theoretical underpinning of the three is based on the premise of 'regulating for the sake of regulation'. Today's evolution of the EU cannot allow Authorities over-passing the Treaty competence. Nor could the ESAs attain their objective of 'setting the common rules for supervising national entities'. Thus the conception of the EU system of financial supervision is deficient, in need of repair.. . We propose an alternative approach to the new EU supervisory architecture consisting of three elements. First, we restate the case for the Central Banks in order to assume responsibility for the 'last resort of managing risk', and endowed with real power. Second, the role of the national central banks (NCBs) in 'micro-supervision' is substantial enhanced. Third, a structure for the budgetary burden is proposed by the establishment of the 'European Fund for Financial Stability' (EFFS)..
    Keywords: Theory of money; European Supervisory Authorities, de Larosière report; financial supervision; money externalities; European Central Bank; National Central Banks; European Steering Committee of Vice-Governors of NCBs; credit rating agencies; European Fiscal Authority; European Fund for Financial Stability; financial transaction tax; natural monopoly
    Date: 2010–01–29
  24. By: Prakash Kannan
    Abstract: Recoveries from recessions associated with a financial crisis tend to be sluggish. In this paper, we present evidence that stressed credit conditions are an important factor constraining the pace of recovery. In particular, using industry-level data, we find that industries relying more on external finance grow more slowly than other industries during recoveries from recessions associated with financial crises. Additional tests, based on establishment size, on alternative definitions of financial crises, and on corporate-government interest rate spreads, support the findings. Moreover, for subsets of industries where financial frictions are more severe, we find much stronger differential growth effects.
    Keywords: Bank credit , Banking crisis , Business cycles , Credit , Developed countries , Economic models , Economic recession , Economic recovery , External financing , Financial crisis , Industrial sector , Production growth ,
    Date: 2010–03–31
  25. By: Jong, A. de; Ongena, S.; Poel, M. van der (Tilburg University, Center for Economic Research)
    Abstract: This paper investigates the effects of international diversification of banks on the value of their M&A advice. We study bidder returns to 1,253 cross-border M&A announcements. We find that acquirers engaging a more internationally diversified financial advisor generate lower excess returns. Acquirers benefit most from advisors with a greater focus on their home country. These results suggest that the benefits of advisors’ international diversification related to greater economies of scale and scope and the flexibility of allocating deals to the most skilled employee do not outweigh the costs emanating from a lack of country-specific knowledge and greater conflicts of interest.
    Keywords: Bank Diversification;Cross-Border Mergers and Acquisitions;Advisor Choice.
    JEL: G24 G34
    Date: 2010
  26. By: T. C. Wong (Hong Kong Monetary Authority); C. H. Hui (Hong Kong Monetary Authority, Hong Kong Institute for Monetary Research); C. F. Lo (The Chinese University of Hong Kong, Hong Kong Institute for Monetary Research)
    Abstract: This paper studies the discriminatory power and calibration quality of the structural credit risk models under the ¡§exogenous default boundary¡¨ approach including those proposed by Longstaff and Schwartz (1995) and Collin-Dufresne and Goldstein (2001), and ¡§endogenous default boundary¡¨ approach in Leland and Toft (1996) based on 2,050 non-financial companies in 46 economies during the period 1998 to 2005. Their discriminatory power in terms of differentiating defaulting and non-defaulting companies is adequate and the differences among them are not material. In addition, the calibration quality of the three models is similar, although limited evidence is found that the Longstaff and Schwartz model marginally outperforms the others in some subsamples. Overall, no significant difference in the capability of measuring credit risk between the ¡§exogenous default boundary¡¨ and ¡§endogenous default boundary¡¨ approaches is found.
    Keywords: Default Probabilities, Credit Risk Models
    JEL: C60 G13 G28
    Date: 2009–11
  27. By: Steven B. Kamin; Laurie Pounder DeMarco
    Abstract: The global financial crisis clearly started with problems in the U.S. subprime sector and spread across the world from there. But was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? To answer this question, we assessed whether countries that held large amounts of U.S. mortgage-backed securities (MBS) and were highly dependent on dollar funding experienced a greater degree of financial distress during the crisis. We found little evidence of such "direct contagion" from the United States to abroad. Although CDS spreads generally rose higher and bank stocks generally fell lower in countries with more exposure to U.S. MBS and greater dollar funding needs, these correlations were not robust, and they fail to explain the lion's share of the deterioration in asset prices that took place during the crisis. Accordingly, channels of "indirect contagion" may have played a more important role in the global spread of the crisis: a generalized run on global financial institutions, given the opacity of their balance sheets; excessive dependence on short-term funding; vicious cycles of mark-to-market losses driving fire sales of MBS; the realization that financial firms around the world were pursuing similar (flawed) business models; and global swings in risk aversion. The U.S. subprime crisis, rather than being a fundamental driver of the global crisis, may have been merely a trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world.
    Date: 2010
  28. By: Matthew J. Eichner; Donald L. Kohn; Michael G. Palumbo
    Abstract: Although the instruments and transactions most closely associated with the financial crisis of 2008 and 2009 were novel, the underlying themes that played out in the crisis were familiar from previous episodes: Competitive dynamics resulted in excessive leverage and risk-taking by large, interconnected firms, in heavy reliance on short-term sources of funding to finance long-term and ultimately terribly illiquid positions, and in common exposures being shared by many major financial institutions. Understandably, in the wake of the crisis, financial supervisors and policymakers want to obtain better and earlier indications regarding these critical, and apparently recurring, core vulnerabilities in the financial system. Indeed, gaps in data and analysis, in a sense, defined the shadows in which the "shadow banking system" associated with the buildup in financial risks grew. We agree that more comprehensive real-time data is necessary, but we also emphasize that collecting more data is only part of the process of developing early warning systems. More fundamental, in our view, is the need to use data in a different way--in a way that integrates the ongoing analysis of macro data to identify areas of interest with the development of highly specialized information to illuminate those areas, including the relevant instruments and transactional forms. In this paper, we describe why we are concerned that specifying this second stage generically and prior to processing the first-stage signals will not be fruitful: We can easily imagine specifying ex ante a program of data collection that would look for vulnerabilities in the wrong place, particularly if the actual act of looking by macro- or microprudential supervisors causes the locus of activity to shift into a new shadow somewhere else--something we argue occurred during the buildup of risks ahead of this crisis.
    Date: 2010
  29. By: W.A van den End; S.A.M. Verkaart; K.A. van Dijkhuizen
    Abstract: During the credit crisis, central banks and governments have taken extraordinary measures to preserve financial stability and prevent strong credit rationing of the private sector. Central banks cut official rates, provided liquidity support to the banking sector and supported specific financial markets with asset purchase programmes, whilst governments introduced measures such as guarantee schemes and made capital injections. These interventions prevented the financial system from collapsing and, in that sense, they have been effective. At the same time, the authorities have been aware that their measures may have distortionary effects on the markets. For instance, they may distort the level playing field between financial institutions that received support and those that did not, as is noticeable, for instance, from differences in funding costs. Furthermore, support aimed at specific market segments may lead to shifts in capital flows, and cross-border shifts may take place as a result of country-specific differences in support packages. Longer-term distortionary effects may follow, in particular, from excessive risk taking, e.g. by management, shareholders, bondholders and depositors of financial institutions. Such ‘moral hazard’ may also be created by extremely low policy rates and IMF measures. In designing their support measures, the authorities have sought to limit possible distortionary effects as much as possible. Thus, to the greatest possible extent, government support was granted on market-compatible and internationally harmonised conditions. Uncertainty among market participants may be mitigated by providing clarity on the details of the support policies, by creating an arm’s length relationship between the government and the business management of the support-receiving institutions and by ensuring sustained responsibility on the part of private stakeholders. Of final importance is a smooth exit from support policies as soon as market recovery allows it.
    Date: 2009–12
  30. By: John Kiff; Michael Kisser
    Abstract: This paper builds on recent research by Fender and Mitchell (2009) who show that if financial institutions securitize loans, retaining an interest in the equity tranche does not always induce the securitizer to diligently screen borrowers ex ante. We first determine the conditions under which this scenario becomes binding and further illustrate the implications for capital requirements. We then propose an extension to the existing model and also solve for optimal retention size. This also allows us to capture feedback effects from capital requirements into the maximization problem. Preliminary results show that equity tranche retention continues to best incentivize loan screening.
    Keywords: Asset management , Capital , Economic models , Financial institutions , Loans , Securities markets ,
    Date: 2010–03–23
  31. By: Ferro, Gustavo
    Abstract: Prior to the 2008 global credit crisis, some developments had occurred in the regulation of the insurance industry worldwide. At different speeds, the world was heading toward a more risk-based solvency regulation and some convergence on principles and criteria. We see a common thread in the present discussion and in the way events happened. We consider that the great debate in the industry is a fundamental decision: whether to engage in other than core business activities. If the industry focuses on its insurance business, the argument for specialized regulation and the continuity of a conservative and prudent line of business is strong. Instead, if the industry deepens its identification with other lines of financial business, the specialized supervision arrangement does not hold. The move entails both possibilities of new, riskier and promising business, but also perils, since the industry “buys” the systemic characteristics that distinguish other financial institutions.
    Keywords: regulation; insurance; financial crisis; integrated supervision; financial conglomerates
    JEL: L51 G22
    Date: 2010–02
  32. By: Sugato Chakravarty (Purdue University); Meifang Xiang (University of Wisconsin, Whitewater)
    Abstract: We use a unique firm-level survey database compiled by the World Bank to examine the drivers of discouraged small businesses in various developing economies around the world. We confirm that older and larger firms are less likely to be discouraged and that the level of competition and the relationships of the firms with banks have a significant impact on the probability of a firm in being discouraged. Further analysis suggests that drivers of discouragement work differently for firms operating in relatively developed and underdeveloped economies. We also provide evidence that firm discouragement, as an efficient self-screening mechanism, is not as efficient in underdeveloped economies as it is in the United States.
    Date: 2009–05
  33. By: Kristopher Gerardi; Lorenz Goette; Stephan Meier
    Abstract: The exact cause of the massive defaults and foreclosures in the U.S. subprime mortgage market is still unclear. This paper investigates whether a particular aspect of borrowers' financial literacy—their numerical ability—may have played a role. We measure several aspects of financial literacy and cognitive ability in a survey of subprime mortgage borrowers who took out mortgages in 2006 or 2007 and match these measures to objective data on mortgage characteristics and repayment performance. We find a large and statistically significant negative correlation between numerical ability and various measures of delinquency and default. Foreclosure starts are approximately two-thirds lower in the group with the highest measured level of numerical ability compared with the group with the lowest measured level. The result is robust to controlling for a broad set of sociodemographic variables and not driven by other aspects of cognitive ability or the characteristics of the mortgage contracts. Our results raise the possibility that limitations in certain aspects of financial literacy played an important role in the subprime mortgage crisis.
    Date: 2010
  34. By: Agur, I.; Demertzis, M. (Tilburg University, Center for Economic Research)
    Abstract: If monetary policy is to aim at financial stability, how would it change? To analyze this question, this paper develops a general-form model with endogenous bank risk profiles. Policy rates affect both bank incentives to search for yield and the cost of wholesale funding. Financial stability objectives are then shown to make a monetary authority more conservative and more aggressive. Conservative as it sets higher rates on average. And aggressive because, in reaction to negative shocks, cuts are deeper but shorter-lived than otherwise. Keeping cuts short is crucial as bank risk responds primarily to stable low rates. Within the short span, cuts then must be deep to achieve standard objectives.
    Keywords: Monetary policy;Financial stability
    JEL: E52 G21
    Date: 2010
  35. By: Van den Berghe, L. (Vlerick Leuven Gent Management School)
    Abstract: The post-Enron period is characterised by increased efforts in strengthening corporate governance. In the wake of the financial crisis, however, the effectiveness of these (governance) reforms is put into question. Although the financial crisis seems to be caused by macro-instabilities and micro regulatory failures, it can be argued that governance failures aggravated the financial meltdown. This paper discusses the systemic governance failures that can (partly) explain the financial crisis and provides insights into the lessons to be learned. The analysis highlights four main deficiencies: (i) inadequate monitoring by the market in combination with an ‘open’ shareholder model; (ii) the perverse side-effects of (variable) performance-related incentive schemes that were supposed to be the disciplinary mechanism per excellence for (top) managers; (iii) insufficient risk modelling and risk management which leads to poor external and internal supervision with regard to risk exposure and (iv) governance investments were too much focused on structures and procedures instead of on stimulating the right corporate behaviour and attitude. Furthermore, possible remedies to restore trust in the business world are being discussed. This includes -amongst others- a reflection on mechanisms that foster company-wide long-term value creation; proper risk assessment encompassing a true audit of strategic risks; a reconsideration of board roles and board composition, thereby paying more attention to leadership and personality issues; etc. Finally, the paper argues that the balance between regulation and self-regulation is at stake.
    Date: 2009–10–28
  36. By: Martin, A.; Skeie, D.; Thadden, E.L. von (Tilburg University, Center for Economic Research)
    Abstract: This paper develops a model of financial institutions that borrow short- term and invest into long-term marketable assets. Because these financial intermediaries perform maturity transformation, they are subject to runs. We endogenize the profits of the intermediary and derive distinct liquidity and solvency conditions that determine whether a run can be prevented. We first characterize these conditions for an isolated intermediary and then generalize them to the case where the intermediary can sell assets to prevent runs. The sale of assets can eliminate runs if the intermediary is solvent but illiquid. However, because of cash-in-the-market pricing, this becomes less likely the more intermediaries are facing problems. In the limit, in case of a general market run, no intermediary can sell assets to forestall a run, and our original solvency and liquidity constraints are again relevant for the stability of financial institutions.
    Keywords: Investment banking;securities dealers;repurchase agreements;tri-party repo;runs;financial fragility.
    JEL: E44 E58 G24
    Date: 2010
  37. By: Leo F. Goodstadt (Hong Kong Institute for Monetary Research, Trinity College, University of Dublin, The University of Hong Kong)
    Abstract: An Anglo-American regulatory ¡¥culture¡¦ became associated with 30 years of worldwide economic reforms, global growth and monetary stability. American and British officials identified major sources of instability in their own financial markets before 2007 but remained non-interventionist, invoking the concepts of virtuous markets and moral hazard. They also ignored the policy defects revealed by past crises. Despite record banking losses and fiscal imbalances during the global crisis, their current resistance to regulatory reforms is supported by a powerful political and business consensus.
    Keywords: Non-Interventionism, Basel, Virtuous Markets, Moral Hazard, Regulatory Culture
    Date: 2009–11
  38. By: David Bowman; Etienne Gagnon; Mike Leahy
    Abstract: This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tightening that included increasing these policy rates been achieved without reliance on reductions in reserves or other deposits held at the central bank? The foreign experience suggests that policy rate floors can be effective lower bounds for market rates, although incomplete access to central bank accounts and interest on them weakens this result. In addition, the foreign experience suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances. These results are consistent with theoretical results that show that tightening without draining is possible, irrespective of whether excess reserves are large or small.
    Date: 2010
  39. By: Ron Berndsen
    Abstract: The aim of this paper is to provide a uniform representation of functional concepts used in the field of payment and securities settlement systems. The framework developed here is encompassing the whole field while using as few elements as possible. It provides a basic functional model for analyzing and tracing the life cycle of the financial legs of a transaction. In line with the network properties of the field the model is based on formal graphs. The visualization of these graphs can be considered as a symbolic language. It is shown on the basis of a number of examples that the framework is capable of representing basic notions of payment and securities settlement systems.
    Keywords: payment systems; securities settlement systems; settlement risk exposure; functional graph modeling; instruction life cycle; financial market infrastructures
    JEL: E42 G10 G20
    Date: 2010–03

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