New Economics Papers
on Banking
Issue of 2010‒05‒22
25 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. The Case for Constructive Ambiguity in a Regulated System: Canadian Banks and the ‘Too Big To Fail’ Problem By Ellen Russell
  2. Illiquidity and All Its Friends By Tirole, Jean
  3. Lessons of the Crisis for Emerging Markets By Eichengreen, Barry
  4. Extreme Volatilities, Financial Crises and L-moment Estimations of Tail-indexes By Bertrand B. Maillet; Jean-Philippe R. Médecin
  5. The Lifecycle of the Financial Sector and Other Speculative Industries By Biais, Bruno; Rochet, Jean-Charles; Woolley, Paul
  6. Loan supply in Germany during the financial crisis By Busch, Ulrike; Scharnagl, Michael; Scheithauer, Jan
  7. Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts By Farhi, Emmanuel; Tirole, Jean
  8. Financial Crisis and Crisis Management in Sweden. Lessons for Today By Jonung, Lars
  9. Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures By Wall, Larry D.
  10. A framework for assessing systemic risk By Dijkman, Miquel
  11. The Impact of Mergers on the Degree of Competition in the Banking Industry By Cerasi, Vittoria; Chizzolini, Barbara; Ivaldi, Marc
  12. Stress Testing Credit Risk: The Great Depression Scenario By Simone Varotto
  13. What Is the Impact of the Global Financial Crisis on the Banking System in East Asia? By Pomerleano, Michael
  14. The Relationship between Risk, Capital and Efficiency: Evidence from Japanese Cooperative Banks By Tara Deelchand; Carol Padgett
  15. The rise and decline of a Belgian banking giant – communication and business ethics in the Fortis case By Limbos S.; Phillips D.
  16. Stock loan model with Automatic termination clause By Zongxia Liang; Weiming Wu; Shuqing Jiang
  17. Tax Evasion and Swiss Bank Deposits By Niels Johannesen
  18. A Re-assessment of Credit Development in European Transition Economies By Zdzienicka, Aleksandra
  19. Payment System in Indonesia: Recent Developments and Policy Issues By Titiheruw, Ira S.; Atje, Raymond
  20. Brazilian Strategy for Managing the Risk of Foreign Exchange Rate Exposure During a Crisis By Antonio Francisco A. Silva Jr.
  21. Enterprise recovery following natural disasters By de Mel, Suresh; McKenzie, David; Woodruff, Christopher
  22. When Is the Optimal Lending Contract in Microfinance State Non-Contingent? By Jeon, Doh-Shin; Menicucci, Dominico
  23. "Collateral Posting and Choice of Collateral Currency - Implications for Derivative Pricing and Risk Management-" By Masaaki Fujii; Yasufumi Shimada; Akihiko Takahashi
  24. Variational inequality method in stock loans By Zongxia Liang; Weiming Wu
  25. Financial globalization and the Russian crisis of 1998 By Pinto, Brian; Ulatov, Sergei

  1. By: Ellen Russell
    Abstract: This brief focuses on the purported Canadian virtues of risk aversion and regulatory caution in light of one important characteristic of the banking system: it is dominated by only five large banks that are “too big to fail.” I address the issue using a concept – ambiguity – which is often mentioned but relatively neglected analytically in the scholarly literature on bank regulation. I argue that the capacity of the Canadian banking system to successfully navigate the “too big to fail” problem presents an instance in which this form of ambiguity may contribute to helpful dynamics in the regulatory landscape, in that it can attenuate the moral hazard dilemma posed by banks that are “too big to fail.” I discuss the ways in which the refusal to permit mergers among the large Canadian banks in the late 1990s shaped the constructive ambiguity animating the relationships among the banks, the Bank of Canada, and bank regulators. I will argue that this policy decision both enhanced the credibility of the government’s constructive ambiguity and attenuated the moral hazard implications of banks that are “too big to fail” in Canada. I conclude with a discussion of the implications of this analysis for regulatory initiatives going forward.
    JEL: L5 G28
    Date: 2010
  2. By: Tirole, Jean (University of Toulouse Capitole)
    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 macroprudential policies.
    JEL: E44 E52 G28
    Date: 2009–09–12
  3. By: Eichengreen, Barry (Asian Development Bank Institute)
    Abstract: This paper attempts to draw out the implication of the financial crisis for emerging markets. The most important implications will center on financial markets, where there will be less reliance on portfolio capital flows to finance investment and some deglobalization of banking so that the domain of bank operations more closely coincides with the domain of regulation. By contrast, the implications for other dimensions of globalization and for the structure of the international monetary system will be more limited.
    Keywords: global financial crisis; lessons; exchange rate policy; financial architecture
    JEL: F00 F30
    Date: 2009–12–15
  4. By: Bertrand B. Maillet (ABN AMRO Advisors, Variances and University of Paris-1 (CES/CNRS and EIF)); Jean-Philippe R. Médecin (Paris School of Economics, University of Paris-1 and Variances)
    Abstract: Following Bali and Weinbaum (2005) and Maillet et al. (2010), we present several estimates of volatilities computed with high- and low frequency data and complement their results using additional measures of risk and several alternative methods for Tail-index estimation. The aim here is to confirm previous results regarding the slope of the tail of various risk measure distributions, in order to define the high watermarks of market risks. We also produce synthetic general results concerning the method of estimation of the Tail-indexes related to expressions of the L-moments. Based on estimates of Tail-indexes, retrieved from the high frequency 30’ sampled CAC40 French stock Index series from the period 1997-2009, using Non-parametric Generalized Hill, Maximum Likelihood and various kinds of L-moment Methods for the estimation of both a Generalized Extreme Value density and a Generalized Pareto Distribution, we confirm that a heavy-tail density specification of the Log-volatility is not necessary.
    Keywords: Financial Crisis, Realized Volatility, Range-based Volatility, Extreme Value Distributions, Tail-index, L-moments, High Frequency Data.
    JEL: G10 G14
  5. By: Biais, Bruno; Rochet, Jean-Charles; Woolley, Paul
    Abstract: Speculative industries exploit novel technologies subject to two risks. First, there is uncertainty about the fundamental value of the innovation: is it strong or fragile? Second, it is difficult to monitor managers, which creates moral hazard. Because of moral hazard, managers earn agency rents in equilibrium. As time goes by and profits are observed, beliefs about the industry are rationally updated. If the industry is strong, confidence builds up. Initially this spurs growth. But increasingly confident managers end up requesting very large rents, which curb the growth of the speculative sector. If rents become too high, investors may give up on incentives, and risk and failure rates rise. Furthermore, if the innovation is fragile, eventually there is a crisis, and the industry shrinks. Our model thus captures important stylized facts of the financial innovation wave which took place at the beginning of this century.
    Date: 2009–04
  6. By: Busch, Ulrike; Scharnagl, Michael; Scheithauer, Jan
    Abstract: Distinguishing pure supply effects from other determinants of price and quantity in the market for loans is a notoriously difficult problem. Using German data, we employ Bayesian vector autoregressive models with sign restrictions on the impulse response functions in order to enquire the role of loan supply and monetary policy shocks for the dynamics of loans to non-financial corporations. For the three quarters following the Lehman collapse, we find very strong negative loan supply shocks, while monetary policy was essentially neutral. Nevertheless, the historical decomposition shows a cumulated negative impact of loan supply shocks and monetary policy shocks on loans to non-financial corporations, due to the lagged effects of past loan supply and monetary policy shocks. However, these negative effects on loans to non-financial corporations are overcompensated by positive other shocks, which implies that loans developed more favorably than implied by the model, over the past few quarters. --
    Keywords: Loan supply,Bayesian VAR,sign restrictions
    JEL: C11 C32 E51
    Date: 2010
  7. By: Farhi, Emmanuel; Tirole, Jean
    Abstract: The paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy. When everyone engages in maturity transformation, authorities haver little choice but facilitating refinancing. In turn, refusing to adopt a risky balance sheet lowers the return on equity. The key ingredient is that monetary policy is non-targeted. The ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage, while the distortion costs are to a large extent fixed. This insight has important consequences. First, banks choose to correlate their risk exposures. Second, private borrowers may deliberately choose to increase their interest-rate sensitivity following bad news about future needs for liquidity. Third, optimal monetary policy is time inconsistent. Fourth, macro-prudential supervision is called for. We characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets. We establish the robustness of our insights when the set of bailout instruments is endogenous and characterize the structure of optimal bailouts.
    JEL: E44 E52 G28
    Date: 2009–06
  8. By: Jonung, Lars (Asian Development Bank Institute)
    Abstract: This paper gives an account of the Swedish financial crisis covering the period 1985–2000, dealing with financial deregulation and the boom in the late 1980s, the bust and the financial crisis in the early 1990s, the recovery from the crisis and the bank resolution policy adopted during the crisis. The paper focuses on three issues: the causes and consequences of the financial crisis, the policy response concerning bank resolution, and the applicability of the Swedish model of bank crisis management for countries currently facing financial problems.
    Keywords: financial crisis; crisis management; bank resolution; solvency crisis; banking crisis
    JEL: E32 E44 E63 F32 F34 G21 G32 G33
    Date: 2009–11–20
  9. By: Wall, Larry D. (Asian Development Bank Institute)
    Abstract: The recent global financial crisis reflects numerous breakdowns in the prudential discipline of financial firms. This paper discusses ways to strengthen micro- and macroprudential supervision and restore credible market discipline. The discussion notes that microprudential supervisors are typically assigned a variety of goals that sometimes have conflicting policy implications. In such a setting, the structure of the regulatory agencies and the priority given to prudential goals are critical to achieving those goals. <p>The analysis of macroprudential supervision emphasizes that this supervisor must be both bold and modest: bold in seeking to understand the sources and distributions of systemically important risks, and modest about what a supervisor can do without imposing overly restrictive regulations. <p>Finally, the paper argues that the primary responsibility for risk management must rest with firms, not with government supervisors. Unfortunately, systemic risk concerns have led governments to shield the private sector from the full losses that dull their incentive to discipline risk taking. This section of the paper suggests that deposit insurance reform, special resolutions for systemically important firms, and requiring firms to plan for their own resolution and contingent capital may all have a role to play in restoring effective market discipline.
    Keywords: prudential discipline financial firms; prudential supervision financial firms; prudential regulatory agencies
    JEL: E44 G28 K23
    Date: 2009–12–10
  10. By: Dijkman, Miquel
    Abstract: When faced with financial crises, authorities worldwide tend to respond aggressively with public support measures. Given the adverse impact on moral hazard and market discipline, support measures involving public money are ideally limited to crisis situations involving systemic risk: a disturbance in the financial system that is serious enough to affect the real economy. This note sets out the main characteristics of a systemic risk assessment framework: a simple analytical framework that can be used by authorities with financial crisis management responsibilities in times of financial crisis to assess the extent to which that particular crisis situation poses systemic risk.
    Keywords: Debt Markets,Banks&Banking Reform,Emerging Markets,Financial Intermediation,Bankruptcy and Resolution of Financial Distress
    Date: 2010–04–01
  11. By: Cerasi, Vittoria; Chizzolini, Barbara; Ivaldi, Marc
    Abstract: This paper analyses the relation between competition and concentration in the banking sector. The empirical answer is given by testing a monopolistic competition model of bank branching behaviour on individual bank data at county level (départements and provinces) in France and Italy. We propose a measure of the degree of competiveness in each local market that is function also of market structure indicators. We then use the econometric model to evaluate the impact of horizontal mergers among incumbent banks on competition and discuss when, depending on the pre-merger structure of the market and geographic distribution of branches, the merger is anti-competitive. The paper has implications for competition policy as it suggests an applied tool to evaluate the potential anti-competitive impact of mergers.
    JEL: G21 L13 L59
    Date: 2009–11
  12. By: Simone Varotto (ICMA Centre, University of Reading)
    Abstract: By using Moody's historical corporate default histories we explore the implications of scenarios based on the Great Depression for banks' economic capital and for existing and proposed regulatory capital requirements. By assuming different degrees of portfolio illiquidity, we then investigate the relationship between liquidity and credit risk and employ our findings to estimate the Incremental Risk Charge (IRC), the new credit risk capital add-on introduced by the Basel Committee for the trading book. Finally, we compare our IRC estimates with stressed market risk measures derived from a sample of corporate bond indices encompassing the recent financial crisis. This allows us to determine the extent to which trading book capital would change in stress conditions under newly proposed rules. We find that, typically, banking book regulation leads to minimum capital levels that would enable banks to withstand Great Depression-like events, except when their portfolios have long average maturity. We also show that although the IRC in the trading book may be considerable, the capital needed to absorb market risk related losses in stressed scenarios can be more than twenty times larger.
    Keywords: Credit Risk, Financial Crisis, Economic Capital, Basel II, Liquidity Risk
    JEL: G11 G21 G22 G28 G32
    Date: 2010–03
  13. By: Pomerleano, Michael (Asian Development Bank Institute)
    Abstract: The paper analyzes the risks in the banking systems in East Asia using the standard supervisory framework, which assesses capital adequacy, asset quality, management, earnings, and liquidity (CAMEL), and finds that banking systems in the region are sound, but that the short-term outlook is negative. Second, it reviews the measures introduced in Asian countries to support their banking systems. The main bank support measures—direct capital support, removal and guarantees of bad assets, direct liquidity support, and guarantees for banks' existing or newly issued obligations—might be necessary to ensure stability, but they need to be handled carefully to prevent long-term distortions. It remains to be seen whether Asian policymakers will manage skillfully the lifting of bank support measures. Third, the paper conducts stress tests of the banking systems. The stress tests indicate that the largest banking systems in East Asia have a total of almost US$1.2 trillion in Tier 1 capital and a possible shortfall of US$758 billion. Fourth, it assesses the implications for liquidity of the increase in international banking flows and finds that the banking system in the Republic of Korea appears vulnerable to a reversal of capital flows. Fifth, the paper explores the implications of the crisis for credit formation, assessing whether nonbank financial institutions in the region have the capacity to provide sufficient liquidity. The author concludes that they do not. The paper ends with a brief assessment of the impact of the crisis on the corporate sector, concluding that the effects of the crisis are likely to be significant but manageable.
    Keywords: east asian bank capital; global financial crisis; government bank support policies
    JEL: F37 G15 G20
    Date: 2009–08–19
  14. By: Tara Deelchand (ICMA Centre, University of Reading); Carol Padgett (ICMA Centre, University of Reading)
    Abstract: The risk-capital positions of Japanese banks have been under tension throughout the 1990s. However, existing theory on the determinants of bank risk-taking still remains limited and the evidence is conflicting. Most studies concentrate on US and European banks, while empirical evidence has remained scarce for Asian banks. Added to that, to our knowledge, there are almost no papers on this subject for cooperative banks in Japan. Thus, the main contribution of this study is to shed some light on the determinants of bank risk-taking and analyse its relationship with capital and efficiency in Japanese cooperative banking (namely shinkin and credit cooperatives banks). This paper focuses on Japanese cooperative banks as they constitute an important segment of the Japanese banking sector. We employ a simultaneous equation model in which the relationships between, risk, capital and cost inefficiency are modelled. Two stage least squares with fixed effects estimation procedure are applied to a panel data set of 263 Japanese cooperative banks over the period 2003 through 2006. The results confirm the belief that risk, capital and inefficiency are simultaneously determined. The empirical model shows a negative relationship between risk and the level of capital for Japanese cooperative banks. Inefficient Japanese cooperative banks appear to operate with larger capital and take on more risk. These arguments may reflect the moral hazard problem that exists in the banking system through exploitation of the benefits of deposit insurance. We also assess the size effects and find that larger cooperative banks holding less capital take on more risk and are less efficient.
    Keywords: Risk; Capital; Efficiency; Japanese cooperative banks
    JEL: C23 D24 E44 E5 E52 G21 N25
    Date: 2009–11
  15. By: Limbos S.; Phillips D.
    Abstract: Like many other countries Belgium was hit by a major banking crisis in 2008-2009. In this article we shall discuss the case of one Belgian bank, namely Fortis. For many years Fortis was considered to be the crown jewel in the Belgian financial landscape. At the global level Fortis Bank was the only Belgian company which as recently as 2007 was ranked in the top 20 of the Fortune 500 list, being preceded by only two other banking competitors.By the end of September 2008, however, Fortis was facing near bankruptcy and could only be saved thanks to crucial government intervention. Although most banks? problems were directly linked to the US sub-prime crisis the Fortis case is more complex. We shall here concentrate on Fortis? poor communication during the crisis and its effects on the bank?s image and reputation.In the first part of this article we shall retrace the Fortis success story up to June 2008 and also sketch the context of some of the managerial decisions taken in this period, which were - with the benefit of hindsight - most unfortunate. These include, firstly, a massive investment in CDOs (Collateralized Debt Obligations); secondly, Fortis? overly ambitious takeover of the large Dutch bank ABN AMRO; and thirdly, a communications policy focusing on problem denial at the start of the collapse in June 2008. The second part will examine the impact of these decisions and how they forced Fortis into a downward spiral as from June 2008.An interesting question is whether in this particular case the bank?s denial policy can be imputed to a lack of ethics or whether it was the result of a lack of well-managed financial communication vis-à-vis the various types of stakeholders. We follow de Bruin?s (1999) definition of financial communication as denoting “any activity involving financial information and the promotion of the financial corporate image” and Balmer and Dinnie?s (1999) categorization of target audiences to whom financial communication should be addressed.The Fortis case may become a textbook example of communication gone wrong because of the failure, on the one hand, to distinguish between financial information and financial communication, and on the other, to diversify communication strategies and formats aimed at different stakeholders. As shown by research conducted by Watson Wyatt (1999), the failure of the majority of mergers and acquisitions could have been prevented if more attention had been paid to what is defined in the literature as soft or peripheral issues. The communication of information to the various stakeholders is one such issue. The findings of our analysis of three decisive communication events in the Fortis case illustrate that companies which fail to recognize this and to act accordingly do so at their peril.
    Date: 2010–05
  16. By: Zongxia Liang; Weiming Wu; Shuqing Jiang
    Abstract: This paper works out fair values of stock loan model with automatic termination clause. This stock loan is treated as a generalized perpetual American option with an automatic termination clause and possibly negative interest rate. Since it helps a bank to control the risk, banks should charge less service fees compared to stock loans without automatic termination clauses. The automatic termination clause is in fact a stop order set by the bank. We aim at establishing explicitly the value of such a loan and ranges of fair values of key parameters : this loan size, interest rate, fee for providing such a service and quantity of this automatic termination clause and relationships among these parameters as well as the optimal terminable stopping times.
    Date: 2010–05
  17. By: Niels Johannesen (Department of Economics, University of Copenhagen)
    Abstract: Bank deposits in jurisdictions with banking secrecy constitute an effective tool to evade taxes on interest income. A recent EU reform reduces the scope for this type of tax evasion by introducing a source tax on interest income earned by EU residents in Switzerland and several other jurisdictions with banking secrecy. In this paper, we estimate the impact of the source tax on Swiss bank deposits held by EU residents while using that non-EU residents were not subject to the tax to apply a natural experiment methodology. We find that the 15% source tax caused Swiss bank deposits of EU residents to drop by more than 40% with most of the response occurring in two quarters immediately before and after the source tax was introduced. The estimates imply an elasticity of Swiss deposits with respect to the net-of-source-tax-rate of around 2.75. The estimated elasticity is used to evaluate the efficiency properties of the tax. Given the large responsiveness of tax evaders, we find that the tax is associated with a very significant deadweight loss and that the 35% tax rate scheduled to apply from 2011 is considerably above the revenue maximizing rate
    Keywords: tax evasion; capital taxation; tax competition; savings directive
    Date: 2010–05
  18. By: Zdzienicka, Aleksandra
    Abstract: The aim of the paper is to re-assess the bank credit development in 11 Central and Eastern European countries and to provide new estimates of the credit-to-GDP ratio equilibrium level. Using filtering methods and dynamic panel estimations, our results suggest an “excessive” credit development for most of the studied economies until 2007. After this period, while credit has continued to remain excessive in Bulgaria, Hungary, Poland and Slovakia, it has decelerated in the other countries. However, while the results suggest a possibility of “credit crunch” in the Baltic republics and, to a less extent, in Croatia, credit deceleration may lead to “soft landing” for the Czech Republic, Romania and Slovenia.
    Keywords: Bank Credit; Dynamic Panel; CEECs
    JEL: G2 C2
    Date: 2010–03
  19. By: Titiheruw, Ira S. (Asian Development Bank Institute); Atje, Raymond (Asian Development Bank Institute)
    Abstract: This paper describes the existing payment system in Indonesia, which is comprised of cash and non-cash payment systems. The non-cash payment system has evolved swiftly due to improvements in information technology and the resulting transition from a paper-based to a card-based system. With the development of e-money, it is already moving toward a paperless payment system. As the monetary authority in Indonesia, Bank Indonesia is responsible for regulating and safeguarding the smooth and efficient operation of the national payment system. In 2004, the bank revised the blueprint of the system, which was originally introduced in 1995 in anticipation of efficiency-related challenges and legal implications arising from economic and technological development. Although Bank Indonesia expects to be able to provide equitable access and offer consumer protection, potential benefits arising from technological advances to the payment system, such as access in remote areas, remains an issue for small- and medium-sized enterprises. This paper examines this issue closely, with an eye to making the payment system more inclusive. It also examines the impact of the recent global financial crisis on Indonesia's payment system. The authors found that the system has remained safe, secure, and reliable despite some minor liquidity problems experienced by small banks in the last quarter of 2008 as the effects of the global crisis began to penetrate the country's financial sector.
    Keywords: payment system indonesia; bank indonesia payment system; indonesia financial crisis
    JEL: E42
    Date: 2009–08–31
  20. By: Antonio Francisco A. Silva Jr.
    Abstract: Even in a floating foreign exchange rate regime, monetary authorities sometimes intervene in the currency market due to liquidity demand and foreign exchange crises. Typically, central banks intervene using foreign currency trades and/or by changing domestic interest rates. We discuss this framework in the context of an optimal impulse stochastic control model. The control and performance equations include interventions with swap operations in the domestic market, since the Central Bank of Brazil also uses these operations. We evaluate risk management strategies for central bank interventions in case of crisis based on the model. We conclude that the Brazilian risk management strategy of increasing holdings of international reserves and decreasing short foreign exchange rate exposure in domestic public debt after 2004 gave the country more flexibility to manage foreign exchange rate risk in 2008 and to avoid higher interest rates to attract international capital as was necessary in previous crises.
    Date: 2010–04
  21. By: de Mel, Suresh; McKenzie, David; Woodruff, Christopher
    Abstract: Using data from surveys of enterprises in Sri Lanka after the December 2004 tsunami, the authors undertake the first microeconomic study of the recovery of the private firmsin a developing country following a major natural disaster. Disaster recovery in low-income countries is characterized by the prevalence of relief aid rather than of insurance payments; the data show this distinction has important consequences. The data indicate that aid provided directly to households correlates reasonably well with reported losses of household assets, but is uncorrelated with reported losses of business assets. Business recovery is found to be slower than commonly assumed, with disaster-affected enterprises lagging behind unaffected comparable firms more than three years after the disaster. Using data from random cash grants provided by the project, the paper shows that direct aid is more important in the recovery of enterprises operating in the retail sector than for those operating in the manufacturing and service sectors.
    Keywords: Microfinance,Debt Markets,Banks&Banking Reform,Natural Disasters,Hazard Risk Management
    Date: 2010–04–01
  22. By: Jeon, Doh-Shin; Menicucci, Dominico
    Abstract: Whether a microfinance institution should use a state-contingent repayment or not is very important since a state-contingent loan can provide insurance for borrowers. However, the classic Grameen bank used state non-contingent repayment, which is puzzling since it forces poor borrowers to make their payments even under hard circumstances. This paper provides an explanation to this puzzle. We consider two modes of lending, group and individual lending, and for each mode we characterize the optimal lending and supervisory contracts when a staff member (a supervisor) can embezzle borrowers' repayments by misrepresenting realized returns. We identify the main trade-off between the insurance gain and the cost of controlling the supervisor's misbehavior. We also found that group lending dominates individual lending either by providing more insurance or by saving audit costs.
    JEL: O16 D82 G20
    Date: 2010–03–09
  23. By: Masaaki Fujii (Graduate School of Economics, University of Tokyo); Yasufumi Shimada (Capital Markets Division, Shinsei Bank, Limited); Akihiko Takahashi (Faculty of Economics, University of Tokyo)
    Abstract: In recent years, we have observed the dramatic increase of the use of collateral as an important credit risk mitigation tool. It has become even rare to make a contract without collateral agreement among the major financial institutions. In addition to the significant reduction of the counterparty exposure, collateralization has important implications for the pricing of derivatives through the change of effective funding cost. This paper has demonstrated the impact of collateralization on the derivative pricing by constructing the term structure of swap rates based on the actual market data. It has also shown the importance of the "choice" of collateral currency. Especially, when the contract allows multiple currencies as eligible collateral and free replacement among them, the paper has found that the embedded "cheapest-to-deliver" option can be quite valuable and significantly change the fair value of a trade. The implications of these findings for market risk management have been also discussed.
    Date: 2010–05
  24. By: Zongxia Liang; Weiming Wu
    Abstract: In this paper we first introduce two new financial products: stock loan and capped stock loan. Then we develop a pure variational inequality method to establish explicitly the values of these stock loans. Finally, we work out ranges of fair values of parameters associated with the loans.
    Date: 2010–05
  25. By: Pinto, Brian; Ulatov, Sergei
    Abstract: Russia had more-or-less completed the privatization of its manufacturing and natural resource sectors by the end of 1997. And in February 1998, the annual inflation rate at last dipped into the single digits. Privatization should have helped with stronger micro-foundations for growth. The conquest of inflation should have cemented macroeconomic credibility, lowered real interest rates, and spurred investment. Instead, Russia suffered a massivepublic debt-exchange rate-banking crisis just six months later, in August 1998. In showing how this turn of events unfolded, the authors focus on the interaction among Russia's deteriorating fiscal fundamentals, its weak micro-foundations of growth and financial globalization. They argue that the expectation of a large official bailout in the final 10 weeks before the meltdown played an important role, with Russia's external debt increasing by $16 billion or 8 percent of post-crisis gross domestic product during this time. The lessons and insights extracted from the 1998 Russian crisis are of general applicability, oil and geopolitics notwithstanding. These include a discussion of when financial globalization might actually hurt and a cutoff in market access might actually help; circumstances in which an official bailout could backfire; and why financial engineering tends to fail when fiscal solvency problems are present.
    Keywords: Debt Markets,Emerging Markets,Banks&Banking Reform,Access to Finance,Currencies and Exchange Rates
    Date: 2010–05–01

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