New Economics Papers
on Banking
Issue of 2010‒08‒14
sixteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Market and Funding Liquidity Stress Testing of the Luxembourg Banking Sector By Francisco Nadal De Simone; Franco Stragiotti
  2. The crisis as a wake-up call. Do banks tighten screening and monitoring during a financial crisis? By Ralph de Haas; Neeltje van Horen
  3. Why the micro-prudential regulation fails? The impact on systemic risk by imposing a capital requirement By Chen Zhou
  4. Debt restructuring and the role of lending technologies By Giacinto Micucci; Paola Rossi
  5. Questions and Answers about the Financial Crisis By Gorton, Gary
  6. Disentangling demand and supply in credit developments: a survey-based analysis for Italy By Paolo Del Giovane; Ginette Eramo; Andrea Nobili
  7. The misconception of the option value of deposit insurance and the efficacy of non-risk-based capital requirements in the literature on bank capital regulation By Paolo Fegatelli
  8. Financial amplification of foreign exchange risk premia By Tobias Adrian; Erkko Etula; Jan J. J. Groen
  9. Implications of bank ownership for the credit channel of monetary policy transmission: Evidence from India By Sumon Kumar Bhaumik; Vinh Dang; Ali M. Kutan
  10. Switching costs in local credit markets By Guglielmo Barone; Roberto Felici; Marcello Pagnini
  11. Who gains and who loses from credit card payments?: theory and calibrations By Scott Schuh; Oz Shy; Joanna Stavins
  12. Countercyclical capital buffers: exploring options By Mathias Drehmann; Claudio Borio; Leonardo Gambacorta; Gabriel Jiminez; Carlos Trucharte
  13. Optimal Default and Liquidation with Tangible Assets and Debt Renegotiation By Goto, Makoto; Kijima, Masaaki; Suzuki, Teruyoshi
  14. The central-bank balance sheet as an instrument of monetary policy By Vasco Cúrdia; Michael Woodford
  15. Funding liquidity risk and the cross-section of stock returns By Tobias Adrian; Erkko Etula
  16. Calculation of aggregate loss distributions By Pavel V. Shevchenko

  1. By: Francisco Nadal De Simone; Franco Stragiotti
    Abstract: This paper performs market and funding liquidity stress testing of the Luxembourg banking sector using stochastic haircuts and run-off rates. It takes into account not only the shocks to the banking sector and banks? responses to them, but second-round effects due to the effects of banks? reactions on asset prices and reputation. In general, banks? business lines and, therefore their buffers? composition, determine the net effect of the shocks on banks? stochastic liquidity buffers. So, results differ across banks. Second-round effects exemplify the relevance of contagion effects that reduce the systemic benefits of diversification. While systemic liquidity risk is low following a shock to the interbank market, for Luxembourg, with its high number of subsidiaries of large foreign financial institutions, the results indicate the importance of monitoring the liquidity of parent groups to which Luxembourg institutions belong. In particular, shocks to related-party deposits are important. Finally, the results, including those of a run-on-deposits shock, show the relevance of system-wide measures to minimize the systemic effects of liquidity crises.
    Keywords: stress test, liquidity risk, banks, stochastic, contagion, macro-prudential
    JEL: E5 C1 G2
    Date: 2010–05
  2. By: Ralph de Haas; Neeltje van Horen
    Abstract: To what extent was the credit contraction during the global financial crisis due to more intense screening and monitoring by banks? We address this question by analyzing changes in the structure of a large number of syndicated loans to private, non-financial corporations. We find an increase in retention rates among syndicate arrangers during the crisis that we cannot explain by borrower risk or interbank liquidity alone. This increased ‘skin in the game’ is especially pronounced when information asymmetries between the borrower and the lending syndicate – or within the syndicate – are high. This indicates that the reduction in bank lending during the crisis was at least partly caused by stricter bank screening and monitoring: a wake-up call.
    Keywords: bank lending; financial crisis; loan retention; screening and monitoring; syndication
    JEL: D82 G15 G21
    Date: 2010–07
  3. By: Chen Zhou
    Abstract: This paper studies why the micro-prudential regulations fails to maintain a stable financial system by investigating the impact of micro-prudential regulation on the systemic risk in a cross-sectional dimension. We construct a static model for risk-taking behavior of financial institutions and compare the systemic risks in two cases with and without a capital requirement regulation. In a system with a capital requirement regulation, the individual risk-taking of the financial institutions are lower, whereas the systemic linkage within the system is higher. With a proper systemic risk measure combining both individual risks and systemic linkage, we find that, under certain circumstance, the systemic risk in a regulated system can be higher than that in a regulation-free system. We discuss a sufficient condition under which the systemic risk in a regulated system is always lower. Since the condition is based on comparing balance sheets of all institutions in the system, it can be verified only if information on risk-taking behaviors and capital structures of all institutions are available. This suggests that a macro-prudential framework is necessary for establishing banking regulations towards the stability of the financial system as a whole.
    Keywords: Banking regulation; systemic risk; capital requirement; macro-prudential regulation
    JEL: G28 G32
    Date: 2010–07
  4. By: Giacinto Micucci (Bank of Italy); Paola Rossi (Bank of Italy)
    Abstract: The literature on debt restructuring usually assumes that banks behave in a uniform way towards firms in distress. Using a recent survey of Italian banks, we show that banks follow different strategies when they decide whether to take part in the workout process, in that some of them do restructure their debt claims towards small and medium-sized enterprises in distress, while others do not. We explain this heterogeneity by considering the role of banksÂ’ internal organization and lending technologies, which the literature has shown to be strictly tied to the type of relationship developed with the borrower (transactional versus relationship lending). We find that the probability of debt restructuring is higher when the bank: i) is geographically closer to borrowing firms; ii) relies more on soft than hard information; and iii) adopts a decentralized structure with more power allocated to local managers. However there are important complementarities among organizational variables: the adoption of credit scoring increases the likelihood of restructuring if banks also use these techniques systematically in the monitoring process and if they adopt more decentralized structures. Bank size per se is not able to fully explain this heterogeneous behaviour, as organizational forms and lending technologies may also have important consequences on bank decisions.
    Keywords: financial distress, debt restructuring, small and medium-sized enterprises (SMEs), bank heterogeneity, bank organization, lending technologies.
    JEL: G21 G33 L2 O3
    Date: 2010–06
  5. By: Gorton, Gary
    Abstract: All bond prices plummeted (spreads rose) during the financial crisis, not just the prices of subprimerelated bonds. These price declines were due to a banking panic in which institutional investors and firms refused to renew sale and repurchase agreements (repo) – short?term, collateralized, agreements that the Fed rightly used to count as money. Collateral for repo was, to a large extent, securitized bonds. Firms were forced to sell assets as a result of the banking panic, reducing bond prices and creating losses. There is nothing mysterious or irrational about the panic. There were genuine fears about the locations of subprime risk concentrations among counterparties. This banking system (the “shadow” or “parallel” banking system) - repo based on securitization - is a genuine banking system, as large as the traditional, regulated and banking system. It is of critical importance to the economy because it is the funding basis for the traditional banking system. Without it, traditional banks will not lend and credit, which is essential for job creation, will not be created.
    Keywords: Technology and Industry
    Date: 2010–02
  6. By: Paolo Del Giovane (Bank of Italy); Ginette Eramo (Bank of Italy); Andrea Nobili (Bank of Italy)
    Abstract: This paper combines qualitative information from the Eurosystem Bank Lending Survey with micro-data on loan prices and quantities for the participating Italian banks to assess the role of supply and demand factors in credit developments, with a focus on the sharp slowdown of 2008-09. Both demand and supply have played a relevant role, especially for lending to enterprises, in the whole sample period and during the financial crisis. A counterfactual exercise shows that the effect of supply factors on the growth of lending to firms was strongest after the Lehman collapse. On average, over the crisis period (2007q3-2009q4) the negative effect on the annualized quarter-on-quarter growth rate of the panel banksÂ’ lending to enterprises can be estimated in a range of 2.2 to 3.1 percentage points, depending on the specification. About one fourth of the total supply effect can be attributed to costs related to the banksÂ’ balance sheet position, the rest to their perception of credit risk.
    Keywords: credit growth, supply tightening, financial crisis
    JEL: E30 E32 E51
    Date: 2010–06
  7. By: Paolo Fegatelli
    Abstract: This study shows how the misconception of the option value of deposit insurance by Merton (1977) and its later misuse by Keeley and Furlong (1990), among others, have led some literature supporting the adoption of binding non-risk-based capital requirements to derive incorrect conclusions about their efficacy. This study further shows that what Merton defines as the option value of deposit insurance is actually a component of a bank?s limited liability option under a third-party deposit guarantee. As such, it is already included in the value of the bank?s equity capital, and the flawed definition makes the Keeley-Furlong model internally incoherent.
    Keywords: Capital requirements, Credit risk, Deposit insurance, Prudential regulation, Portfolio approach
    JEL: G21 G28 G11
    Date: 2010–07
  8. By: Tobias Adrian; Erkko Etula; Jan J. J. Groen
    Abstract: Theories of systemic risk suggest that financial intermediaries’ balance-sheet constraints amplify fundamental shocks. We provide supporting evidence for such theories by decomposing the U.S. dollar risk premium into components associated with macroeconomic fundamentals and a component associated with financial intermediaries’ balance sheets. Relative to the benchmark model with only macroeconomic state variables, balance sheets amplify the U.S. dollar risk premium. We discuss applications to systemic risk monitoring.
    Keywords: Systemic risk ; Intermediation (Finance) ; Foreign exchange ; Assets (Accounting)
    Date: 2010
  9. By: Sumon Kumar Bhaumik; Vinh Dang; Ali M. Kutan
    Abstract: Many developing and emerging markets have high degrees of state bank ownership. In addition, the recent global financial crisis has led to significant state ownership of banking assets in developed countries such as the United Kingdom. These observations beg the question of whether the effectiveness of monetary policy through a lending channel differs across banks with different ownerships. In this paper, using bank-level data from India, we examine this issue and also test whether the reaction of different types of banks (i.e., private, state and foreign) to monetary policy changes is different in easy and tight policy regimes. Our results suggest that there are considerable differences in the reactions of different types of banks to monetary policy initiatives of the central bank and the bank lending channel of monetary policy might be much more effective in a tight money period than in an easy money period. We also find differences in impact of monetary policy changes on less risky short term and more risky medium term lending We discuss the policy implications of the findings. Our results from India are preliminary and further studies are needed to see whether our findings can be generalized to emerging economies or developing countries in general.
    Keywords: bank ownership; credit channel of monetary policy; lending; monetary policy regimes, India.
    JEL: E51 E58 G21 G32
    Date: 2010–05
  10. By: Guglielmo Barone (Bank of Italy); Roberto Felici (Bank of Italy); Marcello Pagnini (Bank of Italy)
    Abstract: Switching costs are a key determinant of market performance. This paper tests their existence in the corporate loan market in which they are likely to play a central role because of the complexity of contracts and informational problems. Using very detailed data at bank-firm level on four Italian local credit markets we empirically show that firms tend to iterate their choice of the main bank over time. This inertia is not related to unobserved and time invariant preferences of firms across banks and can be attributed to the existence of switching costs. We also offer evidence that banks price discriminate between new and old borrowers by charging lower interest rates to the former in order to cover part of the switching costs. The discount is about 44 basis points, equal to 7 per cent of the average interest rate. These results prove robust to a number of other potential identification drawbacks.
    Keywords: switching costs, local credit markets, price discrimination, lending relationships
    JEL: L13 G21
    Date: 2010–06
  11. By: Scott Schuh; Oz Shy; Joanna Stavins
    Abstract: Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash-using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.
    Keywords: Credit cards
    Date: 2010
  12. By: Mathias Drehmann; Claudio Borio; Leonardo Gambacorta; Gabriel Jiminez; Carlos Trucharte
    Abstract: This paper provides some general lessons for the design of countercyclical capital buffers. Its main empirical contribution is to analyse conditioning variables which could guide the build-up and release of capital. A major distinction for countercyclical capital schemes is whether conditioning variables are bank-specific or system-wide. The evidence presented in the paper indicates that the idiosyncratic component can be sizeable when a bank-specific approach is used. This makes a system-wide approach preferable, for which the best variables as signal for the pace and size of the accumulation of the buffers are not necessarily the best for the timing and intensity of the release. The credit-to-GDP ratio seems best for the build-up phase. Some measure of aggregate losses, possibly combined with indicators of credit conditions, seem to perform well for signalling the beginning of the release phase. Nonetheless, the analysis indicates that designing a fully rule-based mechanism may not be possible at this stage as some degree of judgment seems inevitable. A parallel exercise indicates that reducing the sensitivity of the minimum capital requirement is an important element of a credible countercyclical buffer scheme.
    Keywords: countercyclical capital buffers, financial stability, procyclicality
    Date: 2010–07
  13. By: Goto, Makoto; Kijima, Masaaki; Suzuki, Teruyoshi
    Abstract: This paper proposes a new pricing model for corporate securities issued by a levered firm with the possibility of debt renegotiation. We take the structural approach that the firm's earnings follow a geometric Brownian motion with stochastic collaterals. While equity holders can default the firm for their own benefits when the earnings become insufficient to go on the firm, they may want to liquidate it by repaying the face value of debt to debt holders in order to get enough residuals, when the value of collaterals becomes sufficiently high. Unlike the existing theoretical models, the bivariate structure enables us to distinguish strategic default, liquidity default and the ordinary liquidation. It is shown that liquidity default and liquidation possibly occur without entering debt renegotiation, which makes the contribution of strategic debt service to credit spreads lower than that obtained in the previous models, irrespective of the equity holders' bargaining power. Our model resolves the inconsistency reported in recent empirical studies.
    Keywords: Structural model, Debt renegotiation, Strategic debt service, Credit spread, Liquidity default, Strategic default, Liquidation, M&A,
    JEL: D81 G32 G33 G35
    Date: 2010–05
  14. By: Vasco Cúrdia; Michael Woodford
    Abstract: While many analyses of monetary policy consider only a target for a short-term nominal interest rate, other dimensions of policy have recently been of greater importance: changes in the supply of bank reserves, changes in the assets acquired by central banks, and changes in the interest rate paid on reserves. We first extend a standard New Keynesian model to allow a role for the central bank’s balance sheet in equilibrium determination and then consider the connections between these alternative policy dimensions and traditional interest rate policy. We distinguish between “quantitative easing” in the strict sense and targeted asset purchases by a central bank, arguing that, according to our model, while the former is likely to be ineffective at all times, the latter can be effective when financial markets are sufficiently disrupted. Neither is a perfect substitute for conventional interest rate policy, but purchases of illiquid assets are particularly likely to improve welfare when the zero lower bound on the policy rate is reached. We also consider optimal policy with regard to the payment of interest on reserves; in our model, this requires that the interest rate on reserves be kept near the target for the policy rate at all times.
    Keywords: Banks and banking, Central ; Monetary policy ; Interest rates ; Bank reserves
    Date: 2010
  15. By: Tobias Adrian; Erkko Etula
    Abstract: We derive equilibrium pricing implications from an intertemporal capital asset pricing model where the tightness of financial intermediaries’ funding constraints enters the pricing kernel. We test the resulting factor model in the cross-section of stock returns. Our empirical results show that stocks that hedge against adverse shocks to funding liquidity earn lower average returns. The pricing performance of our three-factor model is surprisingly strong across specifications and test assets, including portfolios sorted by industry, size, book-to-market, momentum, and long-term reversal. Funding liquidity can thus account for well-known asset pricing anomalies.
    Keywords: Capital assets pricing model ; Intermediation (Finance) ; Stocks - Rate of return ; Assets (Accounting) ; Liquidity (Economics)
    Date: 2010
  16. By: Pavel V. Shevchenko
    Abstract: Estimation of the operational risk capital under the Loss Distribution Approach requires evaluation of aggregate (compound) loss distributions which is one of the classic problems in risk theory. Closed-form solutions are not available for the distributions typically used in operational risk. However with modern computer processing power, these distributions can be calculated virtually exactly using numerical methods. This paper reviews numerical algorithms that can be successfully used to calculate the aggregate loss distributions. In particular Monte Carlo, Panjer recursion and Fourier transformation methods are presented and compared. Also, several closed-form approximations based on moment matching and asymptotic result for heavy-tailed distributions are reviewed.
    Date: 2010–08

This issue is ©2010 by Christian Calmès. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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