New Economics Papers
on Banking
Issue of 2010‒08‒21
seventeen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Are Banks Too Big to Fail or Too Big to Save? International Evidence from Equity Prices and CDS Spreads By Demirgüc-Kunt, A.; Huizinga, H.P.
  2. Competition, Efficiency, and Soundness in Banking: An Industrial Organization Perspective By Schaeck, K.; Cihák, M.
  3. The impact of institutional investors and increasingly sophisticated financial instruments on risk and leverage By Bojańczyk, Mirosław
  4. Financing Risk and Bubbles of Innovation By Ramana Nanda; Matthew Rhodes-Kropf
  5. Deposit Market Competition, Wholesale Funding, and Bank Risk By Craig, B.R.; Dinger, V.
  6. The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment By Gropp, R.; Grundl, C.; Guttler, A.
  7. Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition By Di Nicolo, G.; Lucchetta, M.
  8. Risk-return Efficiency, Financial Distress Risk, and Bank Financial Strength Ratings By Hua, Changchun; Liu, Li-Gang
  9. The Dynamics in Requested and Granted Loan Terms when Bank and Borrower Interact Repeatedly By Kirschenmann, K.
  10. Executive Compensation Based on Asset Values By Byström, Hans
  11. Financial Deregulation and Profit Efficiency: A Non-parametric Analysis of Indian Banks By Ghosh, Saibal
  12. Capital Requirements and Credit Rationing By Itai Agur
  13. Foreign bank participation in developing countries : what do we know about the drivers and consequences of this phenomenon? By Cull, Robert; Soledad Martinez Peria, Maria
  14. Pricing Payment Cards By Özlem Bedre-Defolie; Emilio Calvano
  15. A trust-driven financial crisis.Implications for the future of financial markets By Luigi Guiso
  16. Who Needs Credit and Who Gets Credit in Eastern Europe? By Brown, M.; Ongena, S.; Popov, A.; Yesin, P.
  17. Does the Presence of the Japan Post Bank in a Regional Financial Market Affect the Deposit Interest Rates of Credit Associations? By Kondo, Kazumine

  1. By: Demirgüc-Kunt, A.; Huizinga, H.P. (Tilburg University, Center for Economic Research)
    Abstract: Deteriorating public finances around the world raise doubts about countries’ abilities to bail out their largest banks. For an international sample of banks, this paper investigates the impact of government indebtedness and deficits on bank stock prices and CDS spreads. Overall, bank stock prices reflect a negative capitalization of government debt and they respond negatively to deficits. We present evidence that in 2008 systemically large banks saw a reduction in their market valuation in countries running large fiscal deficits. Furthermore, the change in bank CDS spreads in 2008 relative to 2007 reflects countries’ deterioration of public deficits. Our results suggest that some systemically important banks can increase their value by downsizing or splitting up, as they have become too big to save, potentially reversing the trend to ever larger banks. We also document that a smaller proportion of banks are systemically important - relative to GDP - in 2008 than in the two previous years, which could reflect these private incentives to downsize.
    Keywords: Banking;Financial crisis;Credit default swap;Too big to fail;Too big to save
    JEL: G21 G28
    Date: 2010
  2. By: Schaeck, K.; Cihák, M. (Tilburg University, Center for Economic Research)
    Abstract: How can competition enhance bank soundness? Does competition improve soundness via the efficiency channel? Do banks heterogeneously respond to competition? To answer these questions, we exploit an innovative measure of competition [Boone, J., A new way to measure competition, EconJnl, Vol. 118, pp. 1245-1261] that captures the reallocation of profits from inefficient banks to their efficient counterparts. Based on two complementary datasets for Europe and the U.S., we first establish that the new competition indicator captures a broad variety of other characteristics of competition in a consistent manner. Second, we verify that competition increases efficiency. Third, we present novel evidence that efficiency is the conduit through which competition contributes to bank soundness. In a final examination of banks’ heterogeneous responses to competition, we find that smaller banks’ soundness measures respond more strongly to competition than larger banks’ soundness measures, and two-stage quantile regressions indicate that the soundness-enhancing effect of competition is larger in magnitude for sound banks than for fragile banks.
    Keywords: bank competition;efficiency;soundness;Boone indicator;quantile regression
    JEL: G21 G28
    Date: 2010
  3. By: Bojańczyk, Mirosław
    Abstract: The volatility of capital markets is often blamed on the activities of institutional investors, or an excessive amount of financial instruments. It must be remembered that there are different institutional investors. Some of them play a very useful role without having a negative impact on the stability of the capital market. The same is true various instruments, many of them play a useful role. Many companies have long used derivatives to hedge against business risks, using them to manage fluctuations in exchange rates, interest rates, commodity prices, etc.
    Keywords: investment banks; institutional investors; financial instruments; risk; leverage; financial crises;
    JEL: E44 G24 G20
    Date: 2010–06–20
  4. By: Ramana Nanda (Harvard Business School, Entrepreneurial Management Unit); Matthew Rhodes-Kropf (Harvard Business School, Entrepreneurial Management Unit)
    Abstract: Investors in risky startups who stage their investments face financing risk -that is, the risk that later stage investors will not fund the startup, even if the fundamentals of the firm are still sound. We show that financing risk is part of a rational equilibrium where investors can flip from investing to not investing in certain sectors of the economy. We further demonstrate that financing risk has the greatest impact on firms with the most real option value. Hence, the mix of projects funded and type of investors who are active varies with the level of financing risk in the economy. We also highlight that some extremely novel technologies may in fact need `hot' financial markets to get through the initial period of diffusion. Our work underscores that financial markets may play a much larger and under-studied role in creating and magnifying bubbles of innovation in the real economy.
    Date: 2010–08
  5. By: Craig, B.R.; Dinger, V. (Tilburg University, Center for Economic Research)
    Abstract: In this paper we revisit the long debate on the risk effects of bank competition and propose a new approach to the empirical estimation of the relation between deposit market competition and bank risk. Our approach accounts for the opportunity of banks to shift to wholesale funding when deposit market competition is intense. The analysis is based on a unique comprehensive dataset which combines retail deposit rates data with data on bank characteristics and with data on local deposit market features for a sample of 589 U.S. banks. Our results support the notion of a risk-enhancing effect of deposit market competition.
    Keywords: bank competition;wholesale funding;bank risk;deposit rates
    JEL: G21
    Date: 2010
  6. By: Gropp, R.; Grundl, C.; Guttler, A. (Tilburg University, Center for Economic Research)
    Abstract: In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank/borrower information. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. At the same time, the banks also increased interest rates on their remaining borrowers. The effects are economically large: the Z-Score of average borrowers increased by 7% and the average loan size declined by 13%. Remaining borrowers paid 57 basis points higher interest rates, despite their higher quality. Using a difference-in-differences approach we show that the effect is larger for banks that ex ante benefitted more from the guarantee. We show that both the credit quality of new customers improved (screening) and that the loans of existing riskier borrowers were less likely to be renewed (monitoring), after the removal of public guarantees. Public guarantees seem to be associated with substantial moral hazard effects.
    Keywords: banking;public guarantees;credit risk;moral hazard
    JEL: G21 G28 G32
    Date: 2010
  7. By: Di Nicolo, G.; Lucchetta, M. (Tilburg University, Center for Economic Research)
    Abstract: We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.
    Keywords: General Equilibrium;Bank Competition;Market Power Rents;Risk
    JEL: D5 G21
    Date: 2010
  8. By: Hua, Changchun (Asian Development Bank Institute); Liu, Li-Gang (Asian Development Bank Institute)
    Abstract: This paper investigates whether there is any consistency between banks' financial strength ratings (bank rating) and their risk-return profiles. It is expected that banks with high ratings tend to earn high expected returns for the risks they assume and thereby have a low probability of experiencing financial distress. Bank ratings, a measure of a bank's intrinsic safety and soundness, should therefore be able to capture the bank's ability to manage financial distress while achieving risk-return efficiency. We first estimate the expected returns, risks, and financial distress risk proxy (the inverse z-score), then apply the stochastic frontier analysis (SFA) to obtain the risk-return efficiency score for each bank, and finally conduct ordered logit regressions of bank ratings on estimated risks, risk-return efficiency, and the inverse z-score by controlling for other variables related to each bank's operating environment. We find that banks with a higher efficiency score on average tend to obtain favorable ratings. It appears that rating agencies generally encourage banks to trade expected returns for reduced risks, suggesting that these ratings are generally consistent with banks' risk-return profiles.
    Keywords: bank ratings; risk-return efficiency; stochastic frontier analysis
    JEL: D21 D24 G21 G24 G28 G32
    Date: 2010–08–12
  9. By: Kirschenmann, K. (Tilburg University, Center for Economic Research)
    Abstract: This paper studies how credit constraints develop over bank relationships. I analyze a unique dataset of matched loan application and loan contract information and measure credit constraints as the ratio of requested to granted loan amounts. I find that the most important determinants of receiving smaller than requested loan amounts are firm age and size at the time of the first interaction between borrower and bank. Over loan sequences, credit constraints decease most pronouncedly in the beginning of relationships and for the initially young and small firms. Moreover, the structure of the dataset allows me to disentangle the demand and supply effects behind these observed credit constraints. I find that the gap between requested and granted loan amounts decreases because both sides converge. If previous credit constraints were large, requested amounts increase more moderately, while granted amounts increase more strongly than in the case of small previous constraints. The findings are a sign of the use of dynamic incentives at the bank side to overcome information problems when contracting repeatedly with opaque borrowers. The results further suggest that, particularly in the beginning of a bank relationship, borrowers learn from their previous experience with credit constraints and adjust their demand accordingly.
    Keywords: Credit constraints;relationship lending;small business lending;asymmetric information;learning
    JEL: D82 G20 G21 G30
    Date: 2010
  10. By: Byström, Hans (Department of Economics, Lund University)
    Abstract: This paper describes how credit default swaps could be employed to create performance based executive compensation portfolios that reflect the value of a firm’s debt as well as equity; i.e. the total value of all a firm’s assets. So-called Asset Value Unit (AVU) compensation portfolios are defined and compared to ordinary (long-term incentive) stock compensation portfolios for a range of banks from the recent EU-wide stress testing exercise conducted by the Committee of European Banking Supervisors (CEBS). While our study is limited to bank executives, the suggested method of paying executives using credit default swaps in addition to stocks also works for non-financial firms as well as for non-executives. The empirical results suggest that executive/CEO compensation plans based on asset values behave more reasonably than traditional equity based plans.
    Keywords: executive pay; executive compensation; stock; credit default swap; bank; stress test
    JEL: G10 G21 G34 G38
    Date: 2010–08–14
  11. By: Ghosh, Saibal
    Abstract: The paper investigates the performance of Indian commercial banking sector during the post reform period 1992-2004. The results indicate high levels of efficiency in costs and lower levels in profits, reflecting the importance of inefficiencies on the revenue side of banking activity. The decomposition of profit efficiency shows that a large portion of outlay lost is due to allocative inefficiency. The proximate determinants of profit efficiency appears to suggest that big state-owned banks performed reasonably well and are more likely to operate at higher levels of profit efficiency. A close relationship is observed between efficiency and soundness as determined by bank’s capital adequacy ratio. The empirical results also show that the profit efficient banks are those that have, on an average, less non-performing loans.
    Keywords: Indian Banks; Deregulation; Profit efficiency; DEA model
    JEL: G21
    Date: 2009–11
  12. By: Itai Agur
    Abstract: This paper analyzes the trade-off between financial stability and credit rationing that arises when increasing capital requirements. It extends the Stiglitz-Weiss model of credit rationing to allow for bank default. Bank capital structure then matters for lending incentives. With default and rationing endogenous, optimal capital requirements can be analyzed. Introducing bank financiers, the paper also shows that uninsured funding raises the sensitivity of rationing to capital requirements. In a world with much wholesale finance, capital requirements have a stronger impact on the real economy. But wholesale finance also amplifies capital requirements’ effect on default rates.
    Keywords: Rationing; Capital requirements; Regulation; Wholesale finance; Deposit Insurance
    JEL: G21 G28
    Date: 2010–08
  13. By: Cull, Robert; Soledad Martinez Peria, Maria
    Abstract: Foreign bank participation has increased steadily across developing countries since the mid-1990s. This paper documents this trend and surveys the existing literature to explore the drivers and consequences of this phenomenon, paying particular attention to the differences observed across regions both in the degree of foreign bank participation and in the impact of this process. Local profit opportunities, the absence of barriers to entry, and the presence of mechanisms to mitigate information problems have been the main factors driving foreign bank entry across developing countries. In general, foreign bank participation has been shown to exert a positive influence on banking sector efficiency and competition. The weight of the evidence suggests that foreign bank presence does not endanger, but rather enhances banking sector stability. And although some case studies suggest that foreign bank entry limits access to finance, many cross-country studies offer evidence to the contrary.
    Keywords: Banks&Banking Reform,Debt Markets,Access to Finance,Emerging Markets,Foreign Direct Investment
    Date: 2010–08–01
  14. By: Özlem Bedre-Defolie (ESMT European School of Management and Technology); Emilio Calvano (Bocconi University)
    Abstract: Payment card networks, such as Visa, require merchants' banks to pay substantial "interchange" fees to cardholders' banks, on a per transaction basis. This paper shows that a network's profit-maximizing fee induces an inefficient price structure, over-subsidizing card usage and over-taxing merchants. In contrast to the literature we show that this distortion is systematic and arises from the fact that consumers make two distinct decisions (membership and usage) whereas merchants make only one (membership). These findings are robust to competition for cardholders and/or for merchants, network competition, and strategic card acceptance to attract consumers.
    Keywords: payment card networks, interchange fees, merchant fees
    JEL: G21 L11 L42 L31 L51 K21
    Date: 2010–08–11
  15. By: Luigi Guiso (European University Institute, EIEF and CEPR)
    Abstract: The financial crisis has brought to light diffuse opportunistic behaviour and some serious frauds. Because of this trust towards banks, bankers, brokers and the stock market has collapsed to unprecedented levels and there are so far no signs of recovery. This paper uses survey-based information to document the collapse of trust, show its link to the emergence of frauds in the financial industry and discuss its consequences for the demand of financial instruments, investors portfolios and more generally investors reliance on financial markets. It argues that unless serious changes happen in the behaviour of the financial industry, the move towards safer portfolios and away from ambiguous securities that lack of trust entails, will have adverse effects on the availability and cost of equity financing. Accordingly a number of proposals to restore trust are discussed. Their common feature is to restore trust – a belief – by limiting the scope for opportunistic behaviour through a transfer of power from financial intermediaries to investors.
    Date: 2010
  16. By: Brown, M.; Ongena, S.; Popov, A.; Yesin, P. (Tilburg University, Center for Economic Research)
    Abstract: Based on survey data covering 8,387 firms in 20 countries we compare credit demand and credit supply for firms in Eastern Europe to those for firms in selected Western European countries.
    Keywords: Credit Constraints;Banking sector;Transition economies
    JEL: G21 G30 F34
    Date: 2010
  17. By: Kondo, Kazumine
    Abstract: The former Minister Shizuka Kamei, who was appointed as the Minister for Financial Services during the premiership of Yukio Hatoyama, pushed reforms to change the previous goal of completely privatizing the postal services. The basic policy is that participation by the government in the businesses of postal savings will be practically maintained and the ceiling of postal savings will be raised from 10,000,000 yen to 20,000,000 yen. Therefore, in the present study we analyzed whether credit associations in a region whose share of postal savings is larger are being pressured to set higher deposit interest rates due to the presence of postal savings. The results showed that the presence of postal savings in a region does not pressure credit associations to set higher deposit interest rates, at least under the present conditions. It can thus be concluded that if a set of reforms is carried out which maintains the participation of the government in the Japan Post Bank, the ceiling of postal savings should be frozen at the present level.
    Keywords: postal savings; credit associations; deposit interest rates; privatization of postal services; the ceiling of postal savings
    JEL: G21
    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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