New Economics Papers
on Banking
Issue of 2010‒09‒11
24 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Do countries “graduate” from crises? Some historical perspective By Reinhart, Carmen; Qian, Rong; Rogoff, Kenneth
  2. Financial Connections and Systemic Risk By Allen, F.; Babus, a.; Carletti, E.
  3. MBS Ratings and the Mortgage Credit Boom By Ashcraft, A.; Goldsmith-Pinkham, P.; Vickery, J.
  4. Resolving the financial crisis: are we heeding the lessons from the Nordics? By Claudio Borio; Bent Vale; Goetz von Peter
  5. Banking competition, monitoring incentives and financial stability By VO Thi Quynh Anh
  6. The effects of bank capital on lending: What do we know, and what does it mean? By Jose M. Berrospide; Rochelle M. Edge
  7. Global Banking and International Business Cycles By Robert Kollmann; Zeno Enders; Gernot J. Müller
  8. Financial Legislation: The Promise and Record of the Financial Modernization Act of 1999 By Tatom, John
  9. On the determinants of banking efficiency in four new European Union Member States: the impact of structural reforms By Mamatzakis, Emmanuel; Koutsomanoli-Filippaki, Anastasia; Staikuras, Christos
  10. Foreign banks and financial stability in emerging markets: Evidence from the global financial crisis By Vogel, Ursula; Winkler, Adalbert
  11. Déjà vu all over again: The causes of U.S. commercial bank failures this time around By Cole, Rebel A.; White, Lawrence J.
  12. Funding Costs and Loan Pricing by Multinational Bank Affiliates By Alexis Derviz; Marie Rakova
  13. Banking globalization and international business cycles By Kozo Ueda
  14. The Role of the State in Managing and Forestalling Systemic Financial Crises: Some Issues and Perspectives By Charles Adams
  15. Bank credit, trade credit or no credit: Evidence from the Surveys of Small Business Finances By Cole, Rebel
  16. The Link between Insurance and Banking Sectors: An International Cross-Section Analysis of Life Insurance Demand By Benjamin Lorent
  17. The feasibility of through-the-cycle ratings By Kauko, Karlo
  18. Managing Markets for Toxic Assets By House, Christopher; Masatlioglu, Yusufcan
  19. Not all financial regulation is global By Nicolas Véron
  20. An assessment of the G20's initial action items By Nicolas Véron; Stephane Rottier
  21. The Anatomy of the Mortgage Securitization Crisis By Fligstein, Neil; Goldstein, Adam
  22. Diversification of Microfinance Institutions: Determinants for Entering the Remittances Market By Ritha Sukadi Mata
  23. Debt Value and Capital Structure with Firm's Net Cash Payouts By Flavia Barsotti; Maria Elvira Mancino; Monique Pontier
  24. Value at Risk Computation in a Non-Stationary Setting By Dominique Guegan

  1. By: Reinhart, Carmen; Qian, Rong; Rogoff, Kenneth
    Abstract: The widespread banking crises since 2007 among advanced economies and the “near” default of Greece in 2010 dashed the popular notion that rich countries have outgrown severe financial crises. Record or near-record declines in output accompanying these events signaled the end of the short-lived “great moderation era.” In fact, graduation from recurring sovereign external debt crises is a very tortuous process that sometimes takes a century or more. For banking crises, we simply do not know what it takes to graduate; it is unclear whether any country has managed it.
    Keywords: financial crisis; debt; default; banking; reversals; duration
    JEL: E0 F3 N0
    Date: 2010–08
  2. By: Allen, F.; Babus, a.; Carletti, E. (Tilburg University, Center for Economic Research)
    Abstract: We develop a model where institutions form connections through swaps of projects in order to diversify their individual risk. These connections lead to two different network structures. In a clustered network groups of financial institutions hold identical portfolios and default together. In an unclustered network defaults are more dispersed. With long term finance welfare is the same in both networks. In contrast, when short term finance is used, the network structure matters. Upon the arrival of a signal about banks’ future defaults, investors update their expectations of bank solvency. If their expectations are low, they do not roll over the debt and there is systemic risk in that all institutions are early liquidated. We compare investors’ rollover decisions and welfare in the two networks.
    Keywords: Financial networks;diversification;short term finance;rollover risk
    JEL: G21
    Date: 2010
  3. By: Ashcraft, A.; Goldsmith-Pinkham, P.; Vickery, J. (Tilburg University, Center for Economic Research)
    Abstract: We study credit ratings on subprime and Alt-A mortgage-backed securities (MBS) deals issued between 2001 and 2007, the period leading up to the subprime crisis. The fraction of highly-rated securities in each deal is decreasing in mortgage credit risk (measured either ex-ante or ex-post), suggesting ratings contain useful information for investors. However, we also find evidence of significant time-variation in risk-adjusted credit ratings, including a progressive decline in standards around the MBS market peak between the start of 2005 and mid-2007. Conditional on initial ratings, we observe underperformance (high mortgage defaults and losses, and large rating downgrades) amongst deals with observably higher-risk mortgages based on a simple ex-ante model, and deals with a high fraction of opaque low-documentation loans. These findings hold over the entire sample period, not just for deal cohorts most affected by the crisis.
    Keywords: Credit Rating Agencies;Subprime Crisis;Mortgage-Backed Securities
    JEL: G21 G24
    Date: 2010
  4. By: Claudio Borio (Bank for International Settlements); Bent Vale (Norges Bank (Central Bank of Norway)); Goetz von Peter (Bank for International Settlements)
    Abstract: How does the management and resolution of the current crisis compare with the response of the Nordic countries in the early 1990s, widely regarded as exemplary? We argue that, while intervention has been prompter, the measures taken so far remain less comprehensive and in-depth. In particular, the cleansing of balance sheets has proceeded more slowly, and less attention has been paid to reducing excess capacity and avoiding competitive distortions. In general, policymakers have given higher priority to sustaining aggregate demand in the short term than to encouraging adjustment in the financial sector and containing moral hazard. We argue that three factors largely explain this outcome: the more international nature of the crisis; the complexity of the instruments involved; and, hardly appreciated so far, the effect of accounting practices on the dynamics of the events, reflecting in particular the prominent role of fair value accounting (and mark to market losses) in relation to amortised cost accounting for loan books. There is a risk that the policies followed so far may delay the establishment of the basis for a sustainably profitable and less risk-prone financial sector.
    Keywords: Crisis management and resolution, principles for successful resolution, Nordic countries, fair value and amortised cost accounting, mark to market losses
    JEL: G21 G28
    Date: 2010–08–31
  5. By: VO Thi Quynh Anh (Norges Bank (Central Bank of Norway))
    Abstract: This paper addresses the desirability of competition in banking industry. In a model where banks compete on both deposit and loan markets and where banks can use monitoring technology to control entrepreneurs' behavior, we investigate three questions: what are the effects of competition on banks' monitoring incentives? Does competition hurt banks' stability? What can be devices to correct potential negative effcts of competition vis à vis financial stability? We find that impacts of competition on banks' monitoring incentives can be decomposed into two effects: one on the attractiveness of monitoring and the other on the monitoring efficiency. The first effect operates through the link between competition and loan margin. The second effect comes from the fact that marginal effct of monitoring on entrepreneur's effort depends on loan rate. We characterize the sufficient condition under which competition will increase monitoring incentives as well as banks' stability. For the third question, we focus on the role of capital requirement and claim that with capital requirement, we can attain a weak correction but not strong correction.
    JEL: G21 G28 D43 D82
    Date: 2010–08–31
  6. By: Jose M. Berrospide; Rochelle M. Edge
    Abstract: The effect of bank capital on lending is a critical determinant of the linkage between financial conditions and real activity, and has received especial attention in the recent financial crisis. We use panel-regression techniques—following Bernanke and Lown (1991) and Hancock and Wilcox (1993, 1994)—to study the lending of large bank holding companies (BHCs) and find small effects of capital on lending. We then consider the effect of capital ratios on lending using a variant of Lown and Morgan’s (2006) VAR model, and again find modest effects of bank capital ratio changes on lending. These results are in marked contrast to estimates obtained using simple empirical relations between aggregate commercial-bank assets and leverage growth, which have recently been very influential in shaping forecasters’ and policymakers’ views regarding the effects of bank capital on loan growth. Our estimated models are then used to understand recent developments in bank lending and, in particular, to consider the role of TARP-related capital injections in affecting these developments.
    Date: 2010–09
  7. By: Robert Kollmann; Zeno Enders; Gernot J. Müller
    Abstract: This paper incorporates a global bank into a two-country business cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007-09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the US and the Euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis.
    Date: 2010–08
  8. By: Tatom, John
    Abstract: On November 12, 1999, President Clinton signed the most significant piece of financial services regulation to be enacted since the Great Depression, at least up to that time. When the Financial Service Modernization Act of 1999, better known as the Gramm-Leach-Bliley Act (GLBA), was signed, the financial services industry faced strong pressures for deregulation of the rigid structure imposed during the Great Depression. During the 2007-08 financial crises and ensuing debate regarding financial services regulation, the GLBA became a target as members of the financial sector, academia and government considered possible triggers that may have precipitated the crisis.
    Keywords: Glass-Steagall Act; Dodd-Frank Act; financial regulation; financial crisis.
    JEL: K20 G18 E50
    Date: 2010–08–01
  9. By: Mamatzakis, Emmanuel; Koutsomanoli-Filippaki, Anastasia; Staikuras, Christos
    Abstract: We employ the stochastic frontier methodology and estimate alternative profit efficiency in the banking industry of four new European Union Member States, namely the Czech Republic, Hungary, Poland and the Slovak Republic, over the period 1999-2003. Our results show that structural reforms in the banking industry improve performance in terms of higher efficiency, whereas the institutional development of the non-bank financial sector hinders banks’ profit efficiency.
    Keywords: structural reforms; alternative profit inefficiency; new EU countries
    JEL: L25 D24 G21
    Date: 2010–08–19
  10. By: Vogel, Ursula; Winkler, Adalbert
    Abstract: Foreign banks have increased their market share in many emerging markets since the mid-1990s. We examine whether this contributed to financial stability in the respective host countries in the global financial crisis. Our results suggest that the stabilizing impact of foreign banks was limited to the cross-border component of financial globalization and to two regions: Eastern Europe and Sub-Saharan Africa. Only in the latter region was this translated into more stable credit growth. Thus hopes that a stronger presence of foreign banks might help host countries in isolating domestic credit from international shocks did not materialize in the current crisis. --
    Keywords: Foreign banks,cross-border lending,bank credit,financial crisis
    JEL: E44 F36 G21
    Date: 2010
  11. By: Cole, Rebel A.; White, Lawrence J.
    Abstract: In this study, we analyze why U.S. commercial banks failed during the recent financial crisis. We find that proxies for commercial real estate investments, as well as traditional proxies for the CAMELS components, do an excellent job in explaining the failures of banks that were closed during 2009, just as they did in the previous banking crisis of 1985 – 1992. Surprisingly, we do not find that residential mortgage-backed securities played a significant role in determining which banks failed and which banks survived.
    Keywords: bank; bank failure; CAMELS; commercial real estate; construction; FDIC; financial crisis; mortgage-backed security; residential mortgage; residential real estate
    JEL: G18 G28 G21
    Date: 2010–07–28
  12. By: Alexis Derviz; Marie Rakova
    Abstract: We conduct a theoretical and empirical investigation of the influence which the financial condition of a multinational bank group may have on the lending rates of its affiliates. We first propose a model of bank lending to risky clients in which the implicit opportunity costs of lending by a foreign bank affiliate are influenced by the abundance/scarcity of funds within the multinational conglomerate. The model predicts that parent banks’ influence should be stronger in loan segments with more pronounced information asymmetry problems. We then formulate an empirical model of the spread charged by the affiliate to clients over the local interbank rate as a function of affiliate-level controls and a parent influence variable. This model is tested for three categories of commercial non-financial borrowers (domestically owned firms, foreign-owned firms and the self-employed) from the ten biggest banks in the Czech Republic under foreign control. Evidence of parent influence on lending spread is found in a limited number of cases of banks and borrower classes for which the constraint on fund flow within the parent bank group is likely to be tight, particularly when the borrower class is of strategic importance for the affiliate’s overall performance. Therefore the parent bank influence probably is not a dominating factor in interest-rate setting on aggregate, but it can influence the cost of credit in borrower categories that are of major importance for the affiliate.
    Keywords: Bank loan pricing, internal capital market, multinational banks.
    JEL: D82 G21 G31 F36
    Date: 2009–12
  13. By: Kozo Ueda
    Abstract: This paper constructs a two-country DSGE model to study the nature of the recent financial crisis and its effects that spread immediately throughout the world owing to the globalization of banking. In the model, financial intermediaries (FIs) enter into chained credit contracts at home and abroad, engaging in cross-border lending to entrepreneurs by undertaking crossborder borrowing from investors. The FIs as well as the entrepreneurs in two countries are credit constrained, so all of their net worths matter. Our model reveals that under FIs' globalization, adverse shocks that hit one country affect the other, yielding business-cycle synchronization on both the real and financial sides. It also suggests that the FIs' globalization, net worth shock, and credit constraints are key to understanding the recent financial crisis.
    Keywords: Globalization ; Global financial crisis ; Business cycles ; Financial markets
    Date: 2010
  14. By: Charles Adams (Asian Development Bank Institute)
    Abstract: This paper reviews recent state interventions in financial crises and draws lessons for crisis management. A number of areas are identified where crisis management could be strengthened, including with regard to the tools and instruments used to involve the private sector in crisis resolution (with a view to reducing the recent enhanced role of official bailouts and the associated moral hazard), to allow for the orderly resolution of systemically important financial firms (to make these firms “safe to fail”), and with regard to achieving better integration with ex ante macroprudential surveillance. The paper proposes the establishment of high level systemic risk councils (SRCs) in each country with responsibility for overseeing systemic risk in both tranquil times and crisis periods and coordinating the activities of key government ministries, agencies, and the central bank.
    Keywords: financial crisis, crisis management, private sector, moral hazard, systemic risk councils
    JEL: E58 E01
    Date: 2010
  15. By: Cole, Rebel
    Abstract: In this study, we use data from the SSBFs to provide new information about the use of credit by small businesses in the U.S. More specifically, we first analyze firms that do and do not use credit; and then analyze why some firms use trade credit while others use bank credit. We find that one in five small firms uses no credit, one in five uses trade credit only, one in five uses bank credit only, and two in five use both bank credit and trade credit. These results are consistent across the three SSBFs we examine—1993, 1998 and 2003. When compared to firms that use credit, we find that firms using no credit are significantly smaller, more profitable, more liquid and of better credit quality; but hold fewer tangible assets. We also find that firms using no credit are more likely to be found in the services industries and in the wholesale and retail-trade industries. In general, these findings are consistent with the pecking-order theory of firm capital structure. Firms that use trade credit are larger, more liquid, of worse credit quality, and less likely to be a firm that primarily provides services. Among firms that use trade credit, the amount used as a percentage of assets is positively related to liquidity and negatively related to credit quality and is lower at firms that primarily provide services. In general, these results are consistent with the financing-advantage theory of trade credit. Firms that use bank credit are larger, less profitable, less liquid and more opaque as measured by firm age, i.e., younger. Among firms that use bank credit, the amount used as a percentage of assets is positively related to firm liquidity and to firm opacity as measured by firm age. Again, these results are generally consistent with the pecking-order theory of capital structure, but with some notable exceptions. We contribute to the literature on the availability of credit in at least two important ways. First, we provide the first rigorous analysis of the differences between small U.S. firms that do and do not use credit. Second, for those small U.S. firms that do participate in the credit markets, we provide new evidence regarding factors that determine their use of trade credit and of bank credit, and whether these two types of credit are substitutes (Meltzer, 1960) or complements (Burkart and Ellingsen, 2004). Our evidence strongly suggests that they are complements.
    Keywords: availability of credit; bank credit; capital structure; entrepreneurship; relationships; small business; SSBF; trade credit
    JEL: L11 J71 G32 M13 G21
    Date: 2010–03–15
  16. By: Benjamin Lorent
    Abstract: Life insurance has become an increasingly important part of the financial sector. The past ten years have witnessed significant changes of the market conditions faced by the insurance industry. Two trends are especially crucial: the assimilation of banking-sector type activities by life insurers and the consolidation of financial services (e.g. bancassurance). This article identifies the factors determining consumption for life insurance products across 90 countries for the year 2005. We introduce new factors to account for the increased link between bank and insurance sectors. Using a larger dataset, our results confirm the existing literature by showing that countries with higher income, better developed financial system, better educated population and higher old ratio spend more money on life insurance products whereas life expectancy tends to decrease life insurance demand. Moreover, institutional, religious and legal factors are found to be important. The levels of inflation and interest rates, the young ratio and the size of the social security system appear to have no robust association with life insurance consumption. The set of new variables introduced: bancassurance and banking efficiency appear significant, with a negative impact on life insurance consumption. Restricting our sample to developed countries confirm previous results for banking efficiency and bancassurance. The results highlight that the increasing blurring of the boundaries between insurers and banks impact life insurance demand.
    Keywords: Life Insurance; Insurance Demand; Bancassurance; Cross-section Analysis
    JEL: G22 C31
    Date: 2010–08
  17. By: Kauko, Karlo (Bank of Finland Research)
    Abstract: It has been proposed that the potential procyclicality of Basel II could be alleviated by using through-the-cycle (TTC) ratings in IRBA models. A TTC rating would be based on the structural component of the debtor’s credit risk ignoring cyclical fluctuations. This paper tests for the existence of such fluctuations in corporate sector credit risk and finds vietually no evidence for their existence at the company level. It is not possible to assign satisfactory TTC ratings to debtors if there are no cyclical variations to be filtered out.
    Keywords: through-the-cycle rating; credit risk; procyclicality
    JEL: G21 G33
    Date: 2010–08–16
  18. By: House, Christopher; Masatlioglu, Yusufcan
    Abstract: We present a model in which banks trade toxic assets to fund investments. Adverse selection in toxic assets reduces liquidity and investment. Investment is inefficiently low because banks must sell high-quality assets below their "fair" value. We consider whether equity injections and asset purchases improve market outcomes. By allowing banks to fund investments without selling high-quality assets, equity injections reduce the number of high-quality assets traded and further contaminate the interbank market. If equity is directed to firms with the greatest liquidity needs, the contamination effect causes investment to fall. Asset purchase programs often improve liquidity, investment and welfare.
    Keywords: Adverse selection; investment; TARP; financial crisis
    JEL: D53 E22 E44 D82 E6
    Date: 2010–06–22
  19. By: Nicolas Véron
    Abstract: Financial regulation at global level has been high on the G20 agenda. However, financial multipolarity, with the rise of emerging economies, and its impact on decision-making at global level has made global convergence difficult. In this policy brief, the authors, Bruegel Senior Fellow Nicolas Véron and Stéphane Rottier, National Bank of Belgium, explain why now is the time to focus on building stronger global public institutions, ensuring globally consistent financial information, creating globally integrated capital-markets infrastructure and addressing competitive distortions among global capital-market intermediaries to set the foundation for global harmonisation of all aspects of financial regulation.
    Date: 2010–08
  20. By: Nicolas Véron; Stephane Rottier
    Abstract: In this policy contribution, Bruegel Senior Fellow Nicolas Veron and Stephane Rottier, National Bank of Belgium, score and grade the implementation and follow up of the 47 action items that were outlined in the G20 summit in 2008. This paper complements their policy brief titled 'Not all financial regulation is global'. 
    Date: 2010–08
  21. By: Fligstein, Neil; Goldstein, Adam
    Abstract: The current crisis in the mortgage securitization industry highlights significant failures in our models of how markets work and our political will, organizational capability, and ideological desire to intervene in markets. This paper shows that one of the main sources of failure has been the lack of a coherent understanding of how these markets came into existence, how tactics and strategies of the principal firms in these markets have evolved over time, and how we ended up with the economic collapse of the main firms. It seeks to provide some insight into these processes by compiling both historical and quantitative data on the emergence and spread of these tactics across the largest investment banks and their principal competitors from the mortgage origination industry. It ends by offering some policy proscriptions based on the analysis.
    Date: 2010–02–23
  22. By: Ritha Sukadi Mata
    Abstract: As financial intermediaries, microfinance institutions (MFIs) contribute to integrate remittances into the formal financial system. Using a database including 225 MFIs from Latin America and the Caribbean, this paper investigates the institutional factors that influence the MFI decision-making process of entering the remittances market. Operational, managerial, and financial performances are considered as potential explanatory factors. Results exhibit that financial performance has the highest impact on the MFIs’ decision to diversify by offering a remittances service.
    Keywords: microfinance; remittances; money transfer activity; diversification
    JEL: G21 L25 O15 O16
    Date: 2010–09
  23. By: Flavia Barsotti (Department of Statistics and Applied Mathematics - University of Pisa, Italy); Maria Elvira Mancino (Dipartimento di Matematica per le Decisioni, Universita' degli Studi di Firenze); Monique Pontier (Institut de Mathematiques de Toulouse (IMT) - University of Toulouse, France)
    Abstract: In this paper a structural model of corporate debt is analyzed following an approach of optimal stopping problem. We extend Leland model [5] introducing a dividend paid to equity holders and studying its effect on corporate debt and optimal capital structure. Varying the parameter affects not only the level of endogenous bankruptcy, which is decreased, but modifies the magnitude of a change on the endogenous failure level as a consequence of an increase in risk free rate, corporate tax rate, riskiness of the firm and coupon payments. Concerning the optimal capital structure, the introduction of dividends allows to obtain results more in line with historical norms: lower optimal leverage ratios and higher yield spreads, compared to Leland's [5] results.
    Keywords: optimal capital structure; endogenous bankruptcy; default; optimal stopping time
    Date: 2010–08
  24. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This chapter recalls the main tools useful to compute Value at Risk associated with a m-dimensional portfolio. Then, the limitations of the use of these tools is explained, as soon as non-stationarities are observed in time series. Indeed, specific behaviours observed by financial assets, like volatility, jumps, explosions, and pseudo-seasonalities, provoke non-stationarities which affect the distribution function of the portfolio. Thus, a new way for computing VaR is proposed which allows the potential non-invariance of the m-dimensional portfolio distribution function to be avoided.
    Keywords: Non-stationarity – Value-at-Risk – Dynamic copula –Meta-distribution – POT method.
    Date: 2010

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