New Economics Papers
on Banking
Issue of 2010‒09‒18
twenty-one papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Bank liquidity creation and risk taking during distress By Berger, Allen N.; Bouwman, Christa H. S.; Kick, Thomas; Schaeck, Klaus
  2. Realized Volatility Risk ( Revised in January 2010 ) By David E. Allen; Michael McAleer; Marcel Scharth
  3. The Structure of Japan's Financial Regulation and Supervision and the Role Played by the Bank of Japan By Kazuo Ueda
  4. The Credit Default Swap Market and the Settlement of Large Defaults By Virginie Coudert; Mathieu Gex
  5. Evaluating the Effects of Deposit Dollarization in Bank Profitability By Ali M. Kutan; Erick W. Rengifo; Emre Ozsoz
  6. Securitization and the Balance Sheet Channel of Monetary Transmission By Uluc Aysun; Ralf Hepp
  7. The determinants of cross-border bank flows to emerging markets: New empirical evidence on the spread of financial crises By Herrmann, Sabine; Mihaljek, Dubravko
  8. The Irish Banking Crisis: Regulatory and Financial Stability Policy By Honohan, Patrick; Donovan, Donal; Gorecki, Paul; Mottiar, Rafique
  9. "What Should Banks Do? A Minskyan Analysis" By L. Randall Wray
  10. Creditor discrimination during sovereign debt restructurings By Aitor Erce; Javier Díaz-Cassou
  11. Assessing EU-10 Banking Sector's Resilience to Credit Losses By Piatkowski, Marcin; Zalduendo, Juan
  12. It Pays to Violate: How Effective are the Basel Accord Penalties? By Bernardo da Veiga; Felix Chan; Michael McAleer
  13. Performance and regulatory effects of non-compliant loans in German synthetic mortgage-backed securities transactions By Trinkaus, Gaby
  14. Optimal Intermediation Under Aggregate Consumption Uncertainty By Ioannis Lazopoulos
  15. Collateral Posting and Choice of Collateral Currency -Implications for Derivative Pricing and Risk Management- By Masaaki Fujii; Yasufumi Shimada; Akihiko Takahashi
  16. The Importance of Being Consulted By A. Fedele; A. Mantovani
  17. Banking, Credit Market Imperfection and Economic Growth By Mahmoud Sami Nabi; Taoufik Rajhi
  18. Measures aimed at enhancing the loss absorbency of regulatory capital at the point of non viability By Ojo, Marianne
  19. Understanding the Effect of Concentration Risk in the Banks’ Credit Portfolio: Indian Cases By Bandyopadhyay, Arindam
  20. Market concentration in the banking sector: Evidence from Albania By Tushaj, Arjan
  21. Stock market reaction to debt financing arrangements in Russia By Christophe J. Godlewski; Zuzana Fungacova; Laurent Weill

  1. By: Berger, Allen N.; Bouwman, Christa H. S.; Kick, Thomas; Schaeck, Klaus
    Abstract: Liquidity creation is one of banks' raisons d'être. But what happens to liquidity creation and risk taking when a bank is identified as distressed by regulatory bodies and subjected to regulatory interventions and/or receives capital injections? What are the long-run effects of such interventions? To address these questions, we exploit a unique dataset of German universal banks for the period 1999 - 2008. Our main findings are as follows. First, regulatory interventions and capital injections are followed by lower levels of liquidity creation. The probability of a decline in liquidity creation increases to up to around 50 percent when such actions are taken. Second, bank risk taking decreases in the aftermath of regulatory interventions and capital injections. Third, while banks' liquidity creation market shares decline over the five years following such disciplinary measures, they also reduce their risk exposure over this period to become safer banks. --
    Keywords: Liquidity creation,bank distress,regulatory interventions,capital injections
    JEL: G21 G28
    Date: 2010
  2. By: David E. Allen (School of Accounting, Finance and Economics,); Michael McAleer (Econometric Institute,); Marcel Scharth (VU University Amsterdam)
    Abstract: In this paper we document that realized variation measures constructed from high-frequency returns reveal a large degree of volatility risk in stock and index returns, where we characterize volatility risk by the extent to which forecasting errors in realized volatility are substantive. Even though returns standardized by ex post quadratic variation measures are nearly gaussian, this unpredictability brings considerably more uncertainty to the empirically relevant ex ante distribution of returns. Carefully modeling this volatility risk is fundamental. We propose a dually asymmetric realized volatility (DARV) model, which incorporates the important fact that realized volatility series are systematically more volatile in high volatility periods. Returns in this framework display time varying volatility, skewness and kurtosis. We provide a detailed account of the empirical advantages of the model using data on the S&P 500 index and eight other indexes and stocks.
    Date: 2009–12
  3. By: Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract: In this short note, I will explain the structure of Japan's financial regulation and supervision and discuss by way of examples the structure's weaknesses and strengths. In doing so, I pay particular attention to the role played by the Bank of Japan (BOJ). The paper focuses mostly on the period since the late 1980s when Japan saw the formation of land and stock price bubbles, their burst and serious negative effects on the financial system and the economy. I argue that, despite a streamlined structure of financial regulation, monetary authorities' response was not quite optimal and discuss possible reasons for the sub-optimal behaviors. I also point out that there are significant synergies between monetary policy and prudence policy at central banks, but that such synergies are not fully exploited.
    Date: 2009–12
  4. By: Virginie Coudert; Mathieu Gex
    Abstract: The huge positions on the credit default swaps (CDS) have raised concerns about the ability of the market to settle major entities’ defaults. The near-failure of AIG and the bankruptcy of Lehman Brothers in 2008 have revealed the exposure of CDS’s buyers to counterparty risk and hence highlighted the necessity of organizing the market, which triggered a large reform process. First we analyse the vulnerabilities of the market at the bursting of this crisis. Second, to understand its resilience to major credit events, we unravel the auction process implemented to settle defaults, the strategies of buyers and sellers and the links with the bond market. We then study the way it worked for key defaults, such as Lehman Brothers, Washington Mutual, CIT and Thomson, as well as, for the Government Sponsored Enterprises. Third, we discuss the ongoing reforms aimed at strengthening the market resilience.
    Keywords: Credit derivatives; bankruptcy; credit default swap; auction
    JEL: D44 G15 G33
    Date: 2010–08
  5. By: Ali M. Kutan (Southern Illinois University, Department of Economics and Finance); Erick W. Rengifo (Fordham University, Department of Economics); Emre Ozsoz (Fordham University, Department of Economics)
    Abstract: Dollar-denominated deposits constitute a large proportion of deposits in many developing economies. This may result in currency mismatches on banks' balance sheets as is suggested by recent literature. In general, having dollar-denominated deposits and loans could increase financial fragility, create balance sheet problems and affect bank profitability. In particular, this currency mismatch does not only increase banks' currency risk when the proportion of dollar-denominated loans with respect to local-denominated loans increases but also it increases their clients' default risk if depreciation occurs. This paper investigates the profitability of 36 dollarized banking systems. Our results suggest that after controlling for some macroeconomic and institutional variables, dollarization, as currency mismatch hypothesis suggests, depresses bank performance and lowers bank profitability.
    Keywords: Dollarization, bank performance, bank profitability
    JEL: F31 G21
    Date: 2010
  6. By: Uluc Aysun (University of Connecticut, Department of Economics); Ralf Hepp (Fordham University, Department of Economics)
    Abstract: This paper shows that the balance sheet channel of monetary transmission works mainly through U.S. bank holding companies that securitize their assets. This finding is different, in spirit, from the widely-found negative relationship between financial development and the strength of the lending channel of monetary transmission. Focusing on the balance sheet channel, and using bank-level observations, we find that securitized banks are more sensitive to borrowers’ balance sheets and that monetary policy has a greater impact on this sensitivity for securitizing bank holding companies. The optimality conditions from a simple partial equilibrium framework suggest that the positive effects of securitization on policy effectiveness could be due to the high sensitivity of security prices to policy rates.
    Keywords: balance sheet channel, banks, bank holding companies, securitization.
    JEL: E44 F31 F41 O16
    Date: 2010
  7. By: Herrmann, Sabine; Mihaljek, Dubravko
    Abstract: This paper studies the nature of spillover effects in bank lending flows from advanced to the emerging market economies and identifies specific channels through which such effects occur. Based on a gravity model we examine a panel data set on cross-border bank flows from 17 advanced to 28 emerging market economies in Asia, Latin America and central and eastern Europe from 1993 to 2008. The empirical analysis suggests that global as well as country specific factors are significant determinants of cross-border bank flows. Greater global risk aversion and expected financial market volatility seem to have been the most important factors behind the decrease in cross-border bank flows during the crisis of 2007-08. The withdraw of cross-border loans from central and eastern Europe was more limited compared to Asia and Latin America, in large measure because of the higher degree of financial and monetary integration in Europe, and relatively sound banking systems in the region. These results are robust to various specification, sub-samples and econometric methodologies. --
    Keywords: Gravity model,cross-border bank flows,financial crises,emerging market economies,spillover effects,panel data
    JEL: F34 F36 O57 C23
    Date: 2010
  8. By: Honohan, Patrick; Donovan, Donal; Gorecki, Paul; Mottiar, Rafique
    Abstract: This report to the Irish Minister for Finance by the Governor of the Central Bank describes the the performance of the respective functions of the Central Bank and Financial Regulator in the period 2003-8 in order to arrive at a fuller understanding of the root causes of the systemic failures that led to the need for extraordinary support from the State to the Irish banking system.
    Keywords: Ireland banking crisis; financial crises; financial stability policy
    JEL: E58 G28
    Date: 2010–05–31
  9. By: L. Randall Wray
    Abstract: In this new brief, Senior Scholar L. Randall Wray examines the later works of Hyman P. Minsky, with a focus on Minsky’s general approach to financial institutions and policy. The New Deal reforms of the 1930s strengthened the financial system by separating investment banks from commercial banks and putting in place government guarantees such as deposit insurance. But the system’s relative stability, and relatively high rate of economic growth, encouraged innovations that subverted those constraints over time. Financial wealth (and private debt) grew on trend, producing immense sums of money under professional management: we had entered what Minsky, in the early 1990s, labeled the “money manager” phase of capitalism. With help from the government, power was consolidated in a handful of huge firms that provided the four main financial services: commercial banking, payments services, investment banking, and mortgages. Brokers didn’t have a fiduciary responsibility to act in their clients’ best interests, while financial institutions bet against households, firms, and governments. By the early 2000s, says Wray, banking had strayed far from the (Minskyan) notion that it should promote “capital development” of the economy.
    Date: 2010–09
  10. By: Aitor Erce (Banco de España); Javier Díaz-Cassou (London School of Economics)
    Abstract: This paper explores patterns of discrimination between residents and foreign creditors during recents sovereign debt restructurings. We analyze 10 recent episodes distinguishing between neutral cases in which the sovereign treated creditors equitably irrespective of their nationality and instances of discrimination against residents and non-residents. We then present evidence in support of the hypothesis that these patterns of discrimination can be explained by the origin of liquidity pressures, the ex ante soundness of the banking system and the extent of the domestic corporate sector’s reliance on international financial markets. On the theoretical side, we present a simple model of a government’s strategic decision to diferentiate between the servicing of its domestic and its external debt. In our model, the basic trade-off facing the authorities is to default on external debt and in so doing restricting private access to international capital markets or to default on domestic debt, thereby curtailing the banking sector’s capacity to lend to domestic firms.
    Keywords: sovereign default, discrimination, bank credit, foreign capital
    JEL: F34 E65
    Date: 2010–09
  11. By: Piatkowski, Marcin; Zalduendo, Juan
    Abstract: The article estimates the likely credit losses in the EU10 countries' banking sector, supposing that economic conditions were to deteriorate further, and that local currencies were depreciated. Factors that may affect the cumulative level of credit losses are discussed. The article concludes that even if the macroeconomic environment were to worsen, credit losses in the EU10 banking sector are likely to be substantial, but remain manageable.
    Keywords: EU10; credit losses; banking sector; banking crisis
    JEL: G20
    Date: 2010–01–01
  12. By: Bernardo da Veiga (School of Economics and Finance,); Felix Chan (School of Economics and Finance,); Michael McAleer (Econometric Institute, Erasmus School)
    Abstract: The internal models amendment to the Basel Accord allows banks to use internal models to forecast Value-at-Risk (VaR) thresholds, which are used to calculate the required capital that banks must hold in reserve as a protection against negative changes in the value of their trading portfolios. As capital reserves lead to an opportunity cost to banks, it is likely that banks could be tempted to use models that underpredict risk, and hence lead to low capital charges. In order to avoid this problem the Basel Accord introduced a backtesting procedure, whereby banks using models that led to excessive violations are penalised through higher capital charges. This paper investigates the performance of five popular volatility models that can be used to forecast VaR thresholds under a variety of distributional assumptions. The results suggest that, within the current constraints and the penalty structure of the Basel Accord, the lowest capital charges arise when using models that lead to excessive violations, thereby suggesting the current penalty structure is not severe enough to control risk management. In addition, an alternative penalty structure is suggested to be more effective in aligning the interests of banks and regulators.
    Date: 2009–10
  13. By: Trinkaus, Gaby
    Abstract: Over the term of a securitization transaction, the concept of non-compliance allows a securitizing bank to classify a securitized loan as materially non-compliant with certain transaction requirements. Such a loan becomes unqualified for loss allocation. Therefore, non-compliant loans can directly affect transaction performance and the extent of risk transfer achieved with the transaction. The concept of non-compliance is incorporated in many securitizations independent of the underlying assets or structure. In Germany, there are currently no specific regulations regarding this concept. However, a bank can use discretion when classifying a loan as non-compliant and could thus report non-compliant loans strategically. This hypothesis is tested and confirmed based on a unique data set. --
    Keywords: Non-compliance,risk transfer,securitization
    JEL: G21 G28
    Date: 2010
  14. By: Ioannis Lazopoulos (University of Surrey)
    Abstract: The paper develops a banking framework where a welfare comparison is made between non-tradable demand deposit and equity contracts. Contrary to the existing literature that relies heavily on smooth preferences assumption to justify the liquidity insurance superiority of the ‘run-prone’ debt contracts over the ‘run-free’ equity contracts, the paper shows that when aggregate consumption uncertainty is introduced, the welfare dominance of deposit contracts emerges for a simpler preference structure as deposit contracts offer more risk-sharing opportunities. The model illustrates that such uncertainty creates a high dispersion between the allocations that can be attained by trading in the secondary market, and therefore the equity contract provides ex ante less risk-sharing to risk-averse consumers than a tailored-made debt contract.
    Keywords: financial intermediation, aggregate uncertainty, deposit contracts, equity contracts.
    JEL: G21 D81 D82
    Date: 2010–09
  15. 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
  16. By: A. Fedele; A. Mantovani
    Abstract: Does management consulting facilitate the access to credit for start-ups? This paper tries to answer the question by developing a theoretical framework where a firm applies for a bank loan to implement a risky project. The probability of success increases if the firm exerts a costly managerial extra-effort, but the bank is unable to observe such an effort: a moral hazard problem may therefore occur. During an economic downturn the project’s expected profitability is likely to be low relatively to the effort cost. In this case we find that credit is granted only if the bank hires a management consultant, even when the latter does not improve the business practice.
    JEL: M11 M13 D82
    Date: 2010–08
  17. By: Mahmoud Sami Nabi (LEGI, Tunisia Polytechnic School and University of Sousse, IHEC, Tunisia); Taoufik Rajhi
    Abstract: We develop a new model that links capital market imperfection to banking emergence and economic growth. It is shown that the banking system emerges endogenously after a first stage of slow economic growth. Interestingly, economic growth increases after the emergence of banking but remains under its potential level. This is due to a credit rationing brake which decreases progressively as the economy develops. Another finding is that a reduction of credit market imperfection reduces the credit rationing stage.
    Date: 2010–09
  18. By: Ojo, Marianne
    Abstract: The Basel Committee’s recent consultative document on the “Proposal to Ensure the Loss Absorbency of Regulatory Capital at the Point of Non Viability” sets out a proposal aimed at “enhancing the entry criteria of regulatory capital to ensure that all regulatory capital instruments issued by banks are capable of absorbing losses in the event that a bank is unable to support itself in the private market.” As well as demonstrating its support of the Basel Committee’s statement that a public sector injection of capital should not protect investors from absorbing the loss that they would have incurred (had the public sector not chosen to rescue the bank), this paper also highlights identified measures which have been put forward as means of rescuing failing banks – without taxpayer financing. Furthermore, it highlights why the controlled winding down procedure also constitutes a means whereby losses could still be absorbed in the event that a bank is unable to support itself in the private market.
    Keywords: capital; insolvency; financial crises; moral hazard; Basel III; Investor Compensation Schemes Directive; bail outs; equity; liquidity
    JEL: D53 K2 E58
    Date: 2010–09
  19. By: Bandyopadhyay, Arindam
    Abstract: Credit Concentration Risk has been the specific cause of many occurrences of financial distress of banks world wide. This paper analyzes the credit portfolio composition of a large and medium sized leading public sector Bank in India to understand the nature and dimensions of credit concentration risk and measure its impact on bank capital from different angles. In evaluating the bank wide measures in managing concentration risk, we demonstrate how economic capital approach may enable the bank to assess the impact of regional, industry and individual concentration. We also show how portfolio selection can be done through correlation, stress tests, marginal risk contribution vis-à-vis risk adjusted return that will enable the top management to manage portfolio concentration risk and accordingly plan its capital.
    Keywords: Credit Concentration; Portfolio Risk; Bank’s Economic Capital
    JEL: G18 G32 G21
    Date: 2010–07
  20. By: Tushaj, Arjan
    Abstract: The market structure can be described by concentration ratios based on the oligopoly theory or the structure - conduct - performance paradigm. Measures of concentration and also competition are essential for banks conduction in the banking industry. Several researchers have proved concentration level to be major determinants of banking system efficiency. Theoretical characteristics of market concentration measures are illustrated with empirical evidence. The market structure of the Albanian Banking Sector has changed dramatically in recent years. On 1990s, our country has experienced deregulation, foreign bank penetration, and an accelerated process of consolidation and competition in the banking sector. Particularly, the working paper examines the nature and the extent of changes in market concentration of Albanian banking sector. It focused primarily on a descriptive and dynamic analysis of change in the concentration indices in banking sector from year to year. Also it examines how the inherited structure of the banking system affects the way of the distribution of market shares amongst the different banks that comprise on the banking sector. --
    Keywords: Bank Concentration,Concentration ratios,HHI index,Market Structure
    JEL: A20
    Date: 2010
  21. By: Christophe J. Godlewski (LaRGE Research Center, Université de Strasbourg); Zuzana Fungacova (BOFIT, Bank of Finland); Laurent Weill (LaRGE Research Center, Université de Strasbourg)
    Abstract: This paper investigates stock market reaction to debt arrangements in Russia. The analysis of the valuation of debt arrangements by stock markets provides information about the use of debt by Russian companies. We apply the event study methodology to check whether debt announcements lead to abnormal returns using a sample of Russian listed companies that issued syndicated loans or bonds between June 2004 and December 2008. We find a negative reaction of stock markets to debt arrangements that can be explained by moral hazard behavior of shareholders at the expense of debtholders. Further, we observe no significant difference between announcements of syndicated loans and bonds. Thus, our findings support the view that Russian companies could have incentives to limit their reliance on external debt.
    Keywords: Corporate bonds, event study, Russia, stock returns, syndicated loans.
    JEL: G14 G20 P30
    Date: 2010

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