New Economics Papers
on Banking
Issue of 2010‒10‒23
23 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Countercyclical contingent capital (CCC): possible use and ideal design By Giuseppe De Martino; Massimo Libertucci; Mario Marangoni; Mario Quagliariello
  2. Endogenous Credit Cycles By Chao Gu; Randall Wright
  3. The Determinants and Policy Implications of Off-Balance Sheet Activities in MENA Countries Commercial Banks By Ahmad Khasawneh; M. Kabir Hassan
  4. Securitized Products, Financial Regulation, and Systemic Risk By Mariko Fujii
  5. GFC-Robust Risk Management Strategies under the Basel Accord By McAleer, M.J.; Jimenez-Martin, J-A.; Perez-Amaral, T.
  6. Credit ratings in structured finance and the role of systemic risk By Roberto Violi
  7. Stock loans in incomplete markets By Matheus R. Grasselli; Cesar G. Velez
  8. Credit risk modeling – a macro perspective By Bogdan Chiriacescu
  9. Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures By Larry D. Wall
  10. Market Liquidity and Funding Liquidity: An Empirical Investigation By Giorgio Valente
  11. Estimating Value-at-Risk (VaR) using TiVEx-POT Models By Mapa, Dennis S.; Cayton, Peter Julian; Lising, Mary Therese
  12. The Effects of Loan Portfolio Concentration on Brazilian Banks' Return and Risk By Benjamin M. Tabak; Dimas M. Fazio; Daniel O. Cajueiro
  13. Partial Deposit Insurance and Moral Hazard in Banking By Li, Gan; Wen-Yao, Wang
  14. Contingent liquidity By Sergio Nicoletti-Altimari; Carmelo Salleo
  15. Reform of the Global Financial Architecture By Garry J. Schinasi; Edwin M. Truman
  16. Hamlet Without The Prince of Denmark: Relationship Banking and Conditionality Lending In The London Market For Foreign Government Debt, 1815 - 1913 By Marc Flandreau, Juan Flores
  17. Payment systems, inside money and financial intermediation By Merrouche, Ouarda; Nier, Erlend
  18. Lessons from Japan’s Banking Crisis By Mariko Fujii; Masahiro Kawai
  19. Credit Scoring Modelling: A Micro–Macro Approach By Ana-Maria Sandica
  20. An Efficient, Distributable, Risk Neutral Framework for CVA Calculation By Dongsheng Lu; Frank Juan
  21. Weathering the financial storm: The importance of fundamentals and flexibility By Thorvardur Tjörvi Ólafsson; Thórarinn G. Pétursson
  22. Microfinance efficiency trade-offs and complementarities By Samuel Kobina Annim
  23. Mandatory IFRS adoption and accounting comparability By Stefano Cascino; Joachim Gassen

  1. By: Giuseppe De Martino; Massimo Libertucci (Banca d'Italia); Mario Marangoni (Banca d'Italia); Mario Quagliariello (Banca d'Italia)
    Abstract: Contingent capital – any debt instrument that converts into equity when a predefined event occurs – has received increasing attention as a viable tool for allowing banks to raise capital when needed at relatively more affordable prices than common equity. While the debate has focused on contingent capital for systemically important financial institutions, this paper concentrates on its possible use for covering capital needs arising from the implementation of countercyclical buffers. We propose the introduction of countercyclical contingent capital (CCC) based on a double trigger. The interaction of the two triggers would determine a quasi-default status. Conversion would be required when the financial system is simultaneously facing aggregate problems and the individual bank – while still in a going concern status – shows weaknesses. Building on this proposal, the paper tests how different double triggers would have worked in the past and discusses the optimal design of the conversion mechanism and prudential treatment.
    Keywords: Basel 2, capital buffer, procyclicality, contingent capital, financial crisis, reforms
    JEL: G18 G28
    Date: 2010–09
  2. By: Chao Gu (Department of Economics, University of Missouri-Columbia); Randall Wright
    Abstract: We study models of credit with limited commitment, which implies endogenous borrowing constraints. We show that there are multiple stationary equilibria, as well as nonstationary equilibria, including some that display deterministic cyclic and chaotic dynamics. There are also stochastic (sunspot) equilibria, in which credit conditions change randomly over time, even though fundamentals are deterministic and stationary. We show this can occur when the terms of trade are determined by Walrasian pricing or by Nash bargaining. The results illustrate how it is possible to generate equilibria with credit cycles (crunches, freezes, crises) in theory, and as recently observed in actual economies.
    Keywords: sunspot credit, commitment, dynamics, cycles.
    JEL: E2
    Date: 2010–10–11
  3. By: Ahmad Khasawneh (Hashemite University, Jordan); M. Kabir Hassan
    Abstract: Although there is literature about off-balance sheet (OBS) activities in the banking system, this is the first paper that investigates the off-balance sheet activities in the Middle East and North Africa (MENA) banking industry. It aims to test the tax regulatory hypothesis and the market discipline hypothesis in determining OBS activities of MENA commercial banks using a panel dataset for the period 1996–2007. We employ Mansfield’s (1961) logistic diffusion model and we consider OBS activities as real financial innovation following a time trend diffusion curve. The model is modified to include regulatory and non-regulatory bank-specific factors in addition to macroeconomic factors. We also added a country dummy vector to incorporate the country’s institutional and financial environment and time dummy vector to control for the political and economic events over time. The results reveal that OBS activities do not follow Mansfield’s financial diffusion model, and that adoption is decreasing over time. Regulatory tax hypothesis is rejected for the case of MENA banks since most of them face high regulatory pressure which negatively affects the OBS adoption. The results also suggest that OBS activities follow the business cycle notion and that the usage decision depends on economic conditions. Moreover, there exists an informational economy of scope between loans and OBS activities. Banks will participate more in OBS activities to reduce their risk resulting from loans. Also, OBS activities are profit driven. Political and economic events negatively affect MENA banks’ OBS activities. The implications of these results suggest that regulations, institutional and technological deficiency in MENA countries prevent the banking system from adopting different financial innovations.
    Date: 2010–10
  4. By: Mariko Fujii
    Abstract: It is widely believed that the practice of securitization is one of the causes that led to the 2007–08 financial crisis. In this paper, I show that securitized products such as collateralized debt obligations (CDO) are particularly vulnerable to systematic risk and tend to show higher tail risk. These characteristics, in turn, are closely associated with joint failures and systemic risk. In order to achieve greater stability of the financial system, it is important to prevent the recurrence of the collapse of specific markets as this may lead to the collapse of other components of the financial system. From this perspective, the financial regulations that should be applied to these problematic financial products and their relation to possible systemic risks are discussed. [ADBI Working Paper 203]
    Keywords: securitization, financial crisis, collateralized, obligations, stability, products
    Date: 2010
  5. By: McAleer, M.J.; Jimenez-Martin, J-A.; Perez-Amaral, T.
    Abstract: A risk management strategy is proposed as being robust to the Global Financial Crisis (GFC) by selecting a Value-at-Risk (VaR) forecast that combines the forecasts of different VaR models. The robust forecast is based on the median of the point VaR forecasts of a set of conditional volatility models. This risk management strategy is GFC-robust in the sense that maintaining the same risk management strategies before, during and after a financial crisis would lead to comparatively low daily capital charges and violation penalties. The new method is illustrated by using the S&P500 index before, during and after the 2008-09 global financial crisis. We investigate the performance of a variety of single and combined VaR forecasts in terms of daily capital requirements and violation penalties under the Basel II Accord, as well as other criteria. The median VaR risk management strategy is GFC-robust as it provides stable results across different periods relative to other VaR forecasting models. The new strategy based on combined forecasts of single models is straightforward to incorporate into existing computer software packages that are used by banks and other financial institutions.
    Keywords: Value-at-Risk (VaR);daily capital charges;robust forecasts;violation penalties;optimizing strategy;aggressive risk management strategy;conservative risk management strategy;Basel II Accord;global financial crisis
    Date: 2010–10–12
  6. By: Roberto Violi (Bank of Italy)
    Abstract: This paper explores the implications of systemic risk in Credit Structured Finance (CSF). Risk measurement issues loomed large during the 2007-08 financial crisis, as the massive, unprecedented number of downgrades of AAA senior bond tranches inflicted severe losses on banks, calling into question the credibility of Rating Agencies. I discuss the limits of the standard risk frameworks in CSF (Gaussian, Single Risk Factor Model; GSRFM), popular among market participants. If implemented in a ‘static’ fashion, GSRFM can substantially underprice risk at times of stress. I introduce a simple ‘dynamic’ version of GSRFM that captures the impact of large systemic shocks (e.g. financial meltdown) for the value of CSF bonds (ABS, CDO, CLO, etc.). I argue that a proper 'dynamic' modeling of systemic risk is crucial for gauging the exposure to default contagion (‘correlation risk’). Two policy implications are drawn from a 'dynamic' GSRFM: (i) when rating CSF deals, Agencies should disclose additional risk information (e.g. the expected losses under stressed scenarios; asset correlation estimates); and (ii) a ‘point-in-time’ approach to rating CSF bonds is more appropriate than a ‘through-the-cycle’ approach.
    Keywords: structured finance, systemic risk, credit risk measures, bond pricing
    JEL: E44 E65 G12 G13 G14 G18 G21 G24 G28 G34
    Date: 2010–09
  7. By: Matheus R. Grasselli; Cesar G. Velez
    Abstract: A stock loan is a contract whereby a stockholder uses shares as collateral to borrow money from a bank or financial institution. In Xia and Zhou (2007), this contract is modeled as a perpetual American option with a time varying strike and analyzed in detail within a risk--neutral framework. In this paper, we extend the valuation of such loans to an incomplete market setting, which takes into account the natural trading restrictions faced by the client. When the maturity of the loan is infinite, we use a time--homogeneous utility maximization problem to obtain an exact formula for the value of the loan fee to be charged by the bank. For loans of finite maturity, we characterize the fee using variational inequality techniques. In both cases we show analytically how the fee varies with the model parameters and illustrate the results numerically.
    Date: 2010–10
  8. By: Bogdan Chiriacescu
    Abstract: The importance of credit risk assessment and monitoring has increased since the recent financial turmoil. This paper presents a toolkit for credit risk modeling that follows the top-down approach proposed by Wilson (1997). The analysis is conducted separately for the household and corporate sector, by means of panel techniques and seemingly unrelated equations, using default aggregated data at county or business sector level. The results indicate that the determinants of default on bank loans for the household sector are unemployment, exchange rate, industrial production, indebtedness and interest rate spreads, while for the corporate sector the output gap, indebtedness and exchange rate are the main factors. Comparing the two models, it arises that default events from the corporate sector occur sooner than for the household sector in case of adverse macroeconomic developments. There are two possible explanations: i) there is no personal bankruptcy law for individuals in Romania, and ii) public administration appears to adjusts slower during recessions, an important part of the work force being part of this system. Furthermore, stress-testing analysis is performed on arbitrarily built portfolios by considering the impact of macroeconomic shocks on the probabilities of default over a one year time horizon.
    Keywords: credit risk models, top-down approach
    Date: 2010–10
  9. By: Larry D. Wall
    Abstract: The recent global financial crisis reflects numerous breakdowns in the prudential discipline of financial firms. This paper discusses ways to strengthen micro- and macroprudential supervision and restore credible market discipline. The discussion notes that microprudential supervisors are typically assigned a variety of goals that sometimes have conflicting policy implications. In such a setting, the structure of the regulatory agencies and the priority given to prudential goals are critical to achieving those goals. [ADBI Working Paper 176]
    Keywords: global financial crisis, prudential, discipline,financial firms, policy,achieving,goals
    Date: 2010
  10. By: Giorgio Valente (University of Leicester and Hong Kong Institute for Monetary Research)
    Abstract: We provide empirical evidence that the relationship between market and funding liquidity display significant nonlinearities, consistent with theories of market trading with financially-constrained agents. Using data for the US equity market, we uncover nonlinearities that are consistent with a model with two extreme regimes: a lower regime characterized by the absence of correlation between market liquidity and funding liquidity, and an upper regime where the two variables are statistically positively correlated. Over the sample period the two variables are uncorrelated most of the time, since shocks to funding liquidity are economically small. This situation persists until agents are forced towards their capital constraints and shocks to funding liquidity becomes economically important.
    Date: 2010–06
  11. By: Mapa, Dennis S.; Cayton, Peter Julian; Lising, Mary Therese
    Abstract: Financial institutions hold risks in their investments that can potentially affect their ability to serve their clients. For banks to weigh their risks, Value-at-Risk (VaR) methodology is used, which involves studying the distribution of losses and formulating a statistic from this distribution. From the myriad of models, this paper proposes a method of formulating VaR using the Generalized Pareto distribution (GPD) with time-varying parameter through explanatory variables (TiVEx) - peaks over thresholds model (POT). The time varying parameters are linked to the linear predictor variables through link functions. To estimate parameters of the linear predictors, maximum likelihood estimation is used with the time-varying parameters being replaced from the likelihood function of the GPD. The test series used for the paper was the Philippine Peso-US Dollar exchange rate with horizon from January 2, 1997 to March 13, 2009. Explanatory variables used were GARCH volatilities, quarter dummies, number of holiday-weekends passed, and annual trend. Three selected permutations of modeling through TiVEx-POT by dropping other covariates were also conducted. Results show that econometric models and static POT models were better-performing in predicting losses from exchange rate risk, but simple TiVEx models have potential as part of the VaR modelling philosophy since it has consistent green status on the number exemptions and lower quadratic loss values.
    Keywords: Value-at-Risk; Extreme Value Theory; Generalized Pareto Distribution; Time-Varying Parameters; Use of Explanatory Variables; GARCH modeling; Peaks-over-Thresholds Model
    JEL: G12 C53 C22 C01
    Date: 2009–12
  12. By: Benjamin M. Tabak; Dimas M. Fazio; Daniel O. Cajueiro
    Abstract: This paper tests whether diversification of the credit portfolio at the bank level is associated to better performance and lower risk. We employ a new high frequency (monthly) panel data constructed for the Brazilian banking system with information at the bank level for loans by economic sector. We find that loan portfolio concentration increases returns and also reduces default risk; there are significant size effects; foreign and public banks seem to be less affected by the degree of diversification. An important additional finding is that there is an increasing concentration trend after the breakout of the recent international financial crisis, especially after the failure of Lehman Brothers.
    Date: 2010–10
  13. By: Li, Gan; Wen-Yao, Wang
    Abstract: Abstract: Countries with deposit insurances differ significantly on how much protection their insurance provides. We study the optimal coverage limit in a model of deposit insurance with capital requirements and risk sensitive premia to prevent moral hazard. Depositors have incentives to monitor the bank’s risk taking behavior, thus threatening banks with withdrawals of deposits if necessary. We find that either banking regulations or market discipline is insufficient to reduce bank’s risk. In addition, our numerical example explains the differences in coverage cross countries which agrees with empirical evidence. We show that low income countries provide more generous insurance protection than higher income countries.
    Keywords: Depositor’s monitoring; moral hazard; optimal coverage; partial deposit insurance.
    JEL: E65 G28 G21
    Date: 2010–07–01
  14. By: Sergio Nicoletti-Altimari (Banca d'Italia); Carmelo Salleo (Banca d'Italia)
    Abstract: After the crisis, bank regulators are considering mitigating liquidity risk by introducing quantity limits on liquidity and maturity mismatch. We argue that aggregate liquidity risk can be reduced with little deadweight loss by encouraging banks, through adequate regulatory relief, to satisfy part of their financing needs with a new class of securities. These would include a Roll-Over Option Facility (ROOF) that allows the issuer, for a price, to keep the funds if at maturity a readily observable variable correlated with systemic liquidity risk (e.g. the LIBOR-OIS spread) is above a trigger threshold. At roll-over the yield would reflect the current price of liquidity and credit risk, making ROOFs attractive to investors. The instrument could attenuate a liquidity crisis by reducing banks’ need to roll debt over or sell off assets, and diminish the probability of runs, if markets are convinced that banks can secure sufficient liquidity when needed thanks to the widespread use of this contingent claim.
    Keywords: funding, liquidity, contingent claim, financial crisis
    JEL: G18 G21 G28
    Date: 2010–09
  15. By: Garry J. Schinasi; Edwin M. Truman (Peterson Institute for International Economics)
    Abstract: This paper examines the implications of the global financial crisis of 2007-10 for reform of the global financial architecture, in particular the International Monetary Fund and the Financial Stability Board and their interaction. These two institutions are not fully comparable, but they must work more closely in the future to help prevent global financial crises. To this end, the paper identifies institutional and substantive reforms separately and in their joint work that would be desirable and appropriate.
    Keywords: International Monetary Fund, Financial Stability Board, Bank for International Settlements, Group of Twenty, banking supervision and regulation, financial crises, financial stability, financial reform
    JEL: F30 F33 F36 F53 G28
    Date: 2010–10
  16. By: Marc Flandreau, Juan Flores (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: This paper offers a theory of conditionality lending in 19th century international capital markets. We argue that ownership of reputation signals by prestigious banks rendered them able and willing to monitor government borrowing. Monitoring was a source of rent, and it led bankers to support countries facing liquidity crises in a manner similar to modern descriptions of “relationship” lending to corporate clients by “parent” banks. Prestigious bankers’ ability to implement conditionality loans and monitor countries’ financial policies also enabled them to deal with solvency. We find that, compared with prestigious bankers, bondholders’ committees had neither the tools nor the prestige required for effectively dealing with defaulters. Hence such committees were far less important than previous research has claimed.
    Date: 2010–06
  17. By: Merrouche, Ouarda; Nier, Erlend
    Abstract: This paper assesses the impact of introducing an efficient payment system on the amount of credit provided by the banking system. Two channels are investigated. First, innovations in wholesale payments technology enhance the security and speed of deposits as a payment medium for customers and therefore affect the split between holdings of cash and the holdings of deposits that can be intermediated by the banking system. Second, innovations in wholesale payments technology help establish well-functioning interbank markets for end-of-day funds, which reduces the need for banks to hold excess reserves. The authors examine these links empirically using payment system reforms in Eastern European countries as a laboratory. The analysis finds evidence that reforms led to a shift away from cash in favor of demand deposits and that this in turn enabled a prolonged credit expansion in the sample countries. By contrast, while payment system innovations also led to a reduction in excess reserves in some countries, this effect was not causal for the credit boom observed in these countries.
    Keywords: Banks&Banking Reform,Debt Markets,Bankruptcy and Resolution of Financial Distress,Access to Finance,Currencies and Exchange Rates
    Date: 2010–10–01
  18. By: Mariko Fujii; Masahiro Kawai
    Abstract: The Japanese government’s response to the financial crisis in the 1990s was late, unprepared and insufficient; it failed to recognize the severity of the crisis, which developed slowly; faced no major domestic or external constraints; and lacked an adequate legal framework for bank resolution. Policy measures adopted after the 1997–1998 systemic crisis, supported by a newly established comprehensive framework for bank resolution, were more decisive. Banking sector problems were eventually resolved by a series of policies implemented from that period, together with an export-led economic recovery. [ADBI Working Paper 222]
    Keywords: Japanese, financial crisis, domestic,framework, policies
    Date: 2010
  19. By: Ana-Maria Sandica
    Abstract: In order to reduce its capital requirement, banks use different credit risk models that are able to detect de difference between defaulter and a non-defaulter customer. In this paper I aim to make a comparison between these models and more to see which ones improve most when a macroeconomic variables is also introduce. What I would like to evidence in this paper is that more important than a particular model is the variables selection and the choice of a loss function that have to be minimized in order to treat the tradeoff between the profit considerations and best classification of customers.
    Keywords: credit risk models
    Date: 2010–10
  20. By: Dongsheng Lu; Frank Juan
    Abstract: The importance of counterparty credit risk to the derivative contracts was demonstrated consistently throughout the financial crisis of 2008. Accurate valuation of Credit value adjustment (CVA) is essential to reflect the economic values of these risks. In the present article, we reviewed several different approaches for calculating CVA, and compared the advantage and disadvantage for each method. We also introduced an more efficient and scalable computational framework for this calculation.
    Date: 2010–10
  21. By: Thorvardur Tjörvi Ólafsson (School of Economics and Management, Aarhus University, Denmark); Thórarinn G. Pétursson (Central Bank of Iceland)
    Abstract: The recent global financial tsunami has had economic consequences that have not been witnessed since the Great Depression. But while some countries suffered a particularly large contraction in economic activity on top of a system-wide banking and currency collapse, others came off relatively lightly. In this paper, we attempt to explain this cross-country variation in post-crisis experience, using a wide variety of pre-crisis explanatory variables in a sample of 46 medium-to-high income countries. We find that domestic macroeconomic imbalances and vulnerabilities were crucial for determining the incidence and severity of the crisis. In particular, we find that the pre-crisis rate of inflation captures factors which are important in explaining the post-crisis experience. Our results also suggest an important role for financial factors. In particular, we find that large banking systems tended to be associated with a deeper and more protracted consumption contraction and a higher risk of a systemic banking or currency crisis. Our results suggest that greater exchange rate flexibility coincided with a smaller and shorter contraction, but at the same time increased the risk of a banking and currency crisis. Countries with exchange rate pegs outside EMU were hit particularly hard, while inflation targeting seemed to mitigate the crisis. Finally, we find some evidence suggesting a role for international real linkages and institutional factors. Our key results are robust to various alterations in the empirical setup and we are able to explain a significant share of the cross-country variation in the depth and duration of the crisis and provide quite sharp predictions of the incidence of banking and currency crises. This suggests that country-specific initial conditions played an important role in determining the economic impact of the crisis and, in particular, that countries with sound fundamentals and flexible economic frameworks were better able to weather the financial storm.
    Keywords: Global financial crisis, real economy impact, banking and currency crisis, initial conditions, cross-country analysis
    JEL: F30 F31 F32 F41
    Date: 2010–10–14
  22. By: Samuel Kobina Annim
    Abstract: This study argues that patterns, trends and drivers of the efficiency of microfinance institutions (MFIs) depend on the scope of financial sustainability measures and on MFIs’ inclination to either of the dual objectives of financial systems and outreach. A balanced panel data of 164 MFIs for the period 2004-08 is extracted from the MIX website for the study’s use. Both parametric and non-parametric efficiency estimation techniques are used. Contrary to a trade-off between financial efficiency and outreach, the latter tends to have a positive link with social efficiency. Negative effects of bureaucracies in property registration and lack of credit information on social efficiency are also observed.
    Date: 2010
  23. By: Stefano Cascino; Joachim Gassen
    Abstract: The adoption of IFRS by many countries worldwide fuels the expectation that financial accounting might become more comparable across countries. This expectation is opposed to an alternative view that stresses the importance of incentives in shaping accounting information. We provide early evidence on this debate by investigating the effects of mandatory IFRS adoption on the comparability of financial accounting information around the world. Our results suggest that while mandatory adoption of IFRS increases the comparability of some prominent balance sheet line items across countries, it has no clear effect on the cross-country comparability of earnings attributes. To provide a rationale for these mixed findings, we investigate the IFRS measurement and disclosure compliance choices for a hand-collected sample of German and Italian firms. We find that predictable country-, region-, and firm-level incentives continue to shape the outcome of the financial reporting process and thus limit the crosssectional comparability of financial accounting information. Overall, our results suggest that the mandatory adoption of IFRS has a limited impact on accounting comparability and that accounting information continues to be shaped by both reporting standards and incentives.
    Keywords: international accounting, IFRS, comparability, accounting harmonization, earnings attributes, disclosure determinants, accounting incentives
    JEL: M41 G14 F42
    Date: 2010–10

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