New Economics Papers
on Banking
Issue of 2010‒11‒20
twenty papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Bank capital : lessons from the financial crisis By Demirguc-Kunt, Asli; Detragiache, Enrica; Merrouche, Ouarda
  2. Understanding Systemic Risk: The Trade-Offs between Capital, Short-Term Funding and Liquid Asset Holdings By Céline Gauthier; Zhongfang He; Moez Souissi
  3. Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive By Anat R. Admati; Peter M. DeMarzo; Martin F. Hellwig; Paul Pfleiderer
  4. Bank lending channel of monetary policy: dynamic panel data evidence from Malaysia By Abdul Karim, Zulkefly; Wan Ngah, Wan Azman Saini; Abdul Karim, Bakri
  5. Cherry Picking or Driving Out Bad Management: Foreign Acquisitions in Turkish Banking By Canan Yildirim
  6. Measuring sectoral/geographic concentration risk By Vincenzo Tola
  7. Pro-cyclicality of capital regulation: is it a problem? How to fix it? By Paolo Angelini; Andrea Enria; Stefano Neri; Fabio Panetta; Mario Quagliariello
  8. Analyzing Systemic Risk with Financial Networks An Application During a Financial Crash By Saltoglu, Burak; Yenilmez, Taylan
  9. Moral Hazard and Ambiguity By Philipp Weinschenk
  10. Financial Inclusion in Karnataka: A Study of Operationalisation of No Frills Accounts By Rai, Anurag; Saha, Amrita
  11. A Multiple Criteria Framework to Evaluate Bank Branch Potential Attractiveness By Fernando A. F. Ferreira; Ronald W. Spahr; Sérgio P. Santos; Paulo M.M. Rodrigues
  12. The rise of risk-based pricing of mortgage interest rates in Italy By Silvia Magri; Raffaella Pico
  13. Essays on financial crises in emerging markets By Komulainen, Tuomas
  14. "Financial Stability, Regulatory Buffers, and Economic Growth: Some Postrecession Regulatory Implications" By Éric Tymoigne
  15. Bank Location and Financial Liberalization Reforms: Evidence from Microgeographic Data By Marieke Huysentruyt; Eva Lefevere; Carlo Menon
  16. On the interaction between market and credit risk: a factor-augmented vector autoregressive (FAVAR) approach By Roberta Fiori; Simonetta Iannotti
  17. LGD credit risk model: estimation of capital with parameter uncertainty using MCMC By Xiaolin Luo; Pavel Shevchenko
  18. Modelling and Forecasting UK Mortgage Arrears and Possessions By Janine Aron; John Muellbauer
  19. Evaluating Value-at-Risk Models via Quantile Regression By Wagner Piazza Gaglianone; Luiz Renato Lima; Oliver Linton; Daniel Smith
  20. Public Ownership of Banks and Economic Growth – The Role of Heterogeneity By Tobias Körner; Isabel Schnabel

  1. By: Demirguc-Kunt, Asli; Detragiache, Enrica; Merrouche, Ouarda
    Abstract: Using a multi-country panel of banks, the authors study whether better capitalized banks fared better in terms of stock returns during the financial crisis. They differentiate among various types of capital ratios: the Basel risk-adjusted ratio; the leverage ratio; the Tier I and Tier II ratios; and the common equity ratio. They find several results: (i) before the crisis, differences in capital did not affect subsequent stock returns; (ii) during the crisis, higher capital resulted in better stock performance, most markedly for larger banks and less well-capitalized banks; (iii) the relationship between stock returns and capital is stronger when capital is measured by the leverage ratio rather than the risk-adjusted capital ratio; (iv) there is evidence that higher quality forms of capital, such as Tier 1 capital, were more relevant. They also examine the relationship between bank capitalization and credit default swap (CDS) spreads.
    Keywords: Banks&Banking Reform,Access to Finance,Debt Markets,Economic Theory&Research,Banking Law
    Date: 2010–11–01
  2. By: Céline Gauthier; Zhongfang He; Moez Souissi
    Abstract: We offer a multi-period systemic risk assessment framework with which to assess recent liquidity and capital regulatory requirement proposals in a holistic way. Following Morris and Shin (2009), we introduce funding liquidity risk as an endogenous outcome of the interaction between market liquidity risk, solvency risk, and the funding structure of banks. To assess the overall impact of different mix of capital and liquidity, we simulate the framework under a severe but plausible macro scenario for different balance-sheet structures. Of particular interest, we find that (1) capital has a decreasing marginal effect on systemic risk, (2) increasing capital alone is much less effective in reducing liquidity risk than solvency risk, (3) high liquid asset holdings reduce the marginal effect of increasing short term liability on systemic risk, and (4) changing liquid asset holdings has little effect on systemic risk when short term liability is sufficiently low.
    Keywords: Financial stability; Financial system regulation and policies
    JEL: G21 C15 C81 E44
    Date: 2010
  3. By: Anat R. Admati (Graduate School of Business, Stanford University); Peter M. DeMarzo (Graduate School of Business, Stanford University); Martin F. Hellwig (Max Planck Institute for Research on Collective Goods); Paul Pfleiderer (Graduate School of Business, Stanford University)
    Abstract: We examine the pervasive view that “equity is expensive,” which leads to claims that high capital requirements are costly and would affect credit markets adversely. We find that arguments made to support this view are either fallacious, irrelevant, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. Any desirable public subsidies to banks’ activities should be given directly and not in ways that encourage leverage. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support. We conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal, and, viewed from an ex ante perspective, high leverage may not even be privately optimal for banks. Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy.
    Keywords: capital regulation, financial institutions, capital structure, too big to fail, systemic risk, bank equity, contingent capital, Basel.
    JEL: G32 K23 G21 G28 G38 H81
    Date: 2010–09
  4. By: Abdul Karim, Zulkefly; Wan Ngah, Wan Azman Saini; Abdul Karim, Bakri
    Abstract: This paper aims to investigate the relevance of bank-lending channel (BLC) of monetary policy in a small-open economy, i.e. Malaysia by using disaggregated bank-level data set. A dynamic panel data method namely GMM framework proposed by Arellano and Bond (1991), Arellano and Bover (1995), and Blundell and Bond (1998) have been used in estimating the dynamic of banks’ loan supply function. The empirical evidence has stated that monetary policy shocks is significantly and negatively influenced the banks’ loan supply, and therefore has supported the existence of BLC in Malaysia. In addition, several bank-characteristics variables namely bank liquidity and bank capitalization (capital adequacy ratio) are also statistically significant in influencing the banks’ loan supply. Therefore, the implementation of monetary policy is effective in influencing economic activity via bank balance sheet position, in particular bank loans.
    Keywords: Bank-lending channel; monetary policy; dynamic panel data
    JEL: E58 E52 C33
    Date: 2010–09–10
  5. By: Canan Yildirim (Department of International Finance, Kadir Has University)
    Abstract: This paper analyzes the determinants of cross-border acquisitions and the impact of foreign acquisitions on performance in the Turkish banking sector. The results suggest that foreign banks target relatively better performing banks to acquire, and that post-acquisition performance of the targets does not improve. There is some evidence that both established and newly acquired foreign banks focus on expanding their market shares. Concerning static-ownership effects, the results also show that, in general, foreign-owned and state-owned banks perform as well as private-owned domestic banks. The only exception is with respect to non-performing loans, in that state-owned banks seem to suffer from asset quality problems.
    Date: 2010–11
  6. By: Vincenzo Tola (Banca d'Italia)
    Abstract: This article focuses on the application of the Pykhtin model to the Italian banking system to measure concentration risk by industry sector and geographic region. The proposed approach generalizes the portfolio model used in Pillar 1 for the calculation of the capital requirement, removing the assumptions of the existence of one systematic risk factor and of an infinitely granular portfolio. The difference between the unexpected loss stemming from the Pykhtin model and that calculated using the supervisory formula can be interpreted as a measure of concentration risk. The Pykhtin model is consistent with the Basel II framework. It accordingly generates an unexpected loss measure that is in line with the IRB capital requirements. The proposed model therefore has the advantage of “speaking the language of supervisors”. This approach makes it possible to interpret the difference between regulatory and economic capital. It also enables concentration risk to be broken down into its two components: single-name and sectoral/geographic concentration risk. The empirical results show the model’s ability to generate internally coherent rankings that are close to the economic intuition: exposure to sectoral/geographic concentration risk is negatively correlated to banks’size.
    Keywords: Basel 2, concentration risk, economic capital, VaR
    JEL: G21
    Date: 2010–10
  7. By: Paolo Angelini (Banca d'Italia); Andrea Enria (Banca d'Italia); Stefano Neri (Banca d'Italia); Fabio Panetta (Banca d'Italia); Mario Quagliariello (Banca d'Italia)
    Abstract: We use a macroeconomic euro area model with a bank sector to study the pro-cyclical effect of the capital regulation, focusing on the extra pro-cyclicality induced by Basel II over Basel I. Our results suggest that this incremental effect is modest. We also find that regulators could offset the extra pro-cyclicality by a countercyclical capital-requirements policy. Our results also suggest that banks may have incentives to accumulate countercyclical capital buffers, making this policy less relevant, but this finding is depends on the type of economic shock posited. We also survey different policy options for dealing with procyclicality and discuss the pros and cons of the measures available.
    Keywords: Basel accord, pro-cyclicality
    JEL: E32 E44 E58
    Date: 2010–10
  8. By: Saltoglu, Burak; Yenilmez, Taylan
    Abstract: A financial network model, where the coded identity of the counterparties of every trade is known, is applied to both stable and crisis periods in a large and liquid overnight repo market in an emerging market economy. We have analyzed the financial crisis by using various network investigation tools such as links, interconnectivity, and reciprocity. In addition, we proposed a centrality measure to monitor and detect the ‘systemically important financial institution’ in the financial system. We have shown that our measure gives strong signals much before the crisis.
    Keywords: systemic risk; financial regulation; financial crisis; BASEL III; systemically important financial institution; Turkey; IMF
    JEL: D53 C45 F47 D85 C01
    Date: 2010–11–14
  9. By: Philipp Weinschenk (Max Planck Institute for Research on Collective Goods)
    Abstract: We consider a principal-agent model with moral hazard where the agent’s knowledge about the performance measure is ambiguous and he is averse towards ambiguity. We show that the principal may optimally provide no incentives or contract only on a subset of all informative performance measures. That is, the Informativeness Principle does not hold in our model. These results stand in stark contrast to the ones of the orthodox theory, but are empirically of high relevance.
    Keywords: financial crisis, Basel Accord, banking regulation, capital requirements, modelbased approach, systemic risk
    JEL: D82 M12 M52
    Date: 2010–09
  10. By: Rai, Anurag; Saha, Amrita
    Abstract: Financial inclusion may be defined as the process of ensuring timely and adequate access to financial services and credit delivery for low income groups at an affordable cost. The basic aim of Financial Inclusion is to ensure the ease of access, availability and usage of the formal financial System by these groups. The objective of this paper is to design a tool for measuring the level of Operationalisation of No-Frills (NF) Accounts (similar to Saving A/c of Banks with limitation of the balance at Rs.50,000) opened during the first phase of Financial Inclusion in the state of Karnataka. The paper identifies usage in 6 different facilities of NF Accounts from banking facilities as parameters. A Sampling Survey is designed and data is collected from 26 Districts and 48 Public, Private and Regional Rural Banks through the Lead Bank System. These parameters are clubbed to form an Operationalisation Index that measures activity in different facilities for the banks and collectively in a district as a percentage of total No Frills A/Cs. On the basis of contribution to Operationalisation, every parameter is assigned a score. The cumulative score for all the parameters for a bank or a district are added and corresponding ranks are assigned. The individual significance of the parameters is assessed using statistical tests on the Cross Sectional Data and recommendations are made to the concerned Bank or District under study. Further, the No-Frills A/C s are analysed as a product on the Ansoff-Matrix and strategic marketing recommendation are drawn.
    Keywords: Financial Inclusion, Operationalisation
    JEL: G2
    Date: 2010–07–10
  11. By: Fernando A. F. Ferreira; Ronald W. Spahr; Sérgio P. Santos; Paulo M.M. Rodrigues
    Abstract: Remarkable progress has occurred over the years in the performance evaluation of bank branches. Even though financial measures are usually considered the most important in assessing branch viability, we posit that insufficient attention has been given to other factors that affect the branches’ potential profitability and attractiveness. Based on the integrated used of cognitive maps and MCDA techniques, we propose a framework that adds value to the way that potential attractiveness criteria to assess bank branches are selected and to the way that the trade-offs between those criteria are obtained. This framework is the result of a process involving several directors from the five largest banks operating in Portugal, and follows a constructivist approach. Our findings suggest that the use of cognitive maps systematically identifies previously omitted criteria that may assess potential attractiveness. The use of MCDA techniques may clarify and add transparency to the way trade-offs are dealt with. Advantages and disadvantages of the proposed framework are also discussed.
    JEL: C44 G21 L25 M10
    Date: 2010
  12. By: Silvia Magri (Bank of Italy); Raffaella Pico (Bank of Italy)
    Abstract: The paper assesses the extent to which mortgage rates in Italy are priced according to credit risk as proxied by the probability of household mortgage delinquency estimated using the EU-Silc database. For reasons of data availability we restrict the analysis of mortgage pricing to Italian households. Consistent with the more extensive use of credit scoring techniques, our estimates indicate that Italian lenders have increasingly priced mortgage interest rates with reference to credit risk. For mortgages granted between 2000 and 2007, a 1 percentage point increase in the probability of default is associated with a 21 basis point rise in mortgage interest rates, less than the 38 basis point premium Edelberg (2006) estimated for the U.S. at the end of the '90s.
    Keywords: mortgage interest rate, mortgage delinquencies, risk-based pricing
    JEL: D10 E43 G21
    Date: 2010–10
  13. By: Komulainen, Tuomas (Bank of Finland Research)
    Abstract: The financial crises in emerging markets in 1997-1999 were preceded by financial liberalisation, rapid surges in capital inflows, increased levels of indebtedness, and then sudden capital outflows. The study contains four essays that extend the different generations of crisis literature and analyse the role of capital movements and borrowing in the recent crises. Essay 1 extends the first generation models of currency crises. It analyses bond financing of fiscal deficits in domestic and foreign currency, and compares the timing and magnitude of attack with the basic case where deficits are monetised. The essay finds that bond financing may not delay the crisis. But if the country’s indebtedness is low, the crisis is delayed by bond financing, especially if the borrowing is carried out with bonds denominated in foreign currency. Essay 2 extends the second generation model of currency crises by adding capital flows. If these depend negatively on crisis probability, there will be multiple equilibria. The range of country fundamentals for which self-fulfilling crises are possible is wider when capital flows are included, and thus more countries may end up in crisis. An application of the model shows that in 1996 in many emerging economies the fundamentals were inside the range of multiple equilibria and hence self-fulfilling crises were possible. Essay 3 studies financial contagion and develops a model of the international financial system. It uses a basic model of financial intermediation, but adds several local banks and an international bank. These banks are able to use outside borrowing, the amount of which is determined by the value of their collateral. The essay finds that the use of leverage by local and global banks and the fall in collateral prices comprise an important channel and reason for contagion. Essay 4 analyses the causes of financial crises in 31 emerging market countries in 1980–2001. A probit model is estimated using 23 macroeconomic and financial sector indicators. The essay finds that traditional variables (eg unemployment and inflation) and several indicators of indebtedness (eg private sector liabilities and banks' foreign liabilities) explain currency crises. When the sample was divided into pre- and post-liberalisation periods, the indicators of indebtedness became more important in predicting crisis in the postliberalisation period.
    Keywords: currency crises; banking crises; emerging markets; borrowing; collateral; contagion; liberalisation
    JEL: E50 E60 F00 N20 O10 O40
    Date: 2010–11–11
  14. By: Éric Tymoigne
    Abstract: Over the past 40 years, regulatory reforms have been undertaken on the assumption that markets are efficient and self-corrective, crises are random events that are unpreventable, the purpose of an economic system is to grow, and economic growth necessarily improves well-being. This narrow framework of discussion has important implications for what is expected from financial regulation, and for its implementation. Indeed, the goal becomes developing a regulatory structure that minimizes the impact on economic growth while also providing high-enough buffers against shocks. In addition, given the overarching importance of economic growth, economic variables like profits, net worth, and low default rates have been core indicators of the financial health of banking institutions. This paper argues that the framework within which financial reforms have been discussed is not appropriate to promoting financial stability. Improving capital and liquidity buffers will not advance economic stability, and measures of profitability and delinquency are of limited use to detect problems early. The paper lays out an alternative regulatory framework and proposes a fundamental shift in the way financial regulation is performed, similar to what occurred after the Great Depression. It is argued that crises are not random, and that their magnitude can be greatly limited by specific pro-active policies. These policies would focus on understanding what Ponzi finance is, making a difference between collateral-based and income-based Ponzi finance, detecting Ponzi finance, managing financial innovations, decreasing competitions in the banking industry, ending too-big-to-fail, and deemphasizing economic growth as the overarching goal of an economic system. This fundamental change in regulatory and supervisory practices would lead to very different ways in which to check the health of our financial institutions while promoting a more sustainable economic system from both a financial and a socio-ecological point of view.
    Keywords: Financial Crisis; Financial Regulation; Banking Supervision; Sustainability
    JEL: E12 E58 G18 G28 Q01
    Date: 2010–11
  15. By: Marieke Huysentruyt; Eva Lefevere; Carlo Menon
    Abstract: We examine the effects of bank deregulation on the spatial dynamics of retail-bankbranching, exploiting, much like a quasi-natural experiment, the context of intenseliberalization reforms in Belgium in the late nineties. Using .ne-grained data on branchnetwork dynamics within the metropolitan area of Antwerp and advancing novel spatialeconometric techniques, we show that these liberalization reforms radically shifted andaccelerated branch network dynamics. Entry and exit dynamics substantially intensified, thelevel change in financial void grew significantly, and bank choice markedly declined.Moreover, all these changes consistently extended (even with greater intensity) after theliberalization peak. However, the immediate and longer-term spatial ramifications of thefinancial sector liberalization were very distinct. All immediate changes systematically,differentially impacted the poorer and wealthier neighborhoods, disenfranchising the poorerneighbourhoods and favoring their wealthier counterparts. The longer-term effects on spatialpatterns of change no longer exhibited this systematic relationship with neighborhoodincome. We draw out the policy implications of our findings.
    Keywords: Location, Retail-banking, Liberalization, Poverty, Spatial Statistics
    JEL: G21 L1 L22 O16 R12
    Date: 2010–10
  16. By: Roberta Fiori (Bank of Italy); Simonetta Iannotti (Bank for International Settlements)
    Abstract: The aim of the paper is to understand the interaction between market and credit risk. Using a comprehensive set of Italian data, we apply a factor model to identify the common sources of risk driving fluctuations in the real and financial sectors. The common latent factors are then inserted in a VAR framework via a Factor Augmented Vector Autoregressive (FAVAR) approach to analyse the role of risk interactions with monetary policy shocks. We find that the impact of a restrictive monetary policy shock on credit risk is amplified when considering the feedback effect deriving from macroeconomic and equity market risk. Thus, neglecting dynamic interactions among risks may lead to biased estimates of the overall risk measure. The approach provides a framework for modelling macro and financial feedback dynamics, shedding some light on the complex interdependence between the financial sector and the real economy.
    Keywords: FAVAR approach, credit risk, market risk, factor model
    JEL: C32 E44 G21
    Date: 2010–10
  17. By: Xiaolin Luo; Pavel Shevchenko
    Abstract: This paper investigates the impact of parameter uncertainty on capital estimate in the well-known extended Loss Given Default (LGD) model with systematic dependence between default and recovery. We demonstrate how the uncertainty can be quantified using the full posterior distribution of model parameters obtained from Bayesian inference via Markov chain Monte Carlo (MCMC). Results show that the parameter uncertainty and its impact on capital can be very significant. We have also quantified the effect of diversification for a finite number of borrowers in comparison with the infinitely granular portfolio.
    Date: 2010–11
  18. By: Janine Aron; John Muellbauer
    Abstract: This paper presents new models for aggregate UK data on mortgage possessions(foreclosures) and mortgage arrears (payment delinquencies). The innovations include thetreatment of difficult to observe variations in loan quality and shifts in forbearance policy bylenders, by common latent variables estimated in a system of equations for arrears andpossessions, for quarterly data over 1983-2009. A second innovation is the theory-justifieduse of an estimate of the proportion of mortgages in negative equity, based on an averagedebt to equity ratio, as one of the key drivers of possessions and arrears. A third is thesystematic treatment of measurement bias in the months in arrears measures. Finally, thepaper does not impose a proportional long-run relationship between possessions and arrearsassumed in the previous UK literature. A range of economic forecast scenarios for forecaststo 2013 reveals the sensitivity of mortgage possessions and arrears to different economicconditions, highlighting potential risks faced by the UK and its mortgage lenders. Acomprehensive review of data on arrears and possessions completes the paper.
    Keywords: foreclosures, mortgage possessions, mortgage payment delinquencies, mortgage arrears,UK mortgage market, defaults, unobserved components model
    JEL: G21 G28 R21 C51 C53 E27
    Date: 2010–08
  19. By: Wagner Piazza Gaglianone (Central Bank of Brazil and Fucape Buisness School); Luiz Renato Lima (University of Tennessee and EFGE-FGV); Oliver Linton (London School of Economics); Daniel Smith (Simon Fraser University and QUT)
    Abstract: This paper is concerned with evaluating Value-at-Risk estimates. It is well known that using only binary variables, such as whether or not there was an exception, sacrifices too much information. However, most of the specification tests (also called backtests) available in the literature, such as Christofferson (1998) and Engle and Mangenelli (2004) are based on such variables. In this paper we propose a new backtest that does not rely solely on binary variables. It is shown that the new backtest provides a sufficient condtion to assess the finite sample performance of a quantile model whereas the existing ones do not. The proposed methodolgy allows us to identify periods of an increased risk exposure based on a quantile regression model (Koenker and Xiao, 2002). Our theoretical findings are corroborated through a Monte Carlo simulation and an empirical exercise with daily S&P500 time series.
    Keywords: Value-at-Risk, Backtesting, Quantile Regression
    JEL: C12 C14 C52 G11
    Date: 2010–11–05
  20. By: Tobias Körner (Ruhr Graduate School in Economics); Isabel Schnabel (University of Mainz, CEPR, and MPI Bonn)
    Abstract: In an influential paper, La Porta, Lopez-De-Silanes and Shleifer (2002) argued that public ownership of banks is associated with lower GDP growth. We show that this relationship does not hold for all countries, but depends on a country’s financial development and political institutions. Public ownership is harmful only if a country has low financial development and low institutional quality. The negative impact of public ownership on growth fades quickly as the financial and political system develops. In highly developed countries, we find no or even positive effects. Policy conclusions for individual countries are likely to be misleading if such heterogeneity is ignored.
    Keywords: Public banks, economic growth, financial development, quality of governance, political institutions
    JEL: G18 G21 O16
    Date: 2010–09

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