New Economics Papers
on Banking
Issue of 2010‒11‒27
twenty-two papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Mapping capital and liquidity requirements to bank lending spreads By Michael R King
  2. Macroeconomic factors and micro-level bank risk By Buch, Claudia M.; Eickmeier, Sandra; Prieto, Esteban
  3. A Reduced Form Model of Default Spreads with Markov-Switching Macroeconomic Factors By Georges Dionne; Geneviève Gauthier; Khemais Hammami; Mathieu Maurice; Jean-Guy Simonato
  4. The Great Retrenchment: International Capital Flows During the Global Financial Crisis By Gian-Maria Milesi-Ferretti, Cédric Tille
  5. Systemic risk in derivative markets: A graph-theory analysis. By Lautier, Delphine; Raynaud, Franck
  6. Entrepreneurial risk choice and credit market equilibria By Heiner Schumacher; Michal Kowalik; Kerstin Gerling
  7. A Non-parametric Approach to Incorporating Incomplete Workouts Into Loss Given Default Estimates By Rapisarda, Grazia; Echeverry, David
  8. Channel systems: Why is there a positive spread? By Aleksander Berentsen; Alessandro Marchesiani; Christopher J. Waller
  9. Dangers of Bilateral Counterparty Risk: the fundamental impact of closeout conventions By Damiano Brigo; Massimo Morini
  10. The Availability and Cost of Short-Term Trade Finance and its Impact on Trade By Jane Korinek; Jean Le Cocguic; Patricia Sourdin
  11. Mortgage contract choice in subprime mortgage markets By Gregory Elliehausen; Min Hwang
  12. Lender exposure and effort in the syndicated loan market By Nada Mora
  13. An economic model of contagion in interbank lending markets By Dan Ladley
  14. Banking Efficiency in Emerging Market Economies By Matthews, Kent
  15. Self-Fulfilling Risk Panics By Philippe Bacchetta, Cedric Tille, Eric van Wincoop
  16. The rise and fall of the ABS market By Mario Cerrato
  17. The Financial Crisis 2007-08 and Causality: A Hicksian Perspective By Fernandez-Pol, Eduardo
  18. O Comportamento Cíclico do Capital dos Bancos Brasileiros By R. A. Ferreira; A. C. Noronha; D. O. Cajueiro; B. M. Tabak
  19. Pricing of bank ATMs in India: Theory & evidence By Panda, Sitakanta
  20. Global financial crisis and its impact on the financial system of Kosovo By Ramosaj, Berim
  21. Total Factor Productivity Growth and Its Decomposition: An Assessment of the Indian Banking Sector in the True Liberalised Era By Anup Kumar Bhandari
  22. Do Male and Female Loan Officers Differ in Small Business Lending?;A Review of the Literature By Andrea Bellucci; Alexander V. Borisov; Alberto Zazzaro

  1. By: Michael R King
    Abstract: This study outlines a methodology for mapping the increases in capital and liquidity requirements proposed under Basel III to bank lending spreads. The higher cost associated with a one percentage point increase in the capital ratio can be recovered by increasing lending spreads by 15 basis points for a representative bank. This calculation assumes the return on equity (ROE) and the cost of debt are unchanged, with no change in other sources of income and no reduction in operating expenses. If ROE and the cost of debt are assumed to decline, the impact on lending spreads is reduced. To recover the additional cost of meeting the December 2009 proposal for the Net Stable Funding Ratio (NSFR), a representative bank would need to increase lending spreads by 24 basis points. Taking into account the fall in risk-weighted assets from holding more government bonds reduces this cost to 12 basis points or less.
    Keywords: banks, regulation, Basel III, capital, liquidity, lending spreads
    Date: 2010–11
  2. By: Buch, Claudia M.; Eickmeier, Sandra; Prieto, Esteban
    Abstract: The interplay between banks and the macroeconomy is of key importance for financial and economic stability. We analyze this link using a factor-augmented vector autoregressive model (FAVAR) which extends a standard VAR for the U.S. macroeconomy. The model includes GDP growth, inflation, the Federal Funds rate, house price inflation, and a set of factors summarizing conditions in the banking sector. We use data of more than 1,500 commercial banks from the U.S. call reports to address the following questions. How are macroeconomic shocks transmitted to bank risk and other banking variables? What are the sources of bank heterogeneity, and what explains differences in individual banks' responses to macroeconomic shocks? Our paper has two main findings: (i) Average bank risk declines, and average bank lending increases following expansionary shocks. (ii) The heterogeneity of banks is characterized by idiosyncratic shocks and the asymmetric transmission of common shocks. Risk of about 1/3 of all banks rises in response to a monetary loosening. The lending response of small, illiquid, and domestic banks is relatively large, and risk of banks with a low degree of capitalization and a high exposure to real estate loans decreases relatively strongly after expansionary monetary policy shocks. Also, lending of larger banks increases less while risk of riskier and domestic banks reacts more in response to house price shocks. --
    Keywords: FAVAR,bank risk,macro-finance linkages,monetary policy,microeconomic adjustment
    JEL: E44 G21
    Date: 2010
  3. By: Georges Dionne; Geneviève Gauthier; Khemais Hammami; Mathieu Maurice; Jean-Guy Simonato
    Abstract: An important research area of the corporate yield spread literature seeks to measure the proportion of the spread that can be explained by factors such as the possibility of default, liquidity, tax differentials and market risk. We contribute to this literature by assessing the ability of observed macroeconomic factors and the possibility of changes in regime to explain the proportion of yield spreads caused by the risk of default in the context of a reduced form model. For this purpose, we extend the Markov Switching risk-free term structure model of Bansal and Zhou (2002) to the corporate bond setting and develop recursive formulas for default probabilities, risk-free and risky zero-coupon bond yields as well as credit default swap premia. The model is calibrated with consumption, inflation, risk-free yields and default data for Aa, A and Baa bonds from the 1987-2008 period. We find that our macroeconomic factors are linked with two out of three sharp increases in the spreads during this sample period, indicating that the variations can be related to macroeconomic undiversifiable risk. The estimated default spreads can explain almost half of the 10 years to maturity industrial Baa zero-coupon yields in some regime. Much smaller proportions are found for Aa and A bonds with numbers around 10%. The proportions of default estimated with credit default swaps are higher, in many cases doubling those found with corporate yield spreads.
    Keywords: Credit spread, default spread, Markov switching, macroeconomic factors, reduced form model of default, random subjective discount factor, credit default swap, CDS
    JEL: G12 G13
    Date: 2010
  4. By: Gian-Maria Milesi-Ferretti, Cédric Tille (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: The current crisis saw an unprecedented collapse in international capital flows after years of rising financial globalization. We identify the stylized facts and main drivers of this development. The retrenchment in international capital flows is a highly heterogeneous phenomenon: first across time, being especially dramatic in the wake of the Lehman Brothers’ failure, second across types of flows, with banking flows being the hardest hit due to their sensitivity of risk perception, and third across regions, with emerging economies experiencing a shorter-lived retrenchment than developed economies. Our econometric analysis shows that the magnitude of the retrenchment in capital flows across countries is linked to the extent of international financial integration, its specific nature—with countries relying on bank flows being the hardest hit—as well as domestic macroeconomic conditions and their connection to world trade flows.
    Date: 2010–06–01
  5. By: Lautier, Delphine; Raynaud, Franck
    Keywords: Integration; Systemic Risk; Derivatives; Commodities; Graph Theory; Minimum Spanning Trees;
    JEL: C4 O13
  6. By: Heiner Schumacher; Michal Kowalik; Kerstin Gerling
    Abstract: We analyze under what condiitons credit markets are efficient in providing loans to entrepreneurs who can start a new project after previous failure. An entrepreneur of uncertain talent chooses the riskiness of her project. If banks cannot perfectly observe the risk of previous projects, two equilibria may coexist: (1) an inefficient equilibrium in which the entrepreneur undertakes a low-risk project and has no access to finance after failure; and (2) a more efficient equilibrium in which the entrepreneur undertakes high-risk projects and gets financed even after an endogenously determined number of failures.
    Date: 2010
  7. By: Rapisarda, Grazia; Echeverry, David
    Abstract: When estimating Loss Given Default (LGD) parameters using a workout approach, i.e. discounting cash flows over the workout period, the problem arises of how to take into account partial recoveries from incomplete work-outs. The simplest approach would see LGD based on complete recovery profiles only. Whilst simple, this approach may lead to data selection bias, which may be at the basis of regulatory guidance requiring the assessment of the relevance of incomplete workouts to LGD estimation. Despite its importance, few academic contributions have covered this topic. We enhance this literature by developing a non-parametric estimator that -under certain distributional assumptions on the recovery profiles- aggregates complete and incomplete workout data to produce unbiased and more efficient estimates of mean LGD than those obtained from the estimator based on resolved cases only. Our estimator is appropriate in LGD estimation for wholesale portfolios, where the exposure-weighted LGD estimators available in the literature would not be applicable under Basel II regulatory guidance.
    Keywords: Credit risk; bank loans; loss-given-default; LGD; incomplete observations; mortality curves
    JEL: C14 G32
    Date: 2010–11–16
  8. By: Aleksander Berentsen; Alessandro Marchesiani; Christopher J. Waller
    Abstract: An increasing number of central banks implement monetary policy via two standing facilities: a lending facility and a deposit facility. In this paper we show that it is socially optimal to implement a non-zero interest rate spread. We prove this result in a dynamic general equilibrium model where market participants have heterogeneous liquidity needs and where the central bank requires government bonds as collateral. We also calibrate the model and discuss the behavior of the money market rate and the volumes traded at the ECB’s deposit and lending facilities in response to the recent financial crisis.
    Date: 2010
  9. By: Damiano Brigo; Massimo Morini
    Abstract: We analyze the practical consequences of the bilateral counterparty risk adjustment. We point out that past literature assumes that, at the moment of the first default, a risk-free closeout amount will be used. We argue that the legal (ISDA) documentation suggests in many points that a substitution closeout should be used. This would take into account the risk of default of the survived party. We show how the bilateral counterparty risk adjustment changes strongly when a substitution closeout amount is considered. We model the two extreme cases of default independence and co-monotonicity, which highlight pros and cons of both risk free and substitution closeout formulations, and allow us to interpret the outcomes as dramatic consequences on default contagion. Finally, we analyze the situation when collateral is present.
    Date: 2010–11
  10. By: Jane Korinek; Jean Le Cocguic; Patricia Sourdin
    Abstract: The systemic nature of the recent financial crisis precipitated a general and synchronized drop of activity in the interbank market, contaminating most banks in almost all regions. The ensuing economic crisis was characterised by a drop in production coupled with a much larger drop in trade flows. There may be a number of reasons for the particularly sharp drop in trade. This paper examines one potential reason for the drop in trade between mid-2008 and the first quarter of 2009 – changes in the cost and availability of trade finance to potential exporters and importers. Results from an econometric model developed to examine this question show that short-term trade finance availability has had an effect on trade flows during the crisis period, but that its impact has been smaller than that of falling demand. It also shows that the availability and cost of trade finance seem to have had a limited impact on trade outside crisis periods. During the crisis period, the cost of financing negatively impacted trade overall due to an increase in spreads. This indicates that financing was probably prohibitively expensive for some traders, thereby severely constraining their ability to trade. This paper however highlights one of the major difficulties regarding policymaking in the area of trade finance – that there is little reliable quantitative information.
    Date: 2010–06–02
  11. By: Gregory Elliehausen; Min Hwang
    Abstract: The boom in the subprime mortgage market yielded many loans with high LTV ratios. From a large proprietary database on subprime mortgages, we find that choice of mortgage rate type is not linear in loan sizes. A fixed rate mortgage contract is a popular choice when loan size, measured by LTV ratio, is small. As LTV ratio increases, borrowers become more likely to choose adjustable rate mortgage contracts. However, when LTV reaches a certain level, borrowers start to switch back to fixed rate contracts. For these high LTV loans, fixed rate mortgages dominate borrowers' choices. We present a very simple model that explains this "nonlinear" pattern in mortgage instrument choice. The model shows that the choice of mortgage rate type depends on two opposing effects: a "term structure" effect and an "interest rate volatility" effect. When the loan size is small, the term structure effect dominates: rising LTV ratios making ARM loans less costly, and more attractive. However, when the loan size is large enough, the interest volatility effect dominates: rising LTV ratios making FRM loans less costly and preferable. We present strong empirical evidence in support of the model predictions.
    Date: 2010
  12. By: Nada Mora
    Abstract: This paper tests for agency problems between the lead arranger and syndicate participants in the syndicated loan market. One problem comes from adverse selection, whereby the lead arranger has a private informational advantage over participants. A second problem comes from moral hazard, whereby the lead arranger puts less effort in monitoring when it retains a smaller loan portion. Applying an instrumental variables strategy, I find that borrowers' performance is influenced by the lead's share. Dynamic tests extract active contributions made by the lead, supporting a monitoring interpretation. Loan covenants serve as a mechanism to induce the lead arranger to monitor.
    Date: 2010
  13. By: Dan Ladley
    Abstract: This paper considers the stability of a financial system in which heterogenous banks interact through a lending market. We analyse a discrete time model in which households and banks are located on a circular city. Households present banks with risky investment opportunities, which banks fund through deposits and interbank borrowing. In the event of bankruptcy, a bank defaults on its interbank loans potentially resulting in contagion and losses for other banks. Through simulation we examine the vulnerability of the financial system to systemic events, demonstrating the non-linear relationship between market concentration, shock severity and bankruptcies. The role and effect of regulatory actions such as reserve requirements, minimum bank capitalisation and constraints on the size of borrowing relationships, are considered in limiting these effects.
    Keywords: Systemic risk; Interbank lending; Regulation; Network; Heterogeneity
    JEL: G21 C63
    Date: 2010–11
  14. By: Matthews, Kent (Cardiff Business School)
    Abstract: This paper reviews the different ways to measure bank efficiency and highlight the results of research on bank efficiency in Asian emerging economies. In particular it will outline the extent of research thus far conducted on the efficiency of banks in Pakistan and comment on how to build and improve upon them.
    Keywords: bank efficiency; bootstrap; Pakistan
    JEL: G20 G21
    Date: 2010–11
  15. By: Philippe Bacchetta, Cedric Tille, Eric van Wincoop (IUHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: Recent crises have seen very large spikes in asset price risk without dramatic shifts in fundamentals. We propose an explanation for these risk panics based on self-fulfilling shifts in risk made possible by a negative link between the current asset price and risk about the future asset price. This link implies that risk about tomorrow’s asset price depends on uncertainty about risk tomorrow. This dynamic mapping of risk into itself gives rise to the possibility of multiple equilibria and self-fulfilling shifts in risk. We show that this can generate risk panics. The impact of the panic is larger when the shift from a low to a high risk equilibrium takes place in an environment of weak fundamentals. The sharp increase in risk leads to a large drop in the asset price, decreased leverage and reduced market liquidity. We show that the model can account well for the developments during the recent financial crisis.
    Date: 2010–06–28
  16. By: Mario Cerrato
    Abstract: The financial crisis has raised some concern about the quality of information available on some traded assets on the securities markets to market participants and regulators. Asset-backed securitization in general got partial blame for the paucity of liquidity on bank balance sheets and the consequent credit crunch. After the Asset-Backed Security (ABS) market fell to near inactivity in 2009, the US federal government's Term Asset-Backed Securities Loan Facility (TALF) provided backing and a boost to the issuance of asset-backed securitization. In this market condition, given the nature of ABS, it is difficult for them not to be relatively illiquid, and this has resulted in unacceptable levels of market risk for most investors. Their liquidity before the crisis was driven by a market in continuous expansion, fed by Special Purpose Vehicle (SPV), Conduits, and other low capitalized term-transformation vehicles. Nowadays, the industry is concerned with the ongoing ABS reforms and how these will be implemented. This article reviews the ABS market in the last decade and the possible consequences of the recent regulatory proposals. It proposes a retention policy and the institution of a new financial body to supervise the quality of the security in an ABS pool, its liquidity, and the model risk implied by the issuer's valuation mode
    Keywords: Asset Backed Security; Government Policy and Regulation
    JEL: G39 G18
    Date: 2010–11
  17. By: Fernandez-Pol, Eduardo (University of Wollongong)
    Abstract: Almost everyone agrees on two general features displayed by the recent banking crisis, namely: the crisis was stupefyingly complex and the financial system was devoured by its own creations. Beyond these points of agreement, there are many questions that will be debated by academics and policymakers for decades. One of the outstanding questions is what caused the financial crisis 2007-08. To shed light on this question, the paper compiles a list of the tentative causes of the recent financial crisis, discusses their separability and attempts an appraisal of the separable causes using the Hicksian methodology for causality analysis. Specifically, this paper identifies three major separable causes of the recent banking crisis and brings into sharp focus the far-from-trivial requirements that are necessary in order to demonstrate that a particular set of events can indeed be the preponderant causes of the severe banking crisis 2007-08.
    Keywords: Financial crisis 2007-08, causality analysis, Hicksian methodology, separable causes
    JEL: B41 G10
    Date: 2010
  18. By: R. A. Ferreira; A. C. Noronha; D. O. Cajueiro; B. M. Tabak
    Abstract: In the context of the implementation of the Basel II accord, this paper analyzes the cyclical behavior of Brazilian bank capital under the current regulation. We use an unbalanced panel data of banks operating in Brazil between 2003 and 2008 to estimate an equation of the bank economic capital. Our results show that this variable moves with the business cycle.
    Date: 2010–11
  19. By: Panda, Sitakanta
    Abstract: We analyze the access pricing policy of bank ATMs in India by developing a model given the existence of interchange fees and absence of own bank ATM usage fee and foreign fees in the Indian context. We find that interchange fees incentivize deployment of ATMs over time and at the profit maximizing interchange fee, banks extract the entire consumer surplus under a system of free usage fees. Banks deploy ATMs not to raise the deposit base, but to generate interchange fee revenues. Consumers prefer to join a bank with large ATM networks to avoid making more foreign withdrawals and this induces banks to expand their ATM networks in a bid to raise their deposit market share. These results are consistent with recent events in India.
    Keywords: Banks; ATMs; interchange fees; regulation.
    JEL: L14 L51 L13 G28 G21
    Date: 2010–11
  20. By: Ramosaj, Berim
    Abstract: The Kosovo’s Financial Sector is one of the newest financial sectors in Eastern Europe whose developments began in early 2000. Kosovo's banking sector consists of 8 privately owned commercial banks, the insurance companies which make up 5% of total financial sector assets by 10 insurance companies with over 70% foreign equity ownership. Pension funds also participate by about 1.5% of the total financial sector assets. In the long history of global financial crisis, and such have been over 120, the current crisis is regarded as among the most profound (similar to that of year 1929) and comprehensive on the speed and breadth of development. The sources of the crisis lie in the three pillars of the functioning of banking institutions: inadequate management of credit risk and liberalization of excessive lending policies; inadequate capitalization of the banking institutions; and inadequate management of their liquidity. Kosovo is part of Europe and cannot act as a closed oasis. The concept of a new model of financial sector in Kosovo is thought to create additional mechanisms that will enable advancements in the development of Kosovo’s financial sector with special focus in the field of investment and that mean financial market development namely the securities market. Legal infrastructure on debt market in Kosovo will create a legal possibility that the central and municipal government have the opportunity to borrow in order to implement their development policies. It is unimaginable implementation of the project without information technology support. This support has to do with that that information technology offers its capacities in supporting of all the activities that include the operation of the securities market and the creation of its electronic data base.
    Keywords: Financial market; ffinancial crisis; financial system; financial institutions; financial intermediation
    JEL: G22 G23 N20 G28 G24 G21 G20
    Date: 2010–08–07
  21. By: Anup Kumar Bhandari
    Abstract: Assessments of the performance of Indian commercial banks are not new in the literature. However, most of the earlier studies consider relatively partial measures such as technical efficiency of the banks in assessing their performance. In this paper they have considered overall (Malmquist) total factor productivity improvement achieved by 68 Indian commercial banks from 1998-99 to 2006-07, the true liberalised era in some senses, and decomposed it into the three of its economically meaningful components, namely technical change, technical efficiency change and scale (efficiency) change factor using Data Envelopment Analysis (DEA) methodology. [Working Paper No. 435]
    Keywords: Total Factor Productivity; Technical Change; Technical Efficiency Change; Scale (Efficiency) Change Factor; Data Envelopment Analysis; Liberalisation
    Date: 2010
  22. By: Andrea Bellucci (Universit… di Urbino); Alexander V. Borisov (Indiana University); Alberto Zazzaro (Universit… Politecnica delle Marche, Department of Economics, MoFiR)
    Date: 2010–11

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