New Economics Papers
on Banking
Issue of 2011‒02‒19
nineteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Systemic Risk and Network Formation in the Interbank Market By Cohen-Cole, Ethan; Patacchini, Eleonora; Zenou, Yves
  2. Monetary policy shocks in a DSGE model with a shadow banking system By Fabio Verona; Manuel M. F. Martins; Inês Drumond
  3. Lifting the Veil: Regulation and Shadow Banking By Christian Calmes; Raymond Theoret
  4. Transition Probability Matrix Methodology for Incremental Risk Charge By Yavin, Tzahi; Zhang, Hu; Wang, Eugene; Clayton, Michael
  5. The Macroeconomic Effects on Interest on Reserves By Peter N. Ireland
  6. Cross-border resolution of failed banks in the EU: A search for the second-best policies By Zdenek Kudrna
  7. The implications of European retail banking integration on small and medium-sized enterprises financing. An overview By Anton, Sorin Gabriel; Avadanei, Andreea
  8. Perspectives on Single Euro Payments Area adoption in the light of the financial crisis By Avadanei, Andreea
  9. Statistical Inference for Time-changed Brownian Motion Credit Risk Models By T. R. Hurd; Zhuowei Zhou
  10. Pairing market risk with credit risk By Isabel Figuerola-Ferretti; Ioannis Paraskevopoulos
  11. Financial Policies, Investment, and the Financial Crisis: Impaired Credit Channel or Diminished Demand for Capital? By Kahle, Kathleen M.; Stulz, Rene M.
  12. What Regulatory Policies Work for Emerging Markets? By Ping, Luo
  13. Financial Fragility in a General Equilibrium Model: the Brazilian case By Benjamin M. Tabak; Daniel O. Cajueiro; Dimas M. Fazio
  15. On the Effects of Deposit Insurance and Observability on Bank Runs: An Experimental Study By Hubert Janoss Kiss; Ismael Rodriguez Lara; Alfonso Rosa Garcia
  16. The Case For Intervening In Bankers' Pay By John Thanassoulis
  17. Integrating Reform of Financial Regulation with Reform of the International Monetary System By Morris Goldstein
  18. Internal Assessment of Credit Concentration Risk Capital: A Portfolio Analysis of Indian Public Sector Bank By Bandyopadhyay, Arindam
  19. Implication of Single Euro Payments Area for financial services market. The case of Romania By Avadanei, Anamaria; Ghiba, Nicolae

  1. By: Cohen-Cole, Ethan (University of Maryland); Patacchini, Eleonora (University of Roma La Sapienza); Zenou, Yves (Dept. of Economics, Stockholm University)
    Abstract: We propose a novel mechanism to facilitate understanding of systemic risk in financial markets. The literature on systemic risk has focused on two mechanisms, common shocks and domino-like sequential default. Our approach is a formal model that provides an intellectual combination of the two by looking at how shocks propagate through a network of interconnected banks. Transmission in our model is not based on default. Instead, we provide a simple microfoundation of banks’ profitability based on classic competition incentives. As competitors lending quantities change, both for closely connected ones and the whole market, banks adjust their own lending decisions as a result, generating a ‘transmission’ of shocks through the system. We provide a unique equilibrium characterization of a static model, and embed this model into a full dynamic model of network formation with n agents. Because we have an explicit characterization of equilibrium behavior, we have a tractable way to bring the model to the data. Indeed, our measures of systemic risk capture the propagation of shocks in a wide variety of contexts; that is, it can explain the pattern of behavior both in good times as well as in crisis.
    Keywords: Financial networks; interbank lending; interconnections; network centrality; spatial autoregressive models
    JEL: C21 G10
    Date: 2011–02–11
  2. By: Fabio Verona (Universidade do Porto, Faculdade de Economia and CEF.UP); Manuel M. F. Martins (Universidade do Porto, Faculdade de Economia and CEF.UP); Inês Drumond (Universidade do Porto, Faculdade de Economia and CEF.UP, and GPEARI-MFAP)
    Abstract: This paper is motivated by the recent financial crisis and addresses whether a “too low for too long” interest rate policy may generate a boom-bust cycle. We suggest a model in which a microfounded shadow banking sector is included in an otherwise state-of-the-art DSGE model. When faced with perverse incentives, financial intermediaries within the shadow banking sector can divert a fraction of stockholders’ profits for their own benefits and extend credit at a discounted rate. The model predicts that long periods of accommodative monetary policy do create the preconditions for, but do not cause per se, a boom-bust cycle. Rather, it is the combination of a persistent monetary ease with microeconomic distortions in the financial system that causes a boom-bust.
    Keywords: monetary policy; DSGE model; shadow banking system; boom-bust
    JEL: E32 E44 E52 G24
    Date: 2011–02
  3. By: Christian Calmes (Université du Québec en Outaouais); Raymond Theoret (Université du Québec en Outaouais)
    Abstract: The growth of shadow banking in recent decades has changed the concept of banking. It has meant less deposit-taking and lending and more market-oriented banking activities, including in particular a growing trade in securitized products. However, shadow banking is opaque; a problem that was underlined in the recent financial crisis. Does the experience of the financial crisis and its links to the riskiness of banking mean bank re-regulation is necessary? In the Canadian context at least, better reporting of bank risk seems to be a more appropriate way than re-regulation to prevent financial turmoil from arising in this area. Market-oriented operations should be more exposed to daylight, to enable a better evaluation of true bank risk, and regulatory agencies should require detailed reports on activities generating noninterest income. Better indicators of leverage need also to be developed, owing to leverage’s role as the principal channel of bank risk-taking.
    Keywords: Financial Services, shadow banking system, Canadian banking system, regulation, subprime mortgage crisis
    JEL: G21 G24 G28
    Date: 2011–01
  4. By: Yavin, Tzahi; Zhang, Hu; Wang, Eugene; Clayton, Michael
    Abstract: As part of Basel II's incremental risk charge (IRC) methodology, this paper summarizes our extensive investigations of constructing transition probability matrices (TPMs) for unsecuritized credit products in the trading book. The objective is to create monthly or quarterly TPMs with predefined sectors and ratings that are consistent with the bank's Basel PDs. Constructing a TPM is not a unique process. We highlight various aspects of three types of uncertainties embedded in different construction methods: 1) the available historical data and the bank's rating philosophy; 2) the merger of one-year Basel PD and the chosen Moody's TPMs; and 3) deriving a monthly or quarterly TPM when the generator matrix does not exist. Given the fact that TPMs and specifically their PDs are the most important parameters in IRC, it is our view that banks may need to make discretionary choices regarding their methodology, with uncertainties well understood and managed.
    Keywords: Basel II; trading book; incremental risk charge; default probability; default correlation; transition probability matrix; generator matrix; credit portfolio
    JEL: C02 G28 G21
    Date: 2011–01–17
  5. By: Peter N. Ireland (Boston College)
    Abstract: This paper uses a New Keynesian model with banks and deposits, calibrated to match the US economy, to study the macroeconomic effects of policies that pay interest on reserves. While their effects on output and inflation are small, these policies require important adjustments in the way that the monetary authority manages the supply of reserves, as liquidity effects vanish and households' portfolio shifts increase banks' demand for reserves when short-term interest rates rise. Money and monetary policy remain linked in the long run, however, since policy actions that change the price level must change the supply of reserves proportionately.
    Keywords: banking, reserves, interest, central banking
    JEL: E31 E32 E51 E52 E58
    Date: 2011–02–01
  6. By: Zdenek Kudrna
    Abstract: This paper analyzes the reasons for the failure of the multilateral resolution of EU cross-border banks such as Fortis. We argue that the pre-crisis regime based on soft law and voluntary coordination was unable to align the incentives of national authorities acting under the time pressure and uncertainty of a banking crisis. We ask whether this experience induced the Commission to propose reforms that would close the regulatory gap between integrated cross-border banks and national resolution regimes. Although, the Commission proposals submitted within a year of the crisis considered the more radical reform options, such as shifting the regime to the EU level or reorganizing cross-border banks so that they could be resolved on the national level, in the end the Commission supported the traditional reform path of deepening soft law and strengthening pre-crisis governance arrangements. At the same time, the new financing mechanisms introduced to stabilize the Eurozone can pave the way for the introduction of an EU-level bank resolution regime, when the next reform opportunity arises.
    Keywords: political science; European Commission
    Date: 2010–11–15
  7. By: Anton, Sorin Gabriel; Avadanei, Andreea
    Abstract: Considering the last few years, the European Union (EU) has became one of the most competitive and integrated economic regions of the world, following a rapid pace of change as a result of an inspired series of initiatives. The harmonization of the banking and other financial services legislation as component of the EU’ Single Market, the creation of the European Economic and Monetary Union (EMU), alongside the ongoing implementation of the Financial Services Action Plan (FSAP) represent the central drivers of financial integration and the set of elements that have helped reducing the barriers to cross-border trade in banking services. The process of deregulation is another element that facilitated the environment in which technology and other bank strategic determinants have become increasingly important. The scope of the present paper is to analyze the implications of a higher degree of banking integration on firms financing options and choices. This paper is composed of two main parts. The first part focuses to the determinants of European banking integration, analyzing this process since the banking system represents the main financial channel for both the small and medium-sized enterprises and households. The second part concentrates on the effects of banking integration on considered entities’ financial constraints. The concluding remarks outline that retail bank integration has an ambiguous implication on SMEs’ access to credit.
    Keywords: retail banking integration; SMEs; firms’ financing; financial constraints; deregulation
    JEL: G32 G21
    Date: 2010–04–09
  8. By: Avadanei, Andreea
    Abstract: The scope of this article is to point out how the present financial crisis is affecting the European payments landscape and the Single Euro Payments Area implementation. The current unpredictable and very challenging market situation has not fundamentally changed the fact that payment services need to continue modernization in order to become more flexible, agile and adapt in order to comply with its important purpose in society. SEPA is needed to ensure the new modern payment platform that can enable Europe to move beyond basic services, increase payments efficiency, embrace innovation and integrate further services in the trade process. Today, the turbulent market conditions could have the effect of accentuating rather than reducing the business case imperative and momentum to achieving full SEPA implementation.
    Keywords: Single Euro Payments Area; credit crunch; corporate bodies; cash management; financial turmoil
    JEL: D53 E42 G21
    Date: 2010–04–02
  9. By: T. R. Hurd; Zhuowei Zhou
    Abstract: We consider structural credit modeling in the important special case where the log-leverage ratio of the firm is a time-changed Brownian motion (TCBM) with the time-change taken to be an independent increasing process. Following the approach of Black and Cox, one defines the time of default to be the first passage time for the log-leverage ratio to cross the level zero. Rather than adopt the classical notion of first passage, with its associated numerical challenges, we accept an alternative notion applicable for TCBMs called "first passage of the second kind". We demonstrate how statistical inference can be efficiently implemented in this new class of models. This allows us to compare the performance of two versions of TCBMs, the variance gamma (VG) model and the exponential jump model (EXP), to the Black-Cox model. When applied to a 4.5 year long data set of weekly credit default swap (CDS) quotes for Ford Motor Co, the conclusion is that the two TCBM models, with essentially one extra parameter, can significantly outperform the classic Black-Cox model.
    Date: 2011–02
  10. By: Isabel Figuerola-Ferretti; Ioannis Paraskevopoulos
    Abstract: This study uses a comprehensive data set of VIX and CDS markets to propose pairs trading strategies that represent the dynamic relation between market risk and credit risk in an equilibrium framework with a common non stationary factor. This involves the analysis of price discovery between VIX and the 47 most traded iTraxx companies. We find cointegration between market risk and credit risk and predominant price leadership in the VIX market. CDS spreads can thus be replicated through positions in the VIX derivatives markets. We demonstrate how one can capitalize on the price discovery between market and credit risk by building a pairs arbitrage strategy whose profits are driven by the common price discovery factor. The respective portfolios are tested against statistical arbitrage.
    Keywords: Pairs strategies, Credit risk, Market risk, Price discovery
    JEL: C13 C51 G12 G13 G14
    Date: 2011–02
  11. By: Kahle, Kathleen M. (University of AZ); Stulz, Rene M. (OH State University)
    Abstract: Though much of the narrative of the financial crisis has focused on the impact of a bank credit supply shock, we show that such a shock cannot explain important features of the financial and investment policies of industrial firms. These features are consistent with a dominant role for the increase in risk and the reduction in demand for goods that occurred during the crisis. The net equity issuance of small firms and unrated firms is abnormally low throughout the crisis, whereas an impaired credit supply by itself would have encouraged these firms to increase their net equity issuance. After September 2008, firms increase their cash holdings rather than use them to mitigate the impact of the credit supply shock. Firms that are more bank-dependent before the crisis do not reduce their capital expenditures more than other firms during the crisis. Finally, the evidence is strongly supportive of theories that emphasize the importance of collateral and corporate net worth in financing and investment policies, as firms with stronger balance sheets reduce capital expenditures less after September 2008.
    Date: 2011–02
  12. By: Ping, Luo (Asian Development Bank Institute)
    Abstract: <p>This paper discusses the banking regulatory and supervisory practices in People’s Republic of China (PRC) with reference to the international standard for banking supervision, namely, the Basel Core Principles for Effective Banking Supervision (BCPs). While the PRC has incorporated many sound practices advocated by the BCPs, there are quite a few areas where significant differences can be observed with respect to qualification review of senior management, broader regulation at the product level, prescriptive rules, and guidance for risk management. Broadly speaking, the PRC adopts a rules-based approach to regulation; in many cases, regulations are prescriptive or even intrusive. In building a robust supervisory system, the PRC finds specific guidance more helpful than sole reliance on principles-based approaches. <p>The paper argues that general principles and a principle-based approach to regulation do not seem to work well for emerging markets. Indeed, the current financial crisis has revealed some shortcomings in the existing international standards on banking supervision. Perhaps this standard can be improved by greater specificity and by incorporating more aspects of the experiences in emerging markets.
    Keywords: banking regulatory supervisory practices prc; international standard banking supervision; basel core banking supervision; bcps
    JEL: G20 G28
    Date: 2011–02–10
  13. By: Benjamin M. Tabak; Daniel O. Cajueiro; Dimas M. Fazio
    Abstract: This paper employs a general equilibrium approach to model the Brazilian financial system. We show that the model is able to replicate the main characteristics of the data and to predict short-term trends. The model is calibrated for the 2002-2006 period. Empirical results suggest that the financial system is improving in terms of financial stability over time. Furthermore, the model has been proven useful to model the Brazilian banking system and could be employed to evaluate the impact of changes in financial regulation on the banking system.
    Date: 2010–12
  14. By: Jean-Marie Baland (University of Namur); Rohini Somanathan (Department of Economics, Delhi School of Economics & Institute for Advanced Study, Princeton); Zaki Wahhaj (University of Oxford)
    Abstract: Group loans with joint liability have been a distinguishing feature of many micronance programs. While such lending has benetted millions of borrowers, major lending insti- tutions have acknowledged their limited impact among the very poor and have recently favored individual contracts. This paper attempts to understand these empirical patterns using a model in which there is a single investment project and access to credit is limited by weak repayment incentives. We show that in the absence of large social sanctions, the poorest borrowers are oered individual and not group contracts. When both types of contracts are feasible, the relative gains from group loans are shown to be decreasing in loan size. We compare the role of bank enforcement with social sanctions and nd that bank enforcement is more eective in increasing outreach while social sanctions raise the welfare of infra-marginal borrowers. Finally, we explore the welfare eects of group size and nd that those requiring small loans are better served by larger groups but group size eects are, in general, ambiguous.
    Keywords: microcredit, joint-liability, group lending, repayment incentives, social sanctions.
    JEL: I38 G21 O12 O16
    Date: 2010–11
  15. By: Hubert Janoss Kiss (University Complutense of Madrid); Ismael Rodriguez Lara (ERI-CES); Alfonso Rosa Garcia (University of Murcia)
    Abstract: We study the effects of deposit insurance and observability of previous actions on the emergence of bank runs by means of a controlled laboratory experiment. We consider three depositors in the line of a common bank. Depositors decide in sequence between withdrawing or keeping their money deposited. We have three different treatments in which depositors who keep the money have full insurance, are partially insured, or not insured at all in case of a bank run. We find that different levels of deposit insurance and the possibility of observing other depositors' actions reduce the likelihood of bank runs. The effect of these variables is not independent. Our data suggest that optimal deposit insurance should take into account the degree of observability: full and partial insurance are equally effective when decisions are observable, whereas full insurance is more likely to prevent bank runs when depositors do not observe other depositors' decisions.
    Keywords: deposit insurance, observability, bank runs, experimental economics
    JEL: G21 C90
    Date: 2011–02
  16. By: John Thanassoulis
    Abstract: This paper studies banker remuneration in a competitive market for banker talent. I model, and then calibrate, the default risk of the banks generated by investments and remuneration pressures. Competing banks prefer to pay their banking staff in bonuses and not in wages as risk sharing on the remuneration bill is valuable. But competition for bankers generates a negative externality driving up rival banks’ default risk. Optimal financial regulation involves an appropriately structured limit on the proportion of the balance sheet used for bonuses. However stringent bonus caps are value destroying, default risk enhancing and cannot be optimal for regulators who control only a small number of banks. The paper allows an assessment of the intellectual arguments behind widespread calls to regulate the pay of bankers. The paper uses US data to calibrate the analysis and demonstrate the significant contribution of remuneration to default risk.
    Keywords: Bonuses, default risk, competition for bankers, financial regulation
    JEL: G21 G34
    Date: 2011
  17. By: Morris Goldstein (Peterson Institute for International Economics)
    Abstract: This paper links reform of the international financial regulatory system with reform of the international monetary system because as this recent global crisis demonstrates so vividly, the root causes can come from both the financial and monetary spheres and they can interact in variety of dangerous ways. On the financial regulatory side, I highlight three problems: developing a better tool kit for pricking asset-price bubbles before they get too large; shooting for national minima for regulatory bank capital that are at least twice as high those recently agreed as part of Basel III; and implementing a comprehensive approach to "too-big-to-fail" financial institutions that will rein-in their past excessive risktaking. On the international monetary side, I emphasize what needs to be done to discourage "beggar-thy-neighbor" exchange rate policies, including agreeing on a graduated set of penalties for countries that refuse persistently to honor their international obligations on exchange rate policy.
    Keywords: financial regulation, IMF surveillance, too-big-to-fail, asset-price bubbles
    JEL: F3 F33 G28 G38
    Date: 2011–02
  18. By: Bandyopadhyay, Arindam
    Abstract: This paper aims at working out a more risk sensitive measure of concentration risk and captures its impact in terms of capital number that will help the bank’s top management to manage it efficiently as well as meet the regulatory compliance. We have designed a more risk sensitive measures like expected loss based Hirschman-Herfindahl Index (HHI), loss correlation approach (single as well as multi factor), credit value at risk (C-VaR) based on bank’s internal loss data history that would measure credit concentration and suggest the amount of capital required to cover concentration risk. Using detailed borrower wide, facility wide, industry and regional loan portfolio data of a mid sized public sector bank in India, our paper attempts to provide a detail insight into measurement of concentration risk in credit portfolio and understand its impact in terms of economic capital for the bank as a whole. Regulators and other stakeholders worldwide are asking for more accurate and precise measure of concentration risk in terms of capital numbers. The detailed analysis and methods used in this paper is an attempt to find out a solution in this direction.
    Keywords: Portfolio Credit Concentration Risk; Bank Capital
    JEL: G32 G21
    Date: 2011–01–31
  19. By: Avadanei, Anamaria; Ghiba, Nicolae
    Abstract: For our country, the development and the modernization of the national system of payments were and are a prevalent subject of the financial arena, after the socialist period since 1990. The purpose of this study is to examine the actual status and the future application of Single Euro Payments Area (SEPA). Frameworks, based on the Romanian experience. The study is structured on chapters that present the theoretical background of the theme, the strategy for the adoption and migration to SEPA payment instruments, the actual stage and the challenges of the SEPA implementation in Romania. Our aim is to underline the importance of adopting Single Euro Payments in our country and to present its overall impact on the national financial services market. Although Romania may be facing obstacles in terms of joining the Euro zone, it is already well integrated in terms of payment infrastructures and has already put in place SEPA instruments.
    Keywords: Single Euro Payments Area; direct debit; Payments Services Directive; corporate bodies; Romanian banking system
    JEL: F30 E44
    Date: 2010–04–25

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