New Economics Papers
on Banking
Issue of 2011‒03‒19
nineteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. "Efficiency in Large Dynamic Panel Models with Common Factor" By Patrick GAGLIARDINI ; Christian GOURIEROUX
  2. "Approximate Derivative Pricing for Large Classes of Homogeneous Assets with Systematic Risk" By Patrick GAGLIARDINI ; Christian GOURIEROUX
  3. Monetary Shocks and the Cyclical Behavior of Loan Spreads By Pierre-Richard Agénor; George Bratsiotis; D. Pfajfar
  4. Caught Between Scylla and Charybdis? Regulating Bank Leverage When There is Rent Seeking and Risk Shifting By Thakor, Anjan; Mehran, Hamid; Acharya, Viral V.
  5. Bank Size, Market Concentration, and Bank Earnings Volatility in the US By Jacob de Haan; Tigran Poghosyan
  6. Credit Risk and Real Capital: An Examination of Swiss Banking Sector Default Risk Using CVaR By Robert Powell; David E Allen
  7. The Fluctuating Default Risk of Australian Banks By David E Allen; Robert Powell
  8. Basel III: Long-term impact on economic performance and fluctuations By Paolo Angelini; Laurent Clerc; Vasco Cúrdia; Leonardo Gambacorta; Andrea Gerali; Alberto Locarno; Roberto Motto; Werner Roeger; Skander Van den Heuvel; Jan Vlcek
  9. The Interactions between the Credit Default Swap and the Bond Markets in Financial Turmoil By Virginie Coudert; Mathieu Gex
  10. Credit availability and investment in Italy: lessons from the "Great Recession" By Eugenio Gaiotti
  11. Testing for East-West contagion in the European banking sector during the financial crisis By Emidio Cocozza; Paolo Piselli
  12. Bridging the gap between migrants and the banking system By Giorgio Albareto; Paolo Mistrulli
  13. Path modeling to bankruptcy: causes and symptoms of the banking crisis By Carlos Serrano-Cinca; Y. Fuertes-Callén; Begoña Gutiérrez-Nieto; B. Cuéllar-Fernández
  14. Too-connected-to-fail Institutions and Payments System’s Stability: Assessing Challenges for Financial Authorities By Carlos León; Clara Machado; Freddy cepeda; Miguel Sarmiento
  15. Systematic risk under extremely adverse market condition By Maarten van Oordt; Chen Zhou
  16. The Effects of Public Listing on the Performance of Banks in China By Bin Liu
  17. Collapse. The story of the international financial crisis, its causes and policy consequences By Stan du Plessis
  18. Co-operative Credit Delinquency: Identification of Factors Discriminating Defaulters By Justin, Nelson Michael
  19. Do microfinance rating assessments make sense? An analysis of the drivers of the MFI ratings By Leif Atle Beisland; Roy Mersland

  1. By: Patrick GAGLIARDINI ; Christian GOURIEROUX (Crest)
    Abstract: This paper deals with asymptotically efficient estimation in exchangeable nonlinear dynamic panel models with common unobservable factor. These models are especially relevant for applications to large portfolios of credits, corporate bonds, or life insurance contracts, and are recommended in the current regulation in Finance (Basel II and Basel III) and Insurance (Solvency II). The specification accounts for both micro- and macro-dynamics, induced by the lagged individual observation and the common stochastic factor, respectively. For large cross-sectional and time dimensions n and T, respectively, we derive the efficiency bound and introduce computationally simple efficient estimators for both the micro- and macroparameters. In particular, we show that the fixed effects estimator of the micro-parameter is asymptotically efficient. The results are based on an asymptotic expansion of the loglikelihood function in powers of 1=n. This expansion is used to investigate the second-order bias properties of the estimators. The results are illustrated with the stochastic migration model for credit risk analysis.
    Keywords: optimal matching
    Date: 2010–05
  2. By: Patrick GAGLIARDINI ; Christian GOURIEROUX (Crest)
    Abstract: We consider a homogeneous class of assets, whose returns are driven by an unobservable factor representing systematic risk. We derive approximated pricing formulas for the future factor values and their proxies, when the size n of the class is large. Up to order 1=n, these closed form approximations involve well-chosen summary statistics of the basic asset returns, but not the current and lagged factor values. The potential of the closed form approximation formulas seems quite large, especially for credit risk analysis, which considers large portfolios of individual loans or corporate bonds, and for longevity risk analysis, which involves large portfolios of life insurance contracts.
    Keywords: optimal matching
    Date: 2010–07
  3. By: Pierre-Richard Agénor; George Bratsiotis; D. Pfajfar
    Abstract: This paper examines the impact of monetary shocks on the loan spread in a DSGE model that combines the cost channel effect of monetary transmission with the role of collateral under asymmetric information. Its key feature is the endogenous derivation of the default probability that results in a lending rate being set as a countercyclical risk premium over the cost of borrowing from the central bank. The endogenous probability of default is shown to provide an accelerator effect through which monetary shocks can amplify the loan spread The behavior of the spread appears to be consistent with existing empirical evidence.
    Date: 2011
  4. By: Thakor, Anjan; Mehran, Hamid; Acharya, Viral V.
    Abstract: Banks face two moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient “pet” projects or simply being lazy and uninnovative). The privately-optimal level of bank leverage is neither too low nor too high: It balances efficiently the market discipline imposed by owners of risky debt on managerial rent-seeking against the asset-substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank creditors. Anticipation of this generates an equilibrium featuring systemic risk in which all banks choose inefficiently high leverage to fund correlated assets. A minimum equity capital requirement can rule out asset substitution but also compromises market discipline by making bank debt too safe. The optimal capital regulation requires that a part of bank capital be unavailable to creditors upon failure, and be available to shareholders only contingent on good performance.
    Date: 2010–12
  5. By: Jacob de Haan; Tigran Poghosyan
    Abstract: We examine whether bank earnings volatility depends on bank size and the degree of concentration in the banking sector. Using quarterly data for non-investment banks in the United States for the period 2004Q1-2009Q4 and controlling for the quality of management, leverage, and diversification , we find that bank size reduces return volatility. The negative impact of bank size on bank earnings volatility decreases (in absolute terms) with market concentration. We also find that larger banks located in concentrated markets have experienced higher volatility during the recent financial crisis.
    Keywords: Bank Earnings Volatility; Bank Size; Market Concentration; Financial Crises
    JEL: G21 G32 L25
    Date: 2011–03
  6. By: Robert Powell (School of Accounting Finance & Economics, Edith Cowan University); David E Allen (School of Accounting Finance & Economics, Edith Cowan University)
    Abstract: The global financial crisis (GFC) has placed the creditworthiness of banks under intense scrutiny. In particular, capital adequacy has been called into question. Current capital requirements make no allowance for capital erosion caused by movements in the market value of assets. This paper examines default probabilities of Swiss banks under extreme conditions using structural modeling techniques. Conditional Value at Risk (CVaR) and conditional probability of default (CPD) techniques are used to measure capital erosion. Significant increase in probability of default (PD) is found during the GFC period. The market asset value based approach indicates a much higher PD than external ratings indicate. Capital adequacy recommendations are formulated which distinguish between real and nominal capital based on asset fluctuations.
    Keywords: Real capital; Financial crisis; Conditional value at risk; Credit risk; Banks; Probability of default; Capital adequacy
    Date: 2010–10
  7. By: David E Allen (School of Accounting Finance & Economics, Edith Cowan University); Robert Powell (School of Accounting Finance & Economics, Edith Cowan University)
    Abstract: Australian banks are widely considered to have fared far better during the Global Financial Crisis (GFC) than their global counterparts, continuing to display solid earnings, good capitalisation and strong credit ratings. Nonetheless, Australian banks experienced significant deterioration in the market values of assets. We use the KMV/Merton structural methodology, which incorporates market asset values, to examine default probabilities of Australian banks. We also modify the model to incorporate conditional probability of default which measures extreme credit risk. We find that, during the GFC, based on extreme asset value fluctuations, Australian bank default probabilities fare only slightly better than their global counterparts.
    Keywords: Financial crisis; Credit risk; Banks; Default; Capital adequacy
    Date: 2010–09
  8. By: Paolo Angelini (Bank of Italy); Laurent Clerc (Banque de France); Vasco Cúrdia (Federal Reserve Bank of New York); Leonardo Gambacorta (Bank for International Settlements); Andrea Gerali (Bank of Italy); Alberto Locarno (Bank of Italy); Roberto Motto (European Central Bank); Werner Roeger (European Commission); Skander Van den Heuvel (Board of Governors of the Federal Reserve System); Jan Vlcek (International Monetary Fund)
    Abstract: We assess the long-term economic impact of the new regulatory standards (the Basel III reform), answering the following questions. (1) What is the impact of the reform on long-term economic performance? (2) What is the impact of the reform on economic fluctuations? (3) What is the impact of the adoption of countercyclical capital buffers on economic fluctuations? The main results are the following. (1) Each percentage point increase in the capital ratio causes a median 0.09 percent decline in the level of steady state output, relative to the baseline. The impact of the new liquidity regulation is of a similar order of magnitude, at 0.08 percent. This paper does not estimate the benefits of the new regulation in terms of reduced frequency and severity of financial crisis, analysed in Basel Committee on Banking Supervision (BCBS, 2010b). (2) The reform should dampen output volatility; the magnitude of the effect is heterogeneous across models; the median effect is modest. (3) The adoption of countercyclical capital buffers could have a more sizeable dampening effect on output volatility. These conclusions are fully consistent with those of reports by the Long-term Economic Impact group (BCBS, 2010b) and Macro Assessment Group (MAG, 2010b).
    Keywords: Basel III, countercyclical capital buffers, financial (in)stability, procyclicality, macroprudential
    JEL: E44 E61 G21
    Date: 2011–02
  9. By: Virginie Coudert; Mathieu Gex
    Abstract: We analyse the links between credit default swap (CDS) and bond spreads and try to determine which one is the leading market in the price discovery process. To do that, we construct a sample of CDS premia and bonds spreads on a generic 5-year bond, for 17 financials and 18 sovereigns. First, we run VECM estimations, showing that the CDS market has a lead over the bond market over the whole sample. A decomposition of the sample shows that this result holds for financials as well as for the high-yield emerging sovereigns. However, the bond market still drives the CDS market for the sovereigns in the core of the euro area. Second, we check for non-linearities in the adjustment process during the current crisis. Results show that the CDS market's lead has been amplified by the crisis for financial institutions.
    Keywords: Financial crisis; credit default swaps; bonds; price discovery process
    JEL: G15
    Date: 2011–02
  10. By: Eugenio Gaiotti (Bank of Italy)
    Abstract: The paper argues that the traditional difficulty encountered in finding evidence on the effects of credit availability on economic activity depends on the fact that these effects are powerful but rare and vary with the cycle. The global financial crisis offers an opportunity to test this assumption. The paper exploits a unique dataset, including direct information on credit rationing for 1,200 Italian firms over the last twenty years. We find that the elasticity of a firm’s investment to the availability of bank credit has been significant in periods of economic contraction, but not in other periods; that the ability to tap alternative sources of finance is crucial to this result; that during the global crisis the impact of credit constraints on Italian investment in manufacturing was significant.
    Keywords: credit availability; credit channel; Great Recession
    JEL: E22 E44 E51
    Date: 2011–02
  11. By: Emidio Cocozza (Bank of Italy); Paolo Piselli (Bank of Italy)
    Abstract: Large and growing international financial linkages between East and West have altered the nature of the stability risks faced by European banking systems, increasing susceptibility to contagion. This paper aims to identify potential risks of cross-border contagion using a sample of large Western and Eastern European banks. We assume that contagion risk is associated with extreme co-movements in a market-based measure of bank soundness, controlling for common underlying factors. We also find evidence that contagion risk across European banks heightened significantly during the recent crisis. Contagion among Western European banks with the highest market share in Eastern Europe and from this group to Eastern European banks shows the largest increase in our sample. We find also evidence of contagion spreading from Eastern European banks, but this effect seems to reflect a broader phenomenon of contagion from emerging markets to banks in advanced countries exposed to these markets. Finally, our findings offer only mixed evidence of the existence of a direct ownership channel in the transmission of contagion.
    Keywords: Banking contagion, Distance to default, Testing hypothesis, Logit model
    JEL: C12 G15 G21
    Date: 2011–02
  12. By: Giorgio Albareto (Bank of Italy); Paolo Mistrulli (Bank of Italy)
    Abstract: In this paper, we test whether micro firms run by migrants pay more for credit than firms run by natives and whether the differences in the cost of credit for these two groups of entrepreneurs decrease as the informational and cultural gaps narrow. We employ a large and unique data set providing us with detailed information on each overdraft loan granted by banks to sole proprietorships based in Italy. We find that migrants pay, on average, almost 70 basis points more for credit than natives. The interest rate differential is lower for entrepreneurs born in Italy whose parents were natives of other countries (“second generation” migrants) and for migrants whose parents were natives of Italy (“Italian migrants”). These results suggest that cultural differences may matter for the functioning of the credit market. A lengthening of credit history reduces the interest rate differential between the two types of entrepreneurs. Finally, we find that both increases in the size of the migrant community and improvements in banks’ ability to deal with cultural diversity help narrow the interest rate differential between migrant and Italian entrepreneurs.
    Keywords: migration, bank lending, interest rates
    JEL: G21 J15 J71
    Date: 2011–02
  13. By: Carlos Serrano-Cinca; Y. Fuertes-Callén; Begoña Gutiérrez-Nieto; B. Cuéllar-Fernández
    Abstract: This paper studies the bankruptcy of USA banks since 2009. It first analyzes the financial symptoms that precede bankruptcy, such as low profitability, insufficient revenue, or low solvency ratios. It also goes into the causes of these symptoms. It poses several hypotheses on causes of failure, such as loans growth (some of them risky), specialization (in this case concentration in real estate), and the pursuit of a turnover-driven strategy neglecting margin. It presents and tests a path modeling to bankruptcy based on structural equations, hypotheses tests and logistic regression. Results show that, five years before the crisis, failed banks had, compared to solvent banks, the following: higher loan growths, higher concentration on real estate loans, higher risk ratios, higher turnover, but lower margins. A relationship is found between symptoms and causes. Failed banks present a significant relationship between the percentage of real estate loans and risk. This relationship is negative in excellent banks, confirming that they allocated less real estate loans with higher quality. Non-failed banks compensated increases in risk by strengthening their core capital.
    Keywords: Bankruptcy; Financial ratios; banking crisis; solvency; PLS-Path
    Date: 2011–03
  14. By: Carlos León; Clara Machado; Freddy cepeda; Miguel Sarmiento
    Abstract: The most recent episode of market turmoil exposed the limitations resulting from the traditional focus on too-big-to-fail institutions within an increasingly systemic-crisis-prone financial system, and encouraged the appearance of the too-connected-to-fail (TCTF) concept. The TCTF concept conveniently broadens the base of potential destabilizing institutions beyond the traditional banking-focused approach to systemic risk, but requires methodologies capable of coping with complex, cross-dependent, context-dependent and non-linear systems. After comprehensively introducing the rise of the TCTF concept, this paper presents a robust, parsimonious and powerful approach to identifying and assessing systemic risk within payments systems, and proposes some analytical routes for assessing financial authorities’ challenges. Banco de la Republica’s approach is based on a convenient mixture of network topology basics for identifying central institutions, and payments systems simulation techniques for quantifying the potential consequences of central institutions failing within Colombian large-value payments systems. Unlike econometrics or network topology alone, results consist of a rich set of quantitative outcomes that capture the complexity, cross-dependency, context-dependency and non-linearity of payments systems, but conveniently disaggregated and dollar-denominated. These outcomes and the proposed analysis provide practical information for enhanced policy and decision-making, where the ability to measure each institution’s contribution to systemic risk may assist financial authorities in their task to achieve payments system’s stability.
    Date: 2011–03–03
  15. By: Maarten van Oordt; Chen Zhou
    Abstract: Extreme losses are the major concern in risk management. The dependence between financial assets and the market portfolio changes under extremely adverse market conditions. We develop a measure of systematic tail risk, the tail regression beta , defined by an asset’s sensitivity to large negative market shocks, and establish the estimation methodology. We compare it to regular systematic risk measures: the market beta and the downside beta. Furthermore, the tail regression beta is a useful instrument in both portfolio risk management and systemic risk management. We demonstrate its applications in analyzing Value-at-Risk (VaR) and Conditional Value-at-Risk (CoVaR).
    Keywords: Tail regression beta; downside risk; Extreme Value Theory; tail dependence; risk management
    JEL: C14 G11
    Date: 2011–03
  16. By: Bin Liu (CCB International (Holdings) Limited and Hong Kong Institute for Monetary Research)
    Abstract: Chinese banks have been pushing further commercialization, corporate restructuring and public listing in recent years. The ten largest commercial banks in China have all been listed, among which nine went public in the past decade. This paper conducts an empirical investigation on how public listing affects the performance of Chinese banks. Particularly, we examine the pre-listing restructuring effect and the different effects of public listing locations such as Shanghai and Hong Kong, which have not received much attention in the literature. Our sample covers all the 16 listed banks in China and 17 other unlisted banks over the period of 1997-2008. Using a pooled cross-section regression, we compare three modified models built upon Berger et al. (2005) to consider the following three effects: 1) the static governance effect; 2) the selection effect and 3) the dynamic effect. We found that the public listing effect should be modeled as a dynamic process rather than a sudden structural change at a cut-off point, thus it is important to compare the banks' performance during the pre-listing restructuring period with the after-listing period. Moreover, the public listing in Hong Kong is found to have more positive and persistent effects on banks' performance in terms of both profitability and financial safety than the public listing in Mainland China. We also provide some tentative explanations for such different effects on banks' performance, and discuss the implications to both policy makers and market participants.
    Keywords: Public Listing, Cross Listing, Bank Performance, Chinese Banks
    Date: 2011–02
  17. By: Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: This paper is the story of success and failure in the financial markets, the markets for goods and services and in politics. It is a difficult story to tell because the crisis had many causes, but the focus here is on three main factors. First, the incentives that contributed to a credit-fuelled bubble, especially in property markets. Monetary and regulatory policies feature prominently in this part of the story. Second, because the housing bubble alone cannot explain the magnitude of the subsequent events, gearing in the financial sector, which affected asset markets unrelated to sub-prime mortgages will be examined. These developments are explained by reference to private financial sector decisions, including the role of the shadow-banking sector, and their regulatory backdrop. Finally, an answer will be sought to the question of how highly geared banks first became fragile and then failed with such dire consequences for the economy that massive policy intervention had become essential. The consequences of these large policy interventions and the international tensions caused by them are also explored.
    Keywords: Financial crisis, Banks, Financial regulation, Monetary policy, Fiscal policy, Currency wars
    JEL: G20 G28 E58
    Date: 2011
  18. By: Justin, Nelson Michael
    Abstract: Co-operative movement dawned in India a century ago to eradicate indebtedness and to accelerate agricultural production in India. Co-operatives are eminently suited to achieve social, economic changes in rural India. However, credit risk is acute in co-operative credit system, predominantly manifested in short-term credit. Delinquency of co-operative credit is the object of enquiry for many committees and researches. Mounting overdues at the level of Primary Agricultural Co-operative Banks (PACB) contribute to the accumulation of Non-performing Assets (NPA) in the Central Co-operative Banks (CCB). Willful default has been identified as the main reason for mounting overdues. This empirical study of defaulters of co-operative credit has examined the factors discriminating default of co-operative credit, which subsequently increase NPA. Univariate Analysis and Discriminant Function analysis was carried out to identify the factors. Such identification of factors discriminating credit default is crucial to reduce credit delinquency in co-operative credit system.
    Keywords: credit risk; credit delinquency; co-operative credit; willful default
    JEL: E51 G32 G21
    Date: 2010–11–03
  19. By: Leif Atle Beisland; Roy Mersland
    Abstract: Rating assessments of microfinance institutions are claimed to measure a combination of creditworthiness, trustworthiness and excellence in microfinance. Using a global dataset covering reports from 324 microfinance institutions, this study suggests that these ratings are mainly driven by size, profitability, and risk. The ratings do not seem to capture the double bottom-line objective of microfinance institutions, as our analyses are unable to prove any statistical relationship between microfinance ratings and the social objectives of these institutions. Moreover, the association between operational efficiency and microfinance ratings appears weak. Although there are some minor differences between the rating agencies, the overall results suggest that microfinance ratings convey information very similar to that communicated by traditional credit ratings.
    Date: 2011–03

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