New Economics Papers
on Banking
Issue of 2011‒05‒07
sixteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Leverage ratio requirement, credit allocation and bank stability By Kiema , Ilkka; Jokivuolle, Esa
  2. What do Basel Capital Accords mean for SMEs? By Clara Cardone Riportella; Antonio Trujillo; Anahí Briozzo
  3. Macro-prudential Policy on Liquidity: What does a DSGE Model tell us? By Jagjit S. Chadha; Luisa Corrado
  4. Illiquid Banks, Financial Stability, and Interest Rate Policy By Douglas W. Diamond; Raghuram Rajan
  5. Systemic Risks and the Macroeconomy By Gianni De Nicolò; Marcella Lucchetta
  6. Cash Holdings and Credit Risk By Viral V. Acharya; Sergei A. Davydenko; Ilya A. Strebulaev
  7. Capital Regulation, Monetary Policy and Financial Stability By Pierre-Richard Agénor; K. Alper; Luiz A. Pereira da Silva
  8. Counterparty Risk Externality: Centralized Versus Over-the-counter Markets By Viral V. Acharya; Alberto Bisin
  9. The bank lending channel: lessons from the crisis By Leonardo Gambacorta; David Marques-Ibanez
  10. Contagion at the interbank market with stochastic LGD By Memmel, Christoph; Sachs, Angelika; Stein, Ingrid
  11. Credit conditions indices: Controlling for regime shifts in the Norwegian credit market By S. Jansen, Eilev; S.H. Krogh, Tord
  12. Efficiency Convergence Properties of Indonesian Banks 1992-2007 By Zhang, Tiantian; Matthews, Kent
  13. Have credit rating agencies become more stringent towards Japanese regional banks? By Kondo, Kazumine
  14. Credit contagion and risk management with multiple non-ordered defaults By Younes Kchia; Martin Larsson
  15. Risk Spillovers in Oil-Related CDS, Stock and Credit Markets By Shawkat Hammoudeh; Tengdong Liu; Chia-Lin Chang; Michael McAleer
  16. Inequality of opportunity in the credit market By Coco, Giuseppe; Pignataro, Giuseppe

  1. By: Kiema , Ilkka (University of Helsinki, Department of Political and Economic Studies); Jokivuolle, Esa (Aalto University School of Economics, Department of Finance and Bank of Finland, Monetary Policy and Research)
    Abstract: We study the effects on credit allocation and bank stability of introducing a leverage ratio requirement (LRR) on top of risk-based capital requirements, as in Basel III. For the current 3% LRR, both low-risk and high-risk loan rates and volumes remain essentially unchanged, because banks previously specializing in low-risk lending can adapt by granting both low-risk and high-risk loans. For sufficiently high LRRs, low-risk lending rates would significantly increase and high-risk lending rates would fall. In the presence of severe ‘model risk’ concerning low-risk loans, as happened in the subprime crisis, the current 3% LRR might even reduce bank stability, counter to regulatory intentions. This is because the allocational effect caused by the LRR, which makes bank loan portfolios more alike, may turn beneficial risk spreading into harmful risk contamination. For higher levels of LRR, however, bank stability is likely to be improved even in the presence of model risk.
    Keywords: bank regulation; Basel III; capital requirements; credit risk; leverage ratio
    JEL: D41 D82 G14 G21 G28
    Date: 2011–04–21
  2. By: Clara Cardone Riportella; Antonio Trujillo; Anahí Briozzo
    Abstract: This paper analyses the impact of the new Basel Capital Accords (Basel II and Basel III) on the bank’s capital requirements in a portfolio of Small and Medium-sized Enterprises (SMEs) when the internal ratings-based (IRB) approach is used. To do this, the study uses a large database of Spanish firms and covers the period from 2005 to 2009. We also examine the effect on the credit risk premium charged by banks of the guarantee offered by a Loan Guarantee Association (LGA) to a SME; and whether this foreseeable decrease in the interest rates applicable to the SME is compensated by the cost of this guarantee
    Keywords: Bank capital requirements, Credit risk mitigation, Bank financing of SMEs, Basel II, Basel III Loan Guarantee Association
    JEL: G21 G32
    Date: 2011–04
  3. By: Jagjit S. Chadha; Luisa Corrado
    Abstract: The financial crisis has led to the development of an active debate on the use of macro-prudential instruments for regulating the banking system, in particular for liquidity and capital holdings. Within the context of a micro-founded macroeconomic model, we allow commercial banks to choose their optimal mix of assets, apportioning these either to reserves or private sector loans. We examine the implications for quantities, relative non-financial and financial prices from standard macroeconomic shocks alongside shocks to the expected liquidity of banks and to the efficiency of the banking sector. We focus on the response by the monetary sector, in particular the optimal reserve-deposit ratio adopted by commercial banks over the business cycle. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold a greater stock of liquid assets, such as reserves, but also to provide incentives to increase the cyclical variation in reserves holdings as this acts to limit excessive procyclicality of lending to the private sector.
    Keywords: Liquidity, interest on reserves, policy instruments, Basel
    JEL: E31 E40 E51
    Date: 2011–04
  4. By: Douglas W. Diamond; Raghuram Rajan
    Abstract: Do low interest rates alleviate banking fragility? Banks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may choose to bail out banks being run. Unconstrained bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks can reduce financial fragility by raising rates in normal times to offset their propensity to reduce rates in adverse times.
    JEL: E4 E5 G2
    Date: 2011–04
  5. By: Gianni De Nicolò; Marcella Lucchetta
    Abstract: This paper presents a modeling framework that delivers joint forecasts of indicators of systemic real risk and systemic financial risk, as well as stress-tests of these indicators as impulse responses to structural shocks identified by standard macroeconomic and banking theory. This framework is implemented using large sets of quarterly time series of indicators of financial and real activity for the G-7 economies for the 1980Q1-2009Q3 period. We obtain two main results. First, there is evidence of out-of sample forecasting power for tail risk realizations of real activity for several countries, suggesting the usefulness of the model as a risk monitoring tool. Second, in all countries aggregate demand shocks are the main drivers of the real cycle, and bank credit demand shocks are the main drivers of the bank lending cycle. These results challenge the common wisdom that constraints in the aggregate supply of credit have been a key driver of the sharp downturn in real activity experienced by the G-7 economies in 2008Q4-2009Q1.
    JEL: E17 E44 G21
    Date: 2011–04
  6. By: Viral V. Acharya; Sergei A. Davydenko; Ilya A. Strebulaev
    Abstract: Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal cash reserves are positively related to credit risk, resulting in a positive correlation between cash and spreads. In contrast, spreads are negatively related to the "exogenous'' component of cash holdings that is independent of credit risk factors. Similarly, although firms with higher cash reserves are less likely to default over short horizons, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.
    JEL: G32 G33
    Date: 2011–04
  7. By: Pierre-Richard Agénor; K. Alper; Luiz A. Pereira da Silva
    Abstract: This paper examines the roles of bank capital regulation and monetary policy in mitigating procyclicality and promoting macroeconomic and financial stability. The analysis is based on a dynamic stochastic model with imperfect credit markets. Macroeconomic (financial) stability is defined in terms of the volatility of nominal income (real house prices). Numerical experiments show that even if monetary policy can react strongly to inflation deviations from target, combining a credit-augmented interest rate rule and a Basel III-type countercyclical capital regulatory rule may be optimal for promoting overall economic stability. The greater the degree of interest rate smoothing, and the stronger the policymaker’s concern with macroeconomic stability, the larger is the sensitivity of the regulatory rule to credit growth gaps.
    Date: 2011–04
  8. By: Viral V. Acharya; Alberto Bisin
    Abstract: We model the opacity of over-the-counter (OTC) markets in a setup where agents share risks, but have incentives to default and their financial positions are not mutually observable. We show that this setup results in excess "leverage" in that parties take on short OTC positions that lead to levels of default risk that are higher than Pareto-efficient ones. In particular, OTC markets feature a "counterparty risk externality" that we show can lead to ex-ante productive inefficiency. This externality is absent when trading is organized via a centralized clearing mechanism that provides transparency of trade positions, or a centralized counterparty (such as an exchange) that observes all trades and sets prices competitively. While collateral requirements and subordination of OTC positions in bankruptcy can ameliorate the counterparty risk externality, they are in general inadequate in addressing it fully.
    JEL: D52 D53 D62 G14 G2 G33
    Date: 2011–04
  9. By: Leonardo Gambacorta; David Marques-Ibanez
    Abstract: The 2007-2010 financial crisis highlighted the central role of financial intermediaries' stability in buttressing a smooth transmission of credit to borrowers. While results from the years prior to the crisis often cast doubts on the strength of the bank lending channel, recent evidence shows that bank-specific characteristics can have a large impact on the provision of credit. We show that new factors, such as changes in banks' business models and market funding patterns, had modified the monetary transmission mechanism in Europe and in the US prior to the crisis, and demonstrate the existence of structural changes during the period of financial crisis. Banks with weaker core capital positions, greater dependence on market funding and on non-interest sources of income restricted the loan supply more strongly during the crisis period. These findings support the Basel III focus on banks' core capital and on funding liquidity risks. They also call for a more forward-looking approach to the statistical data coverage of the banking sector by central banks. In particular, there should be a stronger focus on monitoring those financial factors that are likely to influence the functioning of the monetary transmission mechanism particularly in a period of crisis.
    Keywords: bank lending channel, monetary policy, financial innovation
    Date: 2011–05
  10. By: Memmel, Christoph; Sachs, Angelika; Stein, Ingrid
    Abstract: This paper investigates contagion at the German interbank market under the assumption of a stochastic loss given default (LGD). We combine a unique data set about the LGD of interbank loans with data about interbank exposures. We find that the frequency distribution of the LGD is u-shaped. Under the assumption of a stochastic LGD, simulation results show a more fragile banking system than under the assumption of a constant LGD. There are three types of banks concerning their tendency to trigger contagion: banks with strongly varying impact, banks whose impact is relatively constant, and banks with no direct impact. --
    Keywords: interbank market,contagion,stochastic LGD
    JEL: D53 E47 G21
    Date: 2011
  11. By: S. Jansen, Eilev (Statistics Norway); S.H. Krogh, Tord (Dept. of Economics, University of Oslo)
    Abstract: The interaction between financial markets and the macroeconomy can be strongly affected by changes in credit market regulations. In order to take account of these effects we control explicitly for regime shifts in a system of debt equations for Norway using a common, exible trend. The estimated shape of the trend matches the qualitative development in the regulations, and we argue that it can be viewed as a measure of relative credit availability, or credit conditions, for the period 1975-2008 - a credit conditions index (CCI). This entails years of strict credit market regulations in the 1970s, its gradual deregulation in the 1980s, followed by a full-blown banking crisis in the years around 1990 and the development thereafter up to the advent of the current nancial crisis. Our study is inspired by Fernandez-Corugedo and Muellbauer (2006), which introduced the methodology and provided estimates of a CCI for the UK. The trend conditions on a priori knowledge about changes in the Norwegian regulatory system, as documented in Krogh(2010b), and it shows robustness when estimated recursively.
    Keywords: credit conditions; exible trend; financial deregulation; household loans
    JEL: E44 G21 G28
    Date: 2011–04–28
  12. By: Zhang, Tiantian (Cardiff Business School); Matthews, Kent (Cardiff Business School)
    Abstract: This paper examines the convergence properties of cost efficiency for Indonesian banks for the period 1992-2007. It employs the Simar and Wilson's (2007) two stage semi-parametric double bootstrap DEA procedure to estimate cost efficiency. Using panel data estimation, the paper examines β-convergence and σ-convergence, to test the speed at which Indonesian banks are converging, towards the best practice and country average. We find evidence that in general the post-crisis structural reform process improved the average level of efficiency and improved the distribution of efficiency across banks significantly. The Asian financial crisis and the structural reform had the effect of slowing the adjustment speed of bank efficiency.
    Keywords: Banks; Efficiency; Indonesia; Convergence
    JEL: G21 G28
    Date: 2011–04
  13. By: Kondo, Kazumine
    Abstract: This article investigates empirically whether foreign and domestic credit rating agencies tightened their standards for evaluating Japanese regional banks from 2000 to 2009. We extend and enhance previous studies, including Gonis and Taylor (2009), by estimating an ordered probit model using pooled data for this period. Our results reveal that foreign agencies did not rate Japanese regional banks more stringently during this period, perhaps because they wished not to repel clients and reduce their revenues. Japan’s rating agencies showed the opposite tendency, perhaps to seek credibility among foreign investors.
    Keywords: credit ratings; rating stringencies; regional banks; foreign credit rating agencies; domestic credit rating agencies
    JEL: G21
    Date: 2011–04–21
  14. By: Younes Kchia; Martin Larsson
    Abstract: The classical reduced-form and filtration expansion framework in credit risk is extended to the case of multiple, non-ordered defaults, assuming that conditional densities of the default times exist. Intensities and pricing formulas are derived, revealing how information driven default contagion arises in these models. We then analyze the impact of ordering the default times before expanding the filtration. While not important for pricing, the effect is significant in the context of risk management, and becomes even more pronounced for highly correlated and asymmetrically distributed defaults. Finally, we provide a general scheme for constructing and simulating the default times, given that a model for the conditional densities has been chosen.
    Date: 2011–04
  15. By: Shawkat Hammoudeh; Tengdong Liu; Chia-Lin Chang; Michael McAleer (University of Canterbury)
    Abstract: This paper examines risk transmission and migration among six US measures of credit and market risk during the full period 2004-2011 period and the 2009-2011 recovery subperiod, with a focus on four sectors related to the highly volatile oil price. There are more long-run equilibrium risk relationships and short-run causal relationships among the four oil-related Credit Default Swaps (CDS) indexes, the (expected equity volatility) VIX index and the (swaption expected volatility) SMOVE index for the full period than for the recovery subperiod. The auto sector CDS spread is the most error-correcting in the long run and also leads in the risk discovery process in the short run. On the other hand, the CDS spread of the highly regulated, natural monopoly utility sector does not error correct. The four oil-related CDS spread indexes are responsive to VIX in the short- and long-run, while no index is sensitive to SMOVE which, in turn, unilaterally assembles risk migration from VIX. The 2007-2008 Great Recession seems to have led to “localization” and less migration of credit and market risk in the oil-related sectors.
    Keywords: Risk; Sectoral CDS; VIX; SMOVE; MOVE; Adjustments
    JEL: C13 C22 G1 G12 Q40
    Date: 2011–04–01
  16. By: Coco, Giuseppe (Department of Economics, University of Bari); Pignataro, Giuseppe (Department of Economics, University of Bologna)
    Abstract: Credit market imperfections can prevent the poor from making pro table investments. Under asymmetric information observable features, such as wealth and collateral, play an important role in determining who gets credit, in violation of the Equality of Opportunity principle. We de ne equality of opportunity as the equal possibility of getting credit for a given aversion to e¤ort. We rst establish that, due to larger cross subsidization in high collateral classes of borrowers, richer individuals are more likely to get credit for a given aversion to e¤ort. Our second result is that Inequality of Opportunity is associated with an ine¢ cient allocation of resources among classes of borrowers. The marginal borrower in classes that post more collateral exerts less e¤ort in equilibrium (and therefore produces lower aggregate surplus) than the marginal borrower in lower collateral classes. This suggests that public credit policies should be targeted at poorer classes of would be borrowers both for equity and e¢ ciency reasons, which rarely occurs in practice.
    Keywords: equality of opportunity; credit; moral hazard; cross subsidization; collateral.
    JEL: D63 D80 H80
    Date: 2010–01–19

This issue is ©2011 by Christian Calmès. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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