New Economics Papers
on Banking
Issue of 2011‒05‒14
24 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Financial Cycles: What? How? When? By M. Ayhan Kose; Stijn Claessens; Marco Terrones
  2. Liquidity, Contagion and Financial Crisis By Gümbel, Alexander; Sussman, Oren
  3. Credit Spreads and Business Cycle Fluctuations By Simon Gilchrist; Egon Zakrajšek
  4. Durable Financial Regulation: Monitoring Financial Instruments as a Counterpart to Regulating Financial Institutions By Leonard Nakamura
  5. Incentives through the cycle: microfounded macroprudential regulation By di Iasio, Giovanni; Quagliariello, Mario
  6. Fat Tails and their (Un)happy Endings: Correlation Bias and its Implications for Systemic Risk and Prudential Regulation By Jorge A. Chan-Lau
  7. This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis By Fahlenbrach, Rudiger; Prilmeier, Robert; Stulz, Rene M.
  8. The bank lending channel: lessons from the crisis By Leonardo Gambacorta; David Marques-Ibanez
  9. Macroeconomic Costs of Higher Bank Capital and Liquidity Requirements By Jan Vlcek; Scott Roger
  10. Macro-prudential Policy on Liquidity: What Does a DSGE Model Tell Us? By Jagjit S. Chadha; Luisa Corrado
  11. The Credit Crisis and The Moral Responsibility of Professionals in Finance By Graafland, J.J.; Ven, B.W. van de
  12. The Quantification of Systemic Risk and Stability: New Methods and Measures By Romney B. Duffey
  13. The unequal effect of new banking rules in Europe By Benedicta Marzinotto; Jörg Rocholl
  14. In the quest of macroprudential policy tools By Samano, Daniel
  15. Deregulation of Savings Bank Deposit Interest Rate: A Discussion Paper By Reserve Bank of India RBI
  16. The Impact of Recent Financial Recession on the Banking sector of Pakistan By Khilji, Bashir Ahmad; Farrukh, Muhammad Umer; Iqbal, Mammona; Hameed, Shahzad
  17. Estimation of the competitive conditions in the Czech banking sector By Stavarek, Daniel; Repkova, Iveta
  18. A network analysis of global banking:1978-2009 By Camelia Minoiu; Javier A. Reyes
  19. Spillover and Competition Effects: Evidence from the sub-Saharan African Banking Sector By Birte Pohl
  20. Next Generation Balance Sheet Stress Testing By Maher Hasan; Christian Schmieder; Claus Puhr
  21. Banking and Beyond: New Challenges before Indian Financial System By Chakrabarty K C
  22. Measurement, Monitoring, and Forecasting of Consumer Credit Default Risk - An Indicator Approach Based on Individual Payment Histories By Alexandra Schwarz
  23. Containing Systemic Risk: Paradigm-Based Perspectives on Regulatory Reform By Augusto de la Torre; Alain Ize
  24. Probabilities of Default and the Market Price of Risk in a Distressed Economy By Miguel A. Segoviano Basurto; Raphael A. Espinoza

  1. By: M. Ayhan Kose; Stijn Claessens; Marco Terrones
    Abstract: This paper provides a comprehensive analysis of financial cycles using a large database covering 21 advanced countries over the period 1960:1-2007:4. Specifically, we analyze cycles in credit, house prices, and equity prices. We report three main results. First, financial cycles tend to be long and severe, especially those in housing and equity markets. Second, they are highly synchronized within countries, particularly credit and house price cycles. The extent of synchronization of financial cycles across countries is high as well, mainly for credit and equity cycles, and has been increasing over time. Third financial cycles accentuate each other and become magnified, especially during coincident downturns in credit and housing markets. Moreover, globally synchronized downturns tend to be associated with more prolonged and costly episodes, especially for credit and equity cycles. We discuss how these findings can guide future research on various aspects of financial market developments.
    Keywords: Business cycles , Capital markets , Credit , Developed countries , Housing prices , Stock prices ,
    Date: 2011–04–05
  2. By: Gümbel, Alexander (Toulouse School of Economics); Sussman, Oren (University of Oxford)
    Abstract: We develop a theoretical model where a redistribution of bank capital (e.g., due to reckless trading and/or faulty risk management) leads to a “freeze” of the interbank market. The fire-sale market plays a central role in spreading the crisis to the real economy. In crisis, credit rationing and liquidity hoarding appear simultaneously; endogenous levels of collateral (or margin requirements) are affected by both low fire-sale prices and high lending rates. Relative to previous analysis, this dual channel generates a stronger price and output effect. The main focus is on the policy analysis. We show that i) non-discriminating equity injections are more effective than liquidity injections, but in both the welfare effect is an order-of-magnitude lower than the price effect; ii) a discriminating policy that bails out only distressed banks is feasible but will be limited by incentive-compatibility constraints; iii) a restriction on international capital flows has an ambiguous effect on welfare.
    Keywords: Debt deflation, Bailout, Liquidity Injection
    JEL: G21 G28 G33
    Date: 2010–06–25
  3. By: Simon Gilchrist; Egon Zakrajšek
    Abstract: This paper examines the evidence on the relationship between credit spreads and economic activity. Using an extensive data set of prices of outstanding corporate bonds trading in the secondary market, we construct a credit spread index that is—compared with the standard default-risk indicators—a considerably more powerful predictor of economic activity. Using an empirical framework, we decompose our index into a predictable component that captures the available firm-specific information on expected defaults and a residual component—the excess bond premium. Our results indicate that the predictive content of credit spreads is due primarily to movements in the excess bond premium. Innovations in the excess bond premium that are orthogonal to the current state of the economy are shown to lead to significant declines in economic activity and equity prices. We also show that during the 2007–09 financial crisis, a deterioration in the creditworthiness of broker-dealers—key financial intermediaries in the corporate cash market—led to an increase in the excess bond premium. These find- ings support the notion that a rise in the excess bond premium represents a reduction in the effective risk-bearing capacity of the financial sector and, as a result, a contraction in the supply of credit with significant adverse consequences for the macroeconomy.
    JEL: E22 E44 G12
    Date: 2011–05
  4. By: Leonard Nakamura
    Abstract: This paper sets forth a discussion framework for the information requirements of systemic financial regulation. It specifically describes a potentially large macro-micro database for the U.S. based on an extended version of the Flow of Funds. I argue that such a database would have been of material value to U.S. regulators in ameliorating the recent financial crisis and could be of aid in understanding the potential vulnerabilities of an innovative financial system in the future. I also suggest that making these data available to the academic research community, under strict confidentiality restrictions, would enhance the detection and measurement of systemic risk.
    JEL: G28
    Date: 2011–05
  5. By: di Iasio, Giovanni; Quagliariello, Mario
    Abstract: Following a decline in the fundamental risk of assets, the ability of banks to expand the balance sheet under a Value-at-Risk constraint in- creases (as in Adrian and Shin (2010)), boosting the bank’s incentives to provide costly monitoring effort that prevents asset deterioration. On the other hand, high asset demand and prices, eventually, raise the bank’s pay- off in the event of liquidation associated to asset deterioration, jeopardiz- ing incentives. This paper shows that a microprudential regulatory regime that disregards the equilibrium effect of macro variables (asset prices) on micro behavior (effort), performs poorly as low fundamental (exogenous) risk reduces bank’s effort and induces high (endogenous) deterioration risk. This analysis calls for a macroprudential regulatory regime in which the equilibrium feedback effect is fully taken into account by the author- ity in designing incentive compatible capital requirements, providing a theoretical foundation to the countercyclical buffer of Basel III.
    Keywords: Macroprudential regulation; financial stability; capital requirement.
    JEL: D86 G18 E44
    Date: 2011–01–17
  6. By: Jorge A. Chan-Lau
    Abstract: The correlation bias refers to the fact that claim subordination in the capital structure of the firm influences claim holders’ preferred degree of asset correlation in portfolios held by the firm. Using the copula capital structure model, it is shown that the correlation bias shifts shareholder preferences towards highly correlated assets, making financial institutions more prone to fail and increasing systemic risk given interconnectedness in the financial system. The implications for systemic risk and prudential regulation are assessed under the prism of Basel III, and potential solutions involving changes to the prudential framework and corporate governance are suggested.
    Keywords: Asset management , Bank supervision , Banks , Corporate governance , Economic models , Financial institutions , Financial risk , Risk management ,
    Date: 2011–04–15
  7. By: Fahlenbrach, Rudiger (Ecole Polytechnique Federale de Lausanne); Prilmeier, Robert (OH State University); Stulz, Rene M. (OH State University)
    Abstract: We investigate whether a bank's performance during the 1998 crisis, which was viewed at the time as the most dramatic crisis since the Great Depression, predicts its performance during the recent financial crisis. One hypothesis is that a bank that has an especially poor experience in a crisis learns and adapts, so that it performs better in the next crisis. Another hypothesis is that a bank's poor experience in a crisis is tied to aspects of its business model that are persistent, so that its past performance during one crisis forecasts poor performance during another crisis. We show that banks that performed worse during the 1998 crisis did so as well during the recent financial crisis. This effect is economically important. In particular, it is economically as important as the leverage of banks before the start of the crisis. The result cannot be attributed to banks having the same chief executive in both crises. Banks that relied more on short-term funding, had more leverage, and grew more are more likely to be banks that performed poorly in both crises.
    JEL: G21
    Date: 2011–05
  8. By: Leonardo Gambacorta (Bank for International Settlements (BIS).); David Marques-Ibanez (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    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 forwardlooking 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. JEL Classification: E51, E52, E44.
    Keywords: bank lending channel, monetary policy, financial innovation.
    Date: 2011–05
  9. By: Jan Vlcek; Scott Roger
    Abstract: This paper uses a DSGE model with banks and financial frictions in credit markets to assess the medium-term macroeconomic costs of increasing capital and liquidity requirements. The analysis indicates that the macroeconomic costs of such measures are sensitive to the length of the implementation period as well as to the adjustment strategy used by banks, and the scope for monetary policy to respond to the regulatory changes.
    Date: 2011–05–04
  10. By: Jagjit S. Chadha (Keynes College, University of Kent); Luisa Corrado (Faculty of Economics, University of Rome "Tor Vergata")
    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 asset creation, apportioning this to either 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. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold liquid assets, such as reserves, as this acts to limit the procyclicality of lending to the private sector.
    Keywords: Liquidity, interest on reserves, policy instruments, Basel.
    JEL: E31 E40 E51
    Date: 2011–05–02
  11. By: Graafland, J.J.; Ven, B.W. van de (Tilburg University, Center for Economic Research)
    Abstract: Starting from MacIntyre's virtue ethics, we investigate several codes of conduct of banks to identify the type of virtues that are needed to realize their mission. Based on this analysis, we define three core virtues: honesty, due care and accuracy. We compare and contrast these codes of conduct with the actual behavior of banks that led to the credit crisis and find that in some cases banks did not behave according to the moral standards they set themselves. However, notwithstanding these moral deficiencies, banks and the professionals working in them cannot be fully blamed for what they did, because the institutional context of the free market economy in which they operated left little room for them to live up to the core values lying at the basis of the codes of conduct. Given the neo-liberal free market system, innovative and risky strategies to enhance profits are considered desirable for the sake of shareholder's interests. A return to the core virtues in the financial sector will therefore only succeed if a renewed sense of responsibility in the sector is supported by institutional changes that allow banks to put their mission into practice.
    Keywords: Anglo Saxon capitalism;Banking sector;business principles of banks;credit crisis;external goods;internal goods;MacIntyre;Neo-liberalism.
    JEL: B31 B59 G21 G31 Z12
    Date: 2011
  12. By: Romney B. Duffey
    Abstract: We address the question of the prediction of large failures, busts, or system collapse, and the necessary concepts related to risk quantification, minimization and management. Answering this question requires a new approach since predictions using standard financial techniques and statistical distributions fail to predict or anticipate crises. The key points are that financial markets, systems, trading and manoeuvres are not just about money, debt, stocks, instruments and assets but reflect the actions and motivations of humans, which includes the presence or absence of learning effects. Therefore we have the possibility of failures or rare or low frequency events due to human involvement. The rare or unknown event is directly due to human influence, and reflects both learning and risk taking, with the presence of the finite and persistent human error contribution while taking or exposed to risk. This presence of humans in the marketplace explains the failure of present purely statistical methods to correctly estimate, predict or determine the onset of financial crises, busts and collapses. In this essay, we unify the concepts for predicting financial systemic risk with the general theory for outcomes, trends and measures already derived for other technical and social systems with human involvement. We replace words and qualitative reasoning with measures and quantitative predictions. The paper is therefore written with an introductory section devoted to the measures relevant to risk prediction in other modern technological systems; and is then extended and applied specifically to risk prediction for financial and business systems. The resulting measures also provide useful guidance for risk governance.
    JEL: C99 Z19
    Date: 2011–05
  13. By: Benedicta Marzinotto; Jörg Rocholl
    Abstract: In this paper, Benedicta Marzinotto and Jörg Rocholl focus on the tightening of credit conditions for banking rules (Basel III), particularly the estimated macroeconomic costs range, monetary policy and the aggregate costs of the measures. The authors report that the monetary policy response to these changes is not likely to be accommodating and that the aggregate costs of the measures will be differently distributed across countries depending on a variety of issues.
    Date: 2010–10
  14. By: Samano, Daniel
    Abstract: The global financial crisis of late 2008 could not have provided more convincing evidence that price stability is not a sufficient condition for financial stability. In order to attain both, central banks must develop macroprudential instruments in order to prevent the occurrence of systemic risk episodes. For this reason testing the effectiveness of different macroprudential tools and their interaction with monetary policy is crucial. In this paper we explore whether two policy instruments, namely, a capital adequacy ratio (CAR) rule in combination with a Taylor rule may provide a better macroeconomic outcome than a Taylor rule alone. We conduct our analysis by appending a macroeconometric financial block to an otherwise standard semistructural small open economy neokeynesian model for policy analysis estimated for the Mexican economy. Our results show that with the inclusion of the second policy instrument the central bank can obtain substantial gains. Moreover, we find that when the CAR rule is adequately designed the central authority can mitigate output gap shocks of twice the variance than the Taylor rule alone scenario. Thus, under this two rule case the central authority can isolate financial shocks and dampen their effects over macroeconomic variables.
    Keywords: macroprudential tools; macroprudential policy; capital adequacy ratio; Taylor rule
    JEL: E58 E52 E44
    Date: 2011–03
  15. By: Reserve Bank of India RBI
    Abstract: The paper is an attempt to deal with pros and cons of deregulating savings deposit interest rate and take on board the suggestions of various stakeholders for either maintaining the status quo or deregulating the savings deposit interest rate. URL:[ tent/PDFs/DPS270411F.pdf].
    Keywords: savings bank, deregulating, India, financial sector reform, monetary policy, deposit, lending rates, Benchmark Prime Lending Rate (BPLR), households, rural areas, semi-urban, pricing, savings deposit, interest rate,
    Date: 2011
  16. By: Khilji, Bashir Ahmad; Farrukh, Muhammad Umer; Iqbal, Mammona; Hameed, Shahzad
    Abstract: The basic intent of this study is to examine the impact of recent financial crisis on the Pakistan commercial banking sector. This research paper will help to create the awareness about the risk factor which involves in Pakistan investment sector. The current worldwide financial crisis starts from large financial markets like US, UK and Candia. And this crisis becomes a cause of the fall down of well-known names in banking sector. Objective of this study, to establish the practical facts, that either the recant global financial crisis have or have not significant impact on Pakistan banks. The findings of this study will help to develop the assured recommendations which may help to formulate the policies regarding stabilization and crisis management in Pakistan banking sector.
    Keywords: Financial Crisis; Risk Investment; Commercial Banks; Pakistan
    JEL: R58 D81 P51 G21
    Date: 2010–11–10
  17. By: Stavarek, Daniel; Repkova, Iveta
    Abstract: The paper uses New Empirical Industrial Organization approach, especially Panzar Rosse model to estimates the level of competition of the banking industry in the Czech Republic during the period 2001–2009. We apply Panzar-Rosse model to estimate H statistic for a panel of 15 banks, which represent almost 90 % of the market. This paper also measures and compares the degree of banking competition in two sub-periods, 2001–2005 and 2005–2009, in order to investigate development of the competitive structure of the Czech banking industry. We found that the market was in equilibrium during most of the estimation period, which is a necessary condition for sound evaluation of the competition level. While the market can be described as perfectly competitive in 2001–2005, the intensity of competition decreased after joining the EU in 2004 and the market can be characterized as one of monopolistic competition in 2005–2009. The monopolistic competition in the Czech banking market was also revealed if the full sample 2001–2009 is considered.
    Keywords: Panzar-Rosse model; competition; banking sector; Czech Republic
    JEL: D40 C33 G21
    Date: 2011–03
  18. By: Camelia Minoiu; Javier A. Reyes
    Abstract: In this paper we explore the properties of the global banking network using cross-border bank lending data for 184 countries over 1978-2009. Specifically, we analyze financial interconnectedness using network metrics of centrality, connectivity, and clustering. We document a relatively unstable global banking network, with structural breaks in network indicators identifying several waves of capital flows. Interconnectedness rankings, especially for borrowers, are relatively volatile over the period. Connectivity tends to fall during and after systemic banking crises and sovereign debt crises. The 2008-09 global financial crisis stands out as an unusually large perturbation to the cross-border banking network.
    Keywords: Banking crisis , Capital flows , Cross country analysis , Emerging markets , Financial crisis , International banking , Loans ,
    Date: 2011–04–04
  19. By: Birte Pohl
    Abstract: This paper examines the efficiency effects of foreign bank entry on domestic banks in sub- Saharan Africa during the period 1999–2006. Using a recently compiled dataset on foreign bank presence, the competition and spillover effects of North–South, regional and nonregional South–South banks are distinguished. The results show that the competitive pressure on domestic banks' net interest margins emanates only from regional South–South banks. There is evidence of spillover effects from North-South and regional South-South banks on domestic banks. As domestic banks invest in foreign technologies, their overhead costs increase in the short-run. Non-regional South-South banks seem to have little effect on the efficiency of domestic banks.
    Keywords: sub-Saharan Africa, efficiency, South–South banks, spillover
    Date: 2011–04
  20. By: Maher Hasan; Christian Schmieder; Claus Puhr
    Abstract: This paper presents a "second-generation" solvency stress testing framework extending applied stress testing work centered on Cihák (2007). The framework seeks enriching stress tests in terms of risk-sensitivity, while keeping them flexible, transparent, and user-friendly. The main contributions include (a) increasing the risk-sensitivity of stress testing by capturing changes in risk-weighted assets (RWAs) under stress, including for non-internal ratings based (IRB) banks (through a quasi-IRB approach); (b) providing stress testers with a comprehensive platform to use satellite models, and to define various assumptions and scenarios; (c) allowing stress testers to run multi-year scenarios (up to five years) for hundreds of banks, depending on the availability of data. The framework uses balance sheet data and is Excel-based with detailed guidance and documentation.
    Keywords: Bank supervision , Banks , Basel Core Principles , Credit risk , Financial risk , Risk management ,
    Date: 2011–04–18
  21. By: Chakrabarty K C
    Abstract: A very basic and core issue for the Indian banking system and that is the challenge of achieving Financial Inclusion. Without being inclusive, financial and economic stability cannot be sustainable. First issue staring in the face of banking industry is capital. Even though reasonably well capitalized today, banks will be facing the challenge of growing their business due to capital constraints. [Address at Mint’s Clarity Through Debate, Mumbai]. URL: [ s/PDFs/MCM150311F.pdf]
    Keywords: Indian, banking system, financial inclusion, inclusive, economic stability, capital, constraints, banks, management, mergers, banking system, sustaninable,
    Date: 2011
  22. By: Alexandra Schwarz (German Institute for International Educational Research, Frankfurt am Main, Germany)
    Abstract: The statistical techniques which cover the process of modeling and evaluating consumer credit risk have become widely accepted instruments in risk management. In contrast, we find only few and vague statements on how to define the default event, i. e. on the concrete circumstances that lead to the decision of identifying a certain credit as defaulted. Based on a unique data set of individual payment histories this paper proposes a definition of default which is based on the time due amounts are outstanding and the resulting profitability of the receivables portfolio. Furthermore, to assess the individual payment performance during the credit period, indicators for monitoring and forecasting default events are derived. The empirical results show that these indicators generate valuable information which can be used by the creditor to improve his credit and collection policy and hence, to improve cash flows and reduce bad debt loss.
    Keywords: Credit Risk Analysis, Credit Default, Risk Management, Accounts Receivable Management, Performance Measurement
    JEL: C44 G32 M21
    Date: 2011–04
  23. By: Augusto de la Torre; Alain Ize
    Abstract: Financial crises happen when: (i) nobody really understands what is going on (the collective cognition paradigm); (ii) some understand better and take advantage (the asymmetric information paradigm); (iii) everybody understands but crises are a natural part of the financial landscape (the market segmentation paradigm); or (iv) everybody understands yet fail to act because private and social interests do not coincide (the collective action paradigm). The four paradigms have different and often conflicting prudential policy implications. We propose and discuss three sets of reforms that would give due weight to the insights from the collective action and collective cognition paradigms by: (i) redrawing the regulatory perimeter to internalize systemic risk without promoting dynamic regulatory arbitrage; (ii) introducing a truly systemic liquidity regulation that moves away from a purely idiosyncratic focus on maturity mismatches; and (iii) building up the supervisory function while avoiding the pitfalls of expanded official oversight.
    Date: 2011–02–28
  24. By: Miguel A. Segoviano Basurto; Raphael A. Espinoza
    Abstract: We propose an original method to estimate the market price of risk under stress, which is needed to correct for risk aversion the CDS-implied probabilities of distress. The method is based, for simplicity, on a one-factor asset pricing model. The market price of risk under stress (the expectation of the market price of risk, conditional on it exceeding a certain threshold) is computed from the price of risk (which is the variance of the market price of risk) and the discount factor (which is the inverse of the expected market price of risk). The threshold is endogenously determined so that the probability of the price of risk exceeding it is also the probability of distress of the asset. The price of risk can be estimated via different methods, for instance derived from the VIX or from the factors in a Fama-MacBeth regression.
    Keywords: Asset prices , Bankruptcy , Banks , Credit risk , Economic models , Financial crisis , Risk premium ,
    Date: 2011–04–04

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