New Economics Papers
on Banking
Issue of 2011‒07‒27
nineteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Bank Overleverage and Macroeconomic Fragility By Ryo Kato; Takayuki Tsuruga
  2. Trade credit contracts By Klapper, Leora; Laeven, Luc; Rajan, Raghuram
  3. International Recessions By Perri, Fabrizio; Quadrini, Vincenzo
  4. Quo vadis, Euroland? European Monetary Union between Crisis and Reform By Martin Hellwig
  5. Risk Management of Risk Under the Basel Accord: A Bayesian Approach to Forecasting Value-at-Risk of VIX Futures By Michael McAleer; Roberto Casarin; Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Teodosio Pérez-Amaral
  6. GFC-Robust Risk Management Under the Basel Accord Using Extreme Value Methodologies By Paulo Araújo Santos; Juan-Ángel Jiménez-Martín; Michael McAleer; Teodosio Pérez Amaral
  7. Investible benchmarks & hedge fund liquidity By Freed, Marc S; McMillan, Ben
  8. Varying the VaR for Unconditional and Conditional Environments By John Cotter
  9. Detrimental Effects of Retention Regulation: Incentives for Loan Screening in Securitization under Asymmetric Information By Masazumi Hattori; Kazuhiko Ohashi
  10. Capital allocation in financial institutions: the Euler method By Dora Balog
  11. Negative Impacts of Capital Injection Policies on the Capital Crunch: Evidence from Japan By Takeshi Osada
  12. Marking-to-Market Government Guarantees to Financial Systems.Theory and Evidence for Europe By Angelo Baglioni; Umberto Cherubini
  13. Implied Correlation from VaR By John Cotter; Francois Longin
  14. Tranching, CDS and Asset Prices: How Financial Innovation Can Cause Bubbles and Crashes By Ana Fostel; John Geanakoplos
  15. Accounting for the Decline in the Velocity of Money in the Japanese Economy By Nao Sudo
  16. Development banks : role and mechanisms to increase their efficiency By Gutierrez, Eva; Rudolph, Heinz P.; Homa, Theodore; Beneit, Enrique Blanco
  17. The Business of Development: Trends in Lending by Multilateral Development Banks to Latin America, 1980?2009 By Michaelowa, Katharina; Humphrey, Chris
  18. Spillover and Competition Effects: Evidence from the Sub-Saharan African Banking Sector By Pohl, Birte
  19. Collateral and its Determinants: Evidence from Vietnam By Heinz, Christa; Dinh, Thanh; Kleimeier, Stefanie

  1. By: Ryo Kato (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Takayuki Tsuruga (Associate Professor, Graduate School of Economics, Kyoto University, (E-mail:
    Abstract: This paper develops a dynamic general equilibrium model that explicitly includes a banking sector with a maturity mismatch. We demonstrate that, despite the perfect competition in the banking sector, rational banks take on excessive risks systemically, resulting in overleverage and inefficiently high crisis probabilities. The model accounts for the banks' rational over-optimism regarding future capital prices which arises from pecuniary externalities on their own solvency. Using the model as an example, we introduce MSR (marginal systemic risk) as a general measure to assess the macroeconomic exposure to systemic risks.
    Keywords: Financial crisis, Liquidity shortage, Maturity mismatch, Pecuniary externalities
    JEL: E3 G21
    Date: 2011–07
  2. By: Klapper, Leora; Laeven, Luc; Rajan, Raghuram
    Abstract: The authors employ a novel dataset on almost 30,000 trade credit contracts to describe the broad characteristics of the parties that contract together; the key contractual terms, such as the discount for early payment; and the days by when payment is due. Whereas prior work has typically used information on only one side of the buyer-seller transaction, this paper utilizes information on both. The authors find that the largest and most creditworthy buyers receive contracts with the longest maturities from smaller suppliers, with the latter extending credit to the former perhaps as a way of certifying product quality. Discounts for early payment seem to be offered to riskier buyers to limit the potential nonpayment risk when credit is extended for non-financial reasons.
    Keywords: Debt Markets,Access to Finance,Investment and Investment Climate,Bankruptcy and Resolution of Financial Distress,Economic Theory&Research
    Date: 2011–07–01
  3. By: Perri, Fabrizio; Quadrini, Vincenzo
    Abstract: The 2008-2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions around the date of Lehman bankruptcy. At the same time countries also experienced large and synchronized tightening of credit conditions. We present a two-country model with financial market frictions where a credit tightening can emerge as a self-fulfilling equilibrium caused by pessimistic but fully rational expectations. As a result of the credit tightening, countries experience large and endogenously synchronized declines in asset prices and economic activity (international recessions). The model suggests that these recessions are more severe if they happen after a prolonged period of credit expansion.
    Keywords: credit tightness; international crisis
    JEL: E32 F3
    Date: 2011–07
  4. By: Martin Hellwig (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This lecture discusses the 2010 crisis of the European Monetary Union and draws some lessons for reform. Crisis resolution has been difficult because the sovereign debt crisis of countries like Greece and Portugal has come together with real-estate and banking crises in countries like Ireland and Spain and bank vulnerability in countries like Germany and France. Failure to disentangle and resolve the different crises prevents a satisfactory approach to the long-term reform of governance of sovereign borrowing and banking. Any such reform must find a substitute for the discipline that exchange rate mechanisms impose on sovereign borrowers and their lenders when the currency is national. Any mechanism for imposing discipline on sovereign borrowers and their lenders must be designed so that enforcement is credible even in a crisis. Recommendations for reform include (i) an inclusion of sovereign exposure from too-big-to-fail concerns in banking in monitoring of fiscal stance, (ii) independence of bank supervisors from their respective political authorities, and (iii) a strengthening of the powers of the European Supervisory Authorities over the national supervisors.
    Keywords: European Monetary Union, sovereign debt crisis, bank supervision
    JEL: G28 F53 F33 F36
    Date: 2011–06
  5. By: Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, Complutense University of Madrid, and Institute of Economic Research, Kyoto University); Roberto Casarin (Department of Economics Ca’Foscari University of Venice); Chia-Lin Chang (Department of Applied Economics Department of Finance National Chung Hsing University Taichung, Taiwan); Juan-Ángel Jiménez-Martín (Department of Quantitative Economics Complutense University of Madrid); Teodosio Pérez-Amaral (Department of Quantitative Economics Complutense University of Madrid)
    Abstract: It is well known that the Basel II Accord requires banks and other Authorized Deposit-taking Institutions (ADIs) to communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models, whether individually or as combinations, to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. McAleer et al. (2009) proposed a new approach to model selection for predicting VaR, consisting of combining alternative risk models, and comparing conservative and aggressive strategies for choosing between VaR models. This paper addresses the question of risk management of risk, namely VaR of VIX futures prices, and extends the approaches given in McAleer et al. (2009) and Chang et al. (2011) to examine how different risk management strategies performed during the 2008-09 global financial crisis (GFC). The empirical results suggest that an aggressive strategy of choosing the Supremum of single model forecasts, as compared with Bayesian and non-Bayesian combinations of models, is preferred to other alternatives, and is robust during the GFC. However, this strategy implies relatively high numbers of violations and accumulated losses, which are admissible under the Basel II Accord.
    Keywords: Median strategy, Value-at-Risk, daily capital charges, violation penalties, aggressive risk management, conservative risk management, Basel Accord, VIX futures, Bayesian strategy, quantiles, forecast densities.
    JEL: G32 C53 C22 C11
    Date: 2011–07
  6. By: Paulo Araújo Santos (Escola Superior de Gestão e Tecnologia de Santarém and Center of Statistics and Applications, University of Lisbon); Juan-Ángel Jiménez-Martín (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid); Michael McAleer (Econometrisch Instituut (Econometric Institute), Faculteit der Economische Wetenschappen (Erasmus School of Economics), Erasmus Universiteit, Tinbergen Instituut (Tinbergen Institute).); Teodosio Pérez Amaral (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid)
    Abstract: In McAleer et al. (2010b), a robust risk management strategy to the Global Financial Crisis (GFC) was proposed under the Basel II Accord by selecting a Value-at-Risk (VaR) forecast that combines the forecasts of different VaR models. The robust forecast was based on the median of the point VaR forecasts of a set of conditional volatility models. In this paper we provide further evidence on the suitability of the median as a GFC-robust strategy by using an additional set of new extreme value forecasting models and by extending the sample period for comparison. These extreme value models include DPOT and Conditional EVT. Such models might be expected to be useful in explaining financial data, especially in the presence of extreme shocks that arise during a GFC. Our empirical results confirm that the median remains GFC-robust even in the presence of these new extreme value models. This is illustrated by using the S&P500 index before, during and after the 2008-09 GFC. We investigate the performance of a variety of single and combined VaR forecasts in terms of daily capital requirements and violation penalties under the Basel II Accord, as well as other criteria, including several tests for independence of the violations. The strategy based on the median, or more generally, on combined forecasts of single models, is straightforward to incorporate into existing computer software packages that are used by banks and other financial institutions.
    Keywords: Value-at-Risk (VaR), DPOT, daily capital charges, robust forecasts, violation penalties, optimizing strategy, aggressive risk management, conservative risk management, Basel, global financial crisis.
    JEL: G32 G11 C53 C22
    Date: 2011
  7. By: Freed, Marc S; McMillan, Ben
    Abstract: A lack of commonly accepted benchmarks for hedge fund performance has permitted hedge fund managers to attribute to skill returns that may actually accrue from market risk factors and illiquidity. Recent innovations in hedge fund replication permits us to estimate the extent of this misattribution. Using an option-based model, we find evidence that the value of liquidity options that investors implicitly grant managers when they invest may account for part or even all hedge fund returns. Coupled with the competition from hedge fund replication vehicles, this finding may motivate hedge fund investors to demand less restrictive investment terms in the future.
    Keywords: hedge funds; replication; alpha; exotic beta; hedge fund beta; liquidity; illiquidity; marketability; accessibility; redemption terms
    JEL: G1 G2
    Date: 2011–07–13
  8. By: John Cotter (University College Dublin)
    Abstract: Accurate forecasting of risk is the key to successful risk management techniques. Using the largest stock index futures from twelve European bourses, this paper presents VaR measures based on their unconditional and conditional distributions for single and multi-period settings. These measures underpinned by extreme value theory are statistically robust explicitly allowing for fat-tailed densities. Conditional tail estimates are obtained by adjusting the unconditional extreme value procedure with GARCH filtered returns. The conditional modelling results in iid returns allowing for the use of a simple and efficient multi-period extreme value scaling law. The paper examines the properties of these distinct conditional and unconditional trading models. The paper finds that the biases inherent in unconditional single and multi-period estimates assuming normality extend to the conditional setting.
    Keywords: extreme value theory; GARCH filter; conditional risk
    JEL: G1 G10
    Date: 2011–07–21
  9. By: Masazumi Hattori (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: masazumi.hattori; Kazuhiko Ohashi (Professor, Hitotsubashi University (E-mail:
    Abstract: We consider an economy in which a lender finances his loans to borrowers by issuing a securitized product to investors, and where the credit quality of the product may depend on whether the lender screens the borrowers. In the presence of asymmetric information between the lender and the investors about the credit quality of potential borrowers, overvaluation of the low-quality securitized product may occur, inducing lender to not screen the borrowers and hence to issue a securitized product of low credit quality. This is likely to occur when the investors finds it difficult to distinguish the good state from the bad state, or when the seed of recession creeps toward the booming economy. A retention regulation that requires the lender to hold a minimum ratio of his own securitized products is not necessarily effective in solving this incentive problem. Even worse, in a certain situation, the retention regulation discourages the lender's screening effort and reduces welfare.
    Keywords: originate-to-distribute, securitization, asymmetric information, financial regulation, screening, verification, retention
    JEL: G14 G21 G24
    Date: 2011–07
  10. By: Dora Balog (Department of Finance Corvinus University of Budapest)
    Abstract: Capital allocation is used for many purposes in financial institutions and for this purpose several methods are known. The aim of this paper is to review possible methods (we present six of them) and to help financial companies to choose between the methods. There are some properties that an allocation method should satisfy: full allocation, core compatibility, riskless allocation, symmetry and suitability for performance measurement (compatibility with Return on Risk Adjusted Capital calculation). If we think about practical application we should also consider simplicity of the methods. First we examine the methods from the point of view if they are satisfying core compatibility. We test this with simulation where we add to the existing literature that we test core compatibility with different assumptions on returns: on normal and t-distributed returns and also on returns generated from a copula. We find that if we measure risk by a coherent risk measure, the Expected Shortfall there are two methods satisfying core compatibility: the Euler method (that always fulfills the criteria) and cost gap method (obeys it around in about 99%). As Euler method is very easy to calculate even for many players while cost gap method becomes very complicated as the number of the players increases we examine further the properties of Euler method. We find that it fulfills all the above given criteria but symmetry and as aforementioned it is also very easy to calculate. Therefore we believe that the method might be suggested for practical applications.
    Keywords: Capital Allocation, Coherent Measures of Risk, Core, Simulation
    JEL: C60 C70 G20
    Date: 2011–06
  11. By: Takeshi Osada
    Abstract: This paper empirically investigates the effects of capital injections into Japanese banks, which were based on the Financial Function Stabilization Law and the Early Strengthening Law, on the capital crunch. Using financial panel data for all of the Japanese commercial banks, we estimate dynamic panel models which investigate the effects of capital injections on banks’ lending behaviour. We find a negative impact of capital injections on their lending behaviour. This finding is different from that of previous studies, which concluded that capital injections had positive effects. Though the capital injections were expected to free banks from capital regulatory constraint, Japanese banks that had received capital injections became more sensitive about their capital adequacy ratios, and reduced their loans; the exception was the domestic banks that received capital injection based on the Early Strengthening Law. The difference between success and failure has a lot to do with the frameworks of capital injection policies, suggesting that the manner of conducting capital injection policies and banking supervision is a very crucial matter.
    JEL: G21 G28 C23 E51
    Date: 2011
  12. By: Angelo Baglioni (DISCE, Università Cattolica); Umberto Cherubini
    Abstract: We propose a new index for measuring the systemic risk of default of the banking sector, which is based on a homogeneous version of multivariate intensity based models (Cuadras – Augé distribution). We compute the index for 10 European countries, exploiting the information incorporated in the CDS premia of 44 large banks over the period January 2007 – September 2010. In this way, we provide a market based measure of the liability incurred by the Governments, due to the implicit bail-out guarantees they provide to the financial sector. We find that during the financial crisis the systemic component of the default risk in the banking sector has significantly increased in all countries, with the exception of Germany and the Netherlands. As a consequence, the Governments’ liability implicit in the bail out guarantee amounts to a quite relevant share of GDP in several countries: it is huge for Ireland, lower but still important for the other PIIGS (Italy is the least affected within this group) and for the UK. Finally, our estimate is very close to the overall amount of money already committed in the rescue plans adopted in Europe between Octo ber 2008 and March 2010, despite strong cross-country differences: in particular, Germany and Ireland seem to have committed an amount of resources much larger than needed; to the contrary, the Italian Government has committed much less than it should.
    Keywords: bank bail out, Government budget, systemic risk, financial crisis
    JEL: G21 H63
    Date: 2011–07
  13. By: John Cotter (University College Dublin); Francois Longin (ESSEC Graduate Business School, France)
    Abstract: Value at risk (VaR) is a risk measure that has been widely implemented by financial institutions. This paper measures the correlation among asset price changes implied from VaR calculation. Empirical results using US and UK equity indexes show that implied correlation is not constant but tends to be higher for events in the left tails (crashes) than in the right tails (booms).
    Keywords: Implied Correlation, Value at Risk
    JEL: G12
    Date: 2011–07–21
  14. By: Ana Fostel (Dept. of Economics, George Washington University); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: We study the effect of leverage, tranching, securitization and CDS on asset prices in a general equilibrium model with collateral. We show how the timing of financial innovation might have contributed to the mortgage boom and to the bust of 2007-2009. We show why tranching and leverage tend to raise asset prices and why CDS tend to lower them. This may seem puzzling, since it implies that creating a derivative tranche in the securitization whose payoffs are identical to the CDS will raise the underlying asset price while the CDS outside the securitization lowers it. The resolution of the puzzle is that the CDS lowers the value of the underlying asset since it is equivalent to tranching cash.
    Keywords: Endogenous leverage, Collateral equilibrium, CDS, Tranching, Asset prices
    JEL: D52 D53 E44 G10 G12
    Date: 2011–07
  15. By: Nao Sudo (Deputy Director, Institute for Monetary and Economic Studies (currently Research and Statistics Department), Bank of Japan (E-mail:
    Abstract: A notable feature of the Japanese economy following the banking crisis of the late 1990s is the drastic decline in the velocity of money and the consequent decline in the price level. Based on the inventory model of money demand a la Alvarez, Atkeson, and Edmond (2009), we explore how macroeconomic shocks affect the velocity. Households in the model are subject to a multiple-period cash-in-advance constraint in which the portion of the payment in cash, which we call the liquidity requirement, varies according to the credit service supply in the economy. Extracting various shocks underlying the velocity variations from 1990 to 2010, we find that an increase in the liquidity requirement is the key driver of the decline in velocity. Particularly important is the channel stemming from householdsf expectations about the future liquidity requirement. During the Japanese banking crisis and the global financial crisis, credit service is disrupted and households expect the disruption to last long. Since they demand additional money for a higher liquidity requirement for current and future transactions, the velocity and the price level decrease, even though the growth rate of money stock then exceeds that of consumption.
    Keywords: Velocity of Money, Liquidity Requirement, Financial Crises
    JEL: E4 E5
    Date: 2011–07
  16. By: Gutierrez, Eva; Rudolph, Heinz P.; Homa, Theodore; Beneit, Enrique Blanco
    Abstract: Past performance of development banks, has generally been considered poor and the value of state ownership questioned. There are few institutions that achieve the optimum balance of effectively addressing a policy objective while being financially sustainable. Following the financial crisis, there is a renewed interest in the role development banks can play in weathering the crisis. The purpose of this paper is to highlight the lessons learned following the financial crisis and to present some of the best practices in development banking so that policy makers can be better informed should they be considering how to build strong state financial institutions to address current and future needs in their respective countries.
    Keywords: Banks&Banking Reform,Debt Markets,Access to Finance,Emerging Markets,Bankruptcy and Resolution of Financial Distress
    Date: 2011–07–01
  17. By: Michaelowa, Katharina; Humphrey, Chris
    Abstract: In this paper we investigate how country shareholding arrangements affect the lending of multilateral development banks (MDBs) under different economic conditions and over time. To do so, we consider three different types of MDBs - one dominated by non-borrowers (the World Bank), another controlled by borrowing countries (the Corporación Andina de Fomento, CAF), and a third where control is more evenly split between borrowers and non-borrowers (the Inter-American Development Bank, IADB) - and a common set of borrowing countries in Latin America. Descriptive statistics as well as econometric analysis based on seemingly unrelated regression estimation (SURE) and panel regressions indicate that the lending of the three MDBs does indeed react in a systematically different way to specific economic conditions. As a general trend, countries increasingly favor the CAF and IADB as a source of multilateral borrowing, while during crisis times World Bank lending tends to increase significantly and more strongly than lending by the CAF. IADB lending also increases very strongly during crises, but remains at a relatively high level throughout. In line with expectations based on the different shareholder arrangements, the paper also finds links between borrower government policy stances and World Bank/IADB lending, but none for the CAF. --
    Date: 2011
  18. By: Pohl, Birte
    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
    JEL: F21 F23 F36
    Date: 2011
  19. By: Heinz, Christa; Dinh, Thanh; Kleimeier, Stefanie
    Abstract: This paper analyses the determinants of collateral in loans granted to entrepreneurs and consumers. We use cross-sectional data on more than 39,000 bank loans raised by Vietnamese borrowers between 2006 and 2009. Our data set is unique because it contains information about the bank's assessment of the borrower's ex ante risk and the borrowers' wealth including pledged as well as unpledged assets. We find that observationally riskier borrowers, as measured by the bank through the ex ante risk score, are more likely to pledge collateral. At the same time, wealthier borrowers are more likely to pledge collateral in order to benefit from a reduction in their interest costs. We also present evidence on other determinants of collateral such as borrower-lender relationship, credit market competition, and institutions. --
    Keywords: Collateral,retail lending,observed risk hypothesis,loan pricing,emerging markets
    JEL: G21
    Date: 2011

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