New Economics Papers
on Banking
Issue of 2011‒09‒22
23 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Financial Linkages across Korean Banks By Burcu Aydin; Myeong-Suk Kim; Ho-Seong Moon
  2. Systemic Risk and Optimal Regulatory Architecture By Marco A Espinosa-Vega; Juan Sole; Rafael Matta; Charles Kahn
  3. Credit Spread Interdependencies of European States and Banks during the Financial Crisis By Adrian Alter; Yves Stephan Schüler
  4. Capital Regulation and Tail Risk By Lev Ratnovski; Enrico Perotti; Razvan Vlahu
  5. Loan loss provisioning in the commercial banking system of Barbados: practices and determinants By Craigwell, Roland C; Elliott, Wayne A
  6. Institutional Cash Pools and the Triffin Dilemma of the U.S. Banking System By Zoltan Pozsar
  7. Crashes and Collateralized Lending By Jakub W. Jurek; Erik Stafford
  8. A theory of the non-neutrality of money with banking frictions and bank recapitalization By Zeng, Zhixiong
  9. All things considered: the interaction of the reasons for the financial crisis By Abdala Rioja, Yamile E
  10. How much did banks pay to become too-big-to-fail and to become systematically important? By Elijah Brewer, III; Julapa Jagtiani
  11. Insolvency risk in the network-branded prepaid-card value chain By Philip Keitel
  12. The Taxation and Regulation of Banks By Michael Keen
  13. Liquidity management of U.S. global banks: internal capital markets in the Great Recession By Nicola Cetorelli; Linda Goldberg
  14. The Survival of New Firms: Do Bank Loans at Birth Matter? By Bastié Françoise, University of Caen Basse-Normandie, CREM (UMR CNRS); Cieply Sylvie, University of Caen Basse-Normandie, CREM (UMR CNRS); Cussy Pascal, University of Caen Basse-Normandie, CREM (UMR CNRS)
  15. Generalized Extreme Value for Binary Rare Events Data: an Application to Credit Defaults By Raffaella Calabrese; Silvia Angela Osmetti
  16. The Banking Sector and Recovery in the EU Economy Reference By Barrell, Ray; FitzGerald, John
  17. Currency Total Return Swaps: Valuation and Risk Factor Analysis By Romain Cuchet; Pascal François; Georges Hübner
  18. Sex and Credit: Is There a Gender Bias in Microfinance? By Beck, T.H.L.; Behr, P.; Madestam, A.
  19. The Current State of the Financial Sector and the Regulatory Framework in Asian Economies—The Case of the People’s Republic of China By Ping, Luo
  20. The unreliability of credit-to-GDP ratio gaps in real-time: Implications for countercyclical capital buffers By Rochelle M. Edge; Ralf R. Meisenzahl
  21. Do dynamic provisions reduce income smoothing using loan Loss provisions? By Daniel Pérez; Vicente Salas-Fumás; Jesús Saurina
  22. Measuring the Social Performance of Microfinance in Europe By Fabrizio Botti; Marcella Corsi
  23. Mortgage defaults By Juan Carlos Hatchondo; Leonardo Martinez; Juan M. Sánchez

  1. By: Burcu Aydin; Myeong-Suk Kim; Ho-Seong Moon
    Abstract: This paper assesses the interconnectedness across Korean banks using three alternative methodologies. Two methodologies utilize high frequency financial data while the third uses bank balance sheet data to assess banks’ bilateral exposures, systemically vulnerable banks, and systemically risky banks. The analysis concludes that while Korean banks are interconnected, both the financial risk and contagion risk from such interconnectedness have declined significantly in the aftermath of the global financial crisis.
    Keywords: Banking systems , Banks , Credit risk , Economic models , Financial risk , Korea, Republic of ,
    Date: 2011–08–18
  2. By: Marco A Espinosa-Vega; Juan Sole; Rafael Matta; Charles Kahn
    Abstract: Until the recent financial crisis, the safety and soundness of financial institutions was assessed from the perspective of the individual institution. The financial crisis highlighted the need to take systemic externalities seriously when rethinking prudential oversight and the regulatory architecture. Current financial reform legislation worldwide reflects this intent. However, these reforms have overlooked the need to also consider regulatory agencies’ forbearance and information sharing incentives. In a political economy model that explicitly accounts for systemic connectedness, and regulators’ incentives, we show that under an expanded mandate to explicitly oversee systemic risk, regulators would be more forbearing towards systemically important institutions. We also show that when some regulators have access to information regarding an institutions’ degree of systemic importance, these regulators may have little incentive to gather and share it with other regulators. These findings suggest that (and we show conditions under which) a unified regulatory arrangement can reduce the degree of systemic risk vis-á-vis a multiple regulatory arrangement.
    Keywords: Bank regulations , Banks , Economic models , External shocks , Financial institutions , Financial risk , Liquidity ,
    Date: 2011–08–10
  3. By: Adrian Alter (Department of Economics, University of Konstanz, Germany); Yves Stephan Schüler (Department of Economics, University of Konstanz, Germany)
    Abstract: This study analyzes the relationship between the default risk of several European states and financial institutions during the period June 2007 -May 2010. It investigates how bank bailout schemes affected this linkage. We consider sovereign credit default swap (CDS) spreads from seven Eurozone member states (France, Germany, Italy, Ireland, Netherlands, Portugal, and Spain) together with a selection of bank CDS series from these states. Our main finding suggest that in the period preceding government rescue schemes the contagion from bank credit spreads disperses into the sovereign CDS market. After government interventions, due to changes in the composition of both banks’ and sovereign balance sheets, our results underline the augmented importance of the government CDS spreads in the price discovery mechanism of banks’ CDS series. Furthermore, a financial sector shock affects more strongly the sovereign CDS spreads in the short-run, however the impact becomes insignificant at a long horizon. Our analysis emphasizes heterogeneous outcomes across countries but homogeneous across domestic banks.
    Keywords: credit default swaps, private-to-public risk transfer, bank bailout cointegration, generalized impulse responses
    JEL: G18 G21
    Date: 2011–09–10
  4. By: Lev Ratnovski; Enrico Perotti; Razvan Vlahu
    Abstract: The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk asserts. We show that this undermines the traditional result that high capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an unintended effect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in non-tail risky project realizations. The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.
    Keywords: Bank regulations , Banks , Capital , Economic models , Risk management ,
    Date: 2011–08–08
  5. By: Craigwell, Roland C; Elliott, Wayne A
    Abstract: The purpose of this paper is to investigate the process of loan loss provisioning within the commercial banking system of Barbados. It uses questionnaires and interviews to ascertain how banks set their provisional standards and levels. In addition, the results from this approach reveal, for the first time in Barbados, the individual banks‟ procedures for loan loss provisioning. An evaluation of the impact of macroeconomic and bank specific factors on commercial banks‟ provisions utilising panel dynamic ordinary least squares is also undertaken. Both sets of factors are found to influence the level of provisions. In particular, loan loss provisions are heavily dependent upon the performance of the real economy and competition in international markets is shown to have serious implications for the banking sector in both the short and long run. Moreover, this study asserts that larger banks in Barbados are better able to screen loans and avoid defaults.
    Keywords: Loan Loss Provisioning; Banking System; Loan Classification
    JEL: M41 G28 G21
    Date: 2011
  6. By: Zoltan Pozsar
    Abstract: Through the profiling of institutional cash pools, this paper explains the rise of the "shadow" banking system from a demand-side perspective. Explaining the rise of shadow banking from this angle paints a very different picture than the supply-side angle that views it as a story of banks’ funding preferences and arbitrage. Institutional cash pools prefer to avoid too much unsecured exposure to banks even through insured deposits. Short-term government guaranteed securities are the next best choice, but their supply is insufficient. The shadow banking system arose to fill this vacuum. One way to manage the size of the shadow banking system is by adopting the supply management of Treasury bills as a macroprudential tool.
    Keywords: Banking systems , Banks , Investment , Money , United States ,
    Date: 2011–08–08
  7. By: Jakub W. Jurek; Erik Stafford
    Abstract: This paper develops a parsimonious static model for characterizing financing terms in collateralized lending markets. We characterize the systematic risk exposures for a variety of securities and develop a simple indifference-pricing framework to value the systematic crash risk exposure of the collateral. We then apply Modigliani and Miller's (1958) Proposition Two (MM) to split the cost of bearing this risk between the borrower and lender, resulting in a schedule of haircuts and financing rates. The model produces comparative statics and time-series dynamics that are consistent with the empirical features of repo market data, including the dramatic change in financing terms for structured products during the credit crisis of 2007-2008.
    JEL: G12 G2
    Date: 2011–09
  8. By: Zeng, Zhixiong
    Abstract: The unconventional monetary policy actions of the Federal Reserve during the recent Global Financial Crisis often involve implicit subsidies to banks. This paper offers a theory of the non-neutrality of money associated with capital injection into banks via nominal transfers, in an environment where banking frictions are present in the sense that there exists an agency problem between banks and their private-sector creditors. The analysis is conducted within a general equilibrium setting with two-sided financial contracting. We first show that even with perfect nominal flexibility, the recapitalization policy has real effects on the economy. We then introduce banking riskiness shocks and study optimal policy responses to such shocks.
    Keywords: Bankruptcy of banks; banking riskiness shocks; two-sided debt contract; unconventional monetary policy; financial crisis
    JEL: D86 E52 E44 D82
    Date: 2011–08–15
  9. By: Abdala Rioja, Yamile E
    Abstract: The present paper reviews the causes that led to the financial crisis. Unlike other interpretations, this paper does not place main significance on a single source or on a set of causes. I consider all major standpoints highlighted by research and media prior, during and after the financial market turmoil in 2007. When evidence permits, reasons are validated and their potential consequences are reviewed by means of reductio ad absurdum, specifically by proof by contradiction. This analysis proposes arguments that are in favor and against a specific source whenever applicable, so as to address each cause’s major implications and deterrents. Ultimately, this analysis reveals through graph theory the interconnections among the analyzed sources for the crisis and their forbearance as a cluster that projected the final downturn.
    Keywords: financial crisis, subprime crisis, systemic risk, financial regulation, monetary policy, global imbalances, global savings glut, shadow banking system, predatory lending, too big to fail, securitization, housing bubble, interest rates, credit ratings, toxic assets, liar loans, graph theory, directed graph, finitary relations
    JEL: F34 E44 G24 F42 E66 C65 E58 G18 G15 E52 G28
    Date: 2011–09–13
  10. By: Elijah Brewer, III; Julapa Jagtiani
    Abstract: This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991-2004, the authors find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. They estimate at least $15 billion in added premiums for the eight merger deals that brought the organizations to over $100 billion in assets. In addition, the authors find that both the stock and bond markets reacted positively to these TBTF merger deals. Their estimated TBTF subsidy is large enough to create serious concern, particularly since the recently assisted mergers have effectively allowed for TBTF banking organizations to become even bigger and for nonbanks to become part of TBTF banking organizations, thus extending the TBTF subsidy beyond banking.
    Keywords: Bank mergers
    Date: 2011
  11. By: Philip Keitel
    Abstract: The value chain for network-branded prepaid cards involves more parties than those commonly present in credit- or debit-card issuing arrangements: the merchant acquirer, processors, a payment network, and a card-issuing bank. These additional participants may include a program manager, a distributor, and a seller. Since a number of independent businesses make up the chain, each one, as well as cardholding consumers, could be exposed to losses resulting from the insolvency of another party in the value chain. This risk is both real and manageable, as illustrated by two recent incidents involving network-branded prepaid cards: the failures of Silverton Bank, N.A.. and Sprinbok Services, Inc. The Payment Cards Center of the Federal Reserve Bank of Philadelphia hosted a workshop of March 17, 2011, to examine the implications of insolvency in the network-branded prepaid-card value chains, to review how market participants have responded to this risk, and to discuss controls the industry has developed to mitigate and address these challenges, Kirsten Trusko, president of the Network Branded Prepaid Card Association (NBPCA); Terry Maher, partner at Baird Holm LLP and general counsel to the NBPCA; Jeremy Kuiper, managing director of the Bancorp Bank; and Ted Martinez, head of Visa’s North America credit settlement risk team, led the workshop. This paper summarizes the information presented at the workshop, including the ways in which consumers and businesses are protected from the insolvency of the issuing bank or a key participant. In addition, this paper highlights practices that have been developed in the industry to mitigate this risk.
    Keywords: Electronic funds transfers
    Date: 2011
  12. By: Michael Keen
    Abstract: The financial crisis has prompted a reconsideration of the taxation of financial institutions, with practice outstripping principle: France, Germany, the United Kingdom and several other European countries have now introduced some form of bank tax, and the U.S. administration has revived its own proposal for such a charge. This paper considers the structure, appropriate rate, and revenue yield of corrective taxation of financial institutions addressed to two externalities, consequent on excessive risk-taking, prominent in the crisis: those that arise when such institutions are simply allowed to collapse, and those that arise when, to avoid the harm this would cause, their creditors are bailed out. It also asks whether corrective taxation or a regulatory capital requirement is the better way to address these concerns. The results suggest a potential role for taxing bank borrowing, perhaps as an adjunct to minimum capital requirements, at marginal rates that rise quite sharply at low capital ratios (but are likely lower when the government cannot commit to its bailout policy), reaching levels higher than those of the bank taxes so far adopted or proposed.
    Date: 2011–08–25
  13. By: Nicola Cetorelli; Linda Goldberg
    Abstract: The recent crisis highlighted the importance of globally active banks in linking markets. One channel for this linkage is the liquidity management of these banks, specifically the regular flow of funds between parent banks and their affiliates in diverse foreign markets. We use the Great Recession as an opportunity to identify the balance-sheet shocks to parent banks in the United States and then explore which features of foreign affiliates are associated with protecting, for example, their status as important locations in sourcing funding or as destinations for foreign investment activity. We show that distance from the parent organization plays a significant role in this allocation, where distance is bank-affiliate specific and depends on the location’s ex ante relative importance in local funding pools and overall foreign investment strategies. These flows are a form of global interdependence previously unexplored in the literature on international shock transmission.
    Date: 2011
  14. By: Bastié Françoise, University of Caen Basse-Normandie, CREM (UMR CNRS); Cieply Sylvie, University of Caen Basse-Normandie, CREM (UMR CNRS); Cussy Pascal, University of Caen Basse-Normandie, CREM (UMR CNRS)
    Abstract: In this article, we explore the issue of whether the financial conditions into which a firm is born have an effect on its survival chances. After both correction of the omitted variables bias and introduction of time varying covariates, we show two distinctive effects of banking debt on the survival of new firms in function of the time horizon: an insignificant or negative impact of banking debt in the short term (less than 2 years) and a persistently positive effect in the medium term (more than 2 years). Founding financial conditions have long-lasting effects upon survival.
    Keywords: Survival, New firms, Banking debt, Screening, Duration.
    JEL: M13 D82 G21
    Date: 2011–09
  15. By: Raffaella Calabrese (Geary Institute, University College Dublin); Silvia Angela Osmetti (Department of Statistics, University Cattolica del Dacro Cuore, Milan)
    Abstract: The most used regression model with binary dependent variable is the logistic regression model. When the dependent variable represents a rare event, the logistic regression model shows relevant drawbacks. In order to overcome these drawbacks we propose the Generalized Extreme Value (GEV) regression model. In particular, in a Generalized Linear Model (GLM) with binary dependent variable we suggest the quantile function of the GEV distribution as link function, so our attention is focused on the tail of the response curve for values close to one. The estimation procedure is the maximum likelihood method. This model accommodates skewness and it presents a generalization of GLMs with log-log link function. In credit risk analysis a pivotal topic is the default probability estimation. Since defaults are rare events, we apply the GEV regression to empirical data on Italian Small and Medium Enterprises (SMEs) to model their default probabilities.
    Date: 2011–09–15
  16. By: Barrell, Ray; FitzGerald, John
    Date: 2011–08
  17. By: Romain Cuchet; Pascal François; Georges Hübner
    Abstract: Currency total return swaps (CTRS) are hybrid derivatives instruments that allow to simultaneously hedge against credit and currency risks. We develop a structural credit risk model to evaluate CTRS premia. Empirical test on a sample of 23,005 price observations from 59 underlying issuers yields an average percentage error of around 10%. This indicates that, beyond interest rate risk, firm-specific factors are major drivers of the variations in the valuation of these instruments. Regression analysis of residuals shows that exchange rate determinants account for up to 40% of model pricing errors – indicating that a currency risk premium affects the CTRS price significantly but only marginally, which confirms the prevalence of credit risk in the pricing of CTRS.
    Keywords: Credit derivative, credit risk, currency risk
    JEL: G13 G15 G32
    Date: 2011
  18. By: Beck, T.H.L.; Behr, P.; Madestam, A. (Tilburg University, Center for Economic Research)
    Abstract: This paper examines the effects of group identity in the credit market. Exploiting the quasirandom assignment of first-time borrowers to loan officers of a large Albanian lender, we test for own-gender bias in the loan officer-borrower match. We find that borrowers pay on average 29 basis points higher interest rates when paired with a loan officer of the other sex. The results indicate the presence of a taste-based rather than a statistical bias, as borrowers’ likelihood of going into arrears is independent of loan officer gender. Ending up with an opposite-sex loan officer also affects demand for credit, with borrowers being 11.5 percent less likely to return for a second loan. The bias is more pronounced when the social distance, as proxied by difference in age between the loan officer and the borrower, increases and when financial market competition declines. This is consistent with theories that predict a tastebased bias to be stronger when the psychological costs of being biased are lower and the discretion in setting interest rates is higher. Taken together, the findings suggest that owngender preferences can have substantial welfare effects.
    Keywords: Identity;interest rates;gender;loan officers;microfinance.
    JEL: G21 G32 J16
    Date: 2011
  19. By: Ping, Luo (Asian Development Bank Institute)
    Abstract: Reform of financial regulation is a priority on the international agenda. At the call of the Group of Twenty Finance Ministers and Central Bank Governors (G-20), a number of new international standards have been issued, most notably Basel III. As a member of the G-20, the Financial Stability Board (FSB), and the Basel Committee on Banking Supervision, the People’s Republic of China (PRC) is now on a faster track in adopting international standards. However, the key issue for the PRC—as well as many other emerging markets—is to how to keep focused on the domestic policy agenda while adopting the new global standards.
    Keywords: financial regulation; basel iii; prc financial sector
    JEL: E44 E52 E58 G18 G28
    Date: 2011–09–15
  20. By: Rochelle M. Edge; Ralf R. Meisenzahl
    Abstract: Macroeconomists have long recognized that activity-gap measures are unreliable in real time and that this can present serious difficulties for stabilization policy. This paper investigates whether the credit-to-GDP ratio gap, which has been proposed as a reference point for accumulating countercyclical capital buffers, is subject to similar problems. We find that ex-post revisions to the U.S. credit-to-GDP ratio gap are sizable and as large as the gap itself, and that the main source of these revisions stems from the unreliability of end-of-sample estimates of the series' trend rather than from revised estimates of the underlying data. The paper considers the potential costs of gap mismeasurement. We find that the volume of lending that may incorrectly be curtailed is potentially large, although loan interest-rates appear to increase only modestly.
    Date: 2011
  21. By: Daniel Pérez (Banco de España); Vicente Salas-Fumás (Universidad de Zaragoza and Banco de España); Jesús Saurina (Banco de España)
    Abstract: Spanish banks had to set aside a countercyclical loan loss provision during the period 2000 2004. The amount of such provision as well as the allowance accumulated had to be disclosed by banks. The former creates a natural experiment to test whether banks smooth earnings to mislead investors and other interested parties, or, by contrast, income smoothing is used to avoid the existence of market frictions. Using panel data econometric techniques, we find evidence of income smoothing through loan loss provisions during the period previous to the implementation of the countercyclical provision (1988-1999). However, during 2000-2004, banks relied only on the newly created countercyclical provision to smooth income. This change in behaviour suggests that there may be efficiency gains in reducing the volatility of accounting earnings over time.
    Keywords: income smoothing, earnings management, transparency, countercyclical provisioning
    JEL: G18 G21 M41
    Date: 2011–09
  22. By: Fabrizio Botti; Marcella Corsi
    Abstract: Microfinance promise to serve low-income or disadvantaged beneficiaries excluded from the formal banking sector in a financially sustainable way (thus to achieve the so called “double bottom line” of financial and social performance) built excitement around the development of a global industry. However, for a long time an anti-subsidy position embedded in the international key donor community have shown little concern of social performance data and information on beneficiaries profiles in terms of various dimension of social and financial exclusion. Until recently, most of the emphasis of microfinance advocates has been devoted to MFIs financial performance following the “win-win” proposition, according to which financial viability should be sufficient to show social impact, a view that is supported by a controversial evidence and is based on a selective understanding of conceptual facts. Nevertheless, several initiatives recently translated into the Social Performance Task Force (SPTF) attempt to explore social aspects of microfinance providing a new definition of social performance more focused on the whole process leading to a social impact. Aim of this paper is to measure European MFIs social performance according to a core set of common indicators developed by the SPTF but using data collected in 2010 by the European Microfinance Network (EMN) on a sample of 170 microfinance actors operating in 21 countries out of 27 European Union (EU) member countries, current EU candidate countries and countries belonging to the European Free Trade Area (EFTA). The reference framework followed in the current social performance analysis examines the whole process of translating MFIs mission into social impact and includes the analysis of three connected dimensions of the social performance process corresponding to different set of indicators: the intent of the MFI, the effectiveness of the internal system and activities in achieving its targets, MFI outputs and eventually its capacity to positively affect clients life and achieve social goals.
    Date: 2011–09
  23. By: Juan Carlos Hatchondo; Leonardo Martinez; Juan M. Sánchez
    Abstract: We incorporate house price risk and mortgages into a standard incomplete market (SIM) model. We calibrate the model to match U.S. data and we show that the model also ac- counts for non-targeted features of the data such as the distribution of down payments, the life-cycle profile of home ownership, and the mortgage default rate. In addition, we show that the average coefficients that measure the agents' ability to self-insure against income shocks are similar to those of a SIM model without housing (as presented by Kaplan and Violante, 2010). However, incorporating housing increases the values of these coefficient for younger agents, which narrows the gap between the SIM model's implications and the data. The response of consumption to house price shocks is minimal. We also study the effects of default prevention policies. Introducing a minimum down payment requirement of 15% reduces defaults on mortgages by 30%, reduces the home ownership rate up to only 0.2 percentage points (if the aggregate house price level does not adjust), and may cause house prices to decline up to 0.7% (if home ownership does not adjust). Garnishing defaulters' income in excess of 43% of median consumption for one year produces a similar decline in defaults; but, since it reduces the median equilibrium down payment from 19% to 9%, it boosts home ownership up to 4.3 percentage points (if the aggregate house price level does not adjust) and may increase house prices up to 16.1% (if home ownership does not adjust). The introduction of minimum down payments or income garnishment benefit a majority of the population.
    Keywords: Mortgage loans ; Default (Finance)
    Date: 2011

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