New Economics Papers
on Banking
Issue of 2011‒10‒09
eighteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Macroprudential Stress Testing of Credit Risk: A Practical Approach for Policy Makers By Buncic, Daniel; Melecky, Martin
  2. Relationship Lending, Distance and Efficiency in a Heterogeneous Banking System By Cristina Bernini; Paola Brighi
  3. Using Bank Mergers and Acquisitions to Understand Lending Relationships By Hetland, Ove Rein; Mjøs, Aksel
  4. Financial integration and international business cycle co-movement: the role of balance sheets By Scott Davis
  5. Costly Contracts and Consumer Credit By Livshits, Igor; MacGee, James; Tertilt, Michèle
  6. Competition and Performance in Uganda's Banking System By Adam Mugume
  7. An Estimation of the Inside Bank Premium By NEMOTO Tadanobu; OGURA Yoshiaki; WATANABE Wako
  8. Bank bailouts, interventions, and moral hazard By Dam, Lammertjan; Koetter, Michael
  9. Reconstruction of financial network for robust estimation of systemic risk By Iacopo Mastromatteo; Elia Zarinelli; Matteo Marsili
  10. Central banking post-crisis: What compass for uncharted waters? By Claudio Borio
  11. The role of currency swaps in the domestic banking system and the functioning the swap market during the crisis By Judit Páles; Zsolt Kuti; Csaba Csávás
  12. Securitization and moral hazard: evidence from credit score cutoff rules By Ryan Bubb; Alex Kaufman
  13. A Visual Approach to Community Bank Assessment of Agricultural Portfolio Risk Exposure By Pederson, Glenn D.; Chu, Yu-Szu; Richardson, Wynn
  14. An information economics perspective on main bank relationships and firm R&D By Hoewer, Daniel; Schmidt, Tobias; Sofka, Wolfgang
  15. Mortgage defaults By Juan Carlos Hatchondo; Leonardo Martinez; Juan M. Sanchez
  16. Does Short-Term Debt Increase Vulnerability to Crisis? Evidence from the East Asian Financial Crisis By Efraim Benmelech; Eyal Dvir
  17. Real estate investors, the leverage cycle, and the housing market crisis By Andrew Haughwout; Donghoon Lee; Joseph Tracy; Wilbert van der Klaauw
  18. Cycles and Corporate Investment: Direct Tests Using Survey Data on Banks’ Lending Practices By Jakob B Madsen; Sarah J Carrington

  1. By: Buncic, Daniel; Melecky, Martin
    Abstract: Drawing on the lessons from the global financial crisis and especially from its impact on the banking systems of Eastern Europe, the paper proposes a new practical approach to macroprudential stress testing. The proposed approach incorporates: (i) macroeconomic stress scenarios generated from both a country specific statistical model and historical cross-country crises experience; (ii) indirect credit risk due to foreign currency exposures of unhedged borrowers; (iii) varying underwriting practices across banks and their asset classes based on their relative aggressiveness of lending; (iv) higher correlations between the probability of default and the loss given default during stress periods; (v) a negative effect of lending concentration and residual loan maturity on unexpected losses; and (vi) the use of an economic risk weighted capital adequacy ratio as the relevant outcome indicator to measure the resilience of banks to materialising credit risk. We apply the proposed approach to a set of Eastern European banks and discuss the results.
    Keywords: Supervision, Stress Test, Individual Bank Data, Eastern Europe
    JEL: G28 E58 G21
    Date: 2011–09
  2. By: Cristina Bernini (Department and Faculty of Statistics, University of Bologna, Italy); Paola Brighi (Department of Management, Faculty of Economics-Rimini, University of Bologna, Italy; The Rimini Centre for Economic Analysis (RCEA), Italy)
    Abstract: During the last decades banks have progressively moved towards centralized and hierarchical organizational structures. Therefore, the investigation of the determinants of bank efficiency and relationships with the functional distance between the bank head-quarter and operational units have become increasingly important. This paper extends the literature on bank efficiency examining the impact of different bank business models on the efficiency of the Italian banks, distinguished by size and type over the period 2006-2009. Using a stochastic frontier approach, the intertemporal relationships between bank efficiency and some key variables, as distance and income diversification (used as proxies of different organizational banking models) are investigated. Results suggest that organizational structure significantly affects cost efficiency, being different between bank groups.
    Keywords: relationship lending; bank groups; credit risk; stochastic frontiers; panel data
    JEL: G21 L11 L25
    Date: 2011–09
  3. By: Hetland, Ove Rein (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration); Mjøs, Aksel (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: We study how firm-bank lending relationships affect firms' access to and terms of credit. We use bank mergers and acquisitions (M&As) as exogenous events that affect lending relationships. Bank M&As lead to organisational changes at the involved banks, which may reduce the amount of soft information encompassed in the firm-bank relationship. Using a unique Norwegian dataset, which combines information on companies' bank accounts, annual accounts, bankruptcies, and bank M&As for the years 1997-2009, we find that domestic bank mergers increase interest rate margins by 0.24 percentage points for opaque small and medium sized rms, relative to less opaque firms. Since, due to information asymmetries, opaque firms are typically more dependent on bank lending relationships, our results indicate that these relationships are advantageous for such borrowers, and the destruction of a relationship during the merger process has adverse effects for the firm. Conversely, the results are not consistent with a lock-in effect due to an information monopoly by the relationship lender that on average increases a firm's borrowing costs over its life cycle. The results are robust to the inclusion of variables that control for eects of market competition.
    Keywords: Bank Mergers and Acquisitions; Lending Relationships
    JEL: G00 G30 G34
    Date: 2011–08–31
  4. By: Scott Davis
    Abstract: This paper investigates the effect of international financial integration on international business cycle co-movement. We first show with a reduced form empirical approach how capital market integration (equity) has a negative effect on business cycle co-movement while credit market integration (debt) has a positive effect. We then construct a model that can replicate these empirical results.> ; In the model, capital market integration is modeled as crossborder equity ownership and involves wealth effects. Credit market integration is modeled as cross-border borrowing and lending between credit constrained entrepreneurs and banks, and thus involves balance sheet effects. The wealth effect tends to reduce cross-country output correlation, but balance sheet effects serve to increase correlation as a negative shock in one country causes loan losses on the balance sheets of foreign banks.> ; In versions of the model with a financial accelerator and balance sheet effects, credit market integration has a positive effect on cyclical correlation. However, in versions of the model without the financial accelerator and balance sheet effects, credit market integration has a negative effect on cyclical correlation.
    Keywords: International finance ; Business cycles ; Equity ; Debt
    Date: 2011
  5. By: Livshits, Igor; MacGee, James; Tertilt, Michèle
    Abstract: Financial innovations are a common explanation of the rise in consumer credit and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers’ risk of default and a fixed cost to create each contract offered by lenders. Innovations which reduce the fixed cost or ameliorate asymmetric information have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, as well as increased dispersion of interest rates. Using the Survey of Consumer Finance and interest rate data collected by the Board of Governors, we find evidence supporting these predictions, as the dispersion of credit card interest rates nearly tripled, and the share of credit card debt of lower income households nearly doubled.
    Keywords: bankruptcy; consumer credit; endogenous financial contracts
    JEL: E21 E49 G18 K35
    Date: 2011–09
  6. By: Adam Mugume
    Abstract: By using the non-structural models of competitive behaviour—the Panzar-Rosse model—the study measures competition and emphasizes the competitive conduct of banks without using explicit information about the structure of the market. Estimations indicate monopolistic competition, competition being weaker in 1995–1999 compared with 2000–2005. Moreover, the relationship between competition, measuring conduct, and concentration measuring the market structure, is negative and statistically significant; which could suggest that a few large banks can restrict competition. Overall, the results suggest that while competition in the Ugandan banking sector falls within a range of estimates for comparator markets, it tends to be on the weaker side. The structural approach to model competition includes the structure-conductperformance(SCP) paradigm and the efficiency hypothesis. Using the SCP framework, we investigate whether a highly concentrated market causes collusive behaviour among larger banks resulting in superior market performance; whereas under the efficiency hypothesis we test whether it is the efficiency of larger banks that makes for enhanced performance. Using Granger causation test, we establish that the efficiency Granger causes concentration and using instrumental variable approach, the study establishes that market power and concentration as measured by market share and Herfindahl index, respectively, positively affect bank profitability. In addition, bank efficiency also affects bank profitability. Other factors that affect bank profitability include operational costs, taxation and core capital requirement. A major policy implication derived from this analysis is that the Ugandan banking system has been subject to deep structural transformation since the early 1990s. Advances in information technology, liberalization of international capital movement, consolidation and privatization have permitted economies of scale in the production and distribution of services and increased risk diversification. These forces have led to lower costs and, undoubtedly, higher efficiency. However, to ensure that lower costs are passed through to households and firms, greater efficiency must be accompanied by a similar strengthening in the competitive environment in the banking sector.
    Date: 2010–11
  7. By: NEMOTO Tadanobu; OGURA Yoshiaki; WATANABE Wako
    Abstract: This paper is an empirical examination of the existence of the inside bank premium arising from relationship banking, which is predicted in the extant theoretical models. These models predict that the contracted interest rate of a loan extended by an inside bank when there exist asymmetries between the inside bank and outside banks, such as the information advantage of the inside bank or the implicit insurance and other borrower-specific services exclusively provided by the inside bank, is higher than that without such asymmetries. Our statistical estimations are based on the dataset collected through the survey for small and medium-sized firms in Japan, which were designed to contain the questions about a firm's loan application process, and the agreed-upon loan terms that are crucial to our tests. Our estimations show that such an inside bank premium is 30-50 basis points on average for short-term loans. This is economically significant for the median short-term interest rate of 1.9 %. The subsample regressions show that this premium is more likely to come from the implicit insurance and that this premium is more significant for smaller inside banks in more competitive loan markets.
    Date: 2011–09
  8. By: Dam, Lammertjan; Koetter, Michael
    Abstract: To test if safety nets create moral hazard in the banking industry, we develop a simultaneous structural two-equations model that specifies the probability of a bailout and banks' risk taking.We identify the effect of expected bailout probabilities on risk taking using exclusion restrictions based on regional political, supervisor, and banking market traits. The sample includes all observed capital preservation measures and distressed exits in the German banking industry during 1995-2006. The marginal effect of risk with respect to bailout expectations is 7.2 basis points. A change of bailout expectations by two standard deviations increases the probability of official distress from 6.2% to 9.9%. Only interventions directly targeting bank management and, to a lesser extent, penalties mitigate moral hazard. Weak interventions, such as warnings, do not reduce moral hazard. --
    Keywords: Banking,supervision,moral hazard,intervention,bailouts
    JEL: C30 C78 G21 G28 L51
    Date: 2011
  9. By: Iacopo Mastromatteo; Elia Zarinelli; Matteo Marsili
    Abstract: In this paper we estimate the propagation of liquidity shocks through interbank markets when the information about the underlying credit network is incomplete. We show that techniques such as Maximum Entropy currently used to reconstruct credit networks severely underestimate the risk of contagion by assuming a trivial (fully connected) topology, a type of network structure which can be very different from the one empirically observed. We propose an efficient message-passing algorithm to explore the space of possible network structures, and show that a correct estimation of the network degree of connectedness leads to more reliable estimations for systemic risk. Such algorithm is also able to produce maximally fragile structures, providing a practical upper bound for the risk of contagion when the actual network structure is unknown. We test our algorithm on ensembles of synthetic data encoding some features of real financial networks (sparsity and heterogeneity), finding that more accurate estimations of risk can be achieved. Finally we find that this algorithm can be used to control the amount of information regulators need to require from banks in order to sufficiently constrain the reconstruction of financial networks.
    Date: 2011–09
  10. By: Claudio Borio
    Abstract: The global financial crisis has shaken the foundations of the deceptively comfortable pre-crisis central banking world. Central banks face a threefold challenge: economic, intellectual and institutional. This essay puts forward a compass to help central banks sail in the largely uncharted waters ahead. The compass is based on tighter integration of the monetary and financial stability functions, keener awareness of the global dimensions of those tasks, and stronger safeguards for an increasingly vulnerable central bank operational independence.
    Keywords: central banking, monetary and financial stability, macroprudential, own-house-in-order doctrine, operational independence
    Date: 2011–09
  11. By: Judit Páles (Magyar Nemzeti Bank (central bank of Hungary)); Zsolt Kuti (Magyar Nemzeti Bank (central bank of Hungary)); Csaba Csávás (Magyar Nemzeti Bank (central bank of Hungary))
    Abstract: The basic purpose of this study is to didactically demonstrate the factors shaping the currency swap stock of domestic banks prior to the crisis and to provide a descriptive analysis of how the structure and the functioning of the market changed during the crisis. The main conclusions of the study are as follows. In addition to the wide ranging applicability of the transaction, the rise in the currency swap stock of domestic credit institutions is also attributable to macroeconomic factors. The bulk of the exchange rate risk resulting from the high external borrowing requirement and rising external debt was carried by the domestic private sector, while the foreign sector shared a decreasing portion of the risk. The rapid increase in the swap stock was also due to the fact that the synthetic production of foreign currency funds with currency swaps was often more successful than the direct inflow of foreign currency funds. On the basis of the decomposition of the domestic banking system’s on-balance sheet foreign currency position, we can state that it increased mainly as a result of items that also increased the balance sheet total. Following the outbreak of the global financial crisis in the autumn of 2008, the conditions for ensuring foreign currency liquidity deteriorated significantly, which had a substantial effect on implied forint yields, and the turnover and structure of the swap market. While the total average turnover of the domestic FX swap market did not drop radically when the crisis was spreading, market liquidity did decline significantly for a few days and access to foreign currency liquidity became limited. The active role assumed by parent banks and shortening maturities contributed to moderating the decline in turnover. Anecdotal information relating to the tightening of counterparty limits vis-a-vis domestic banks is supported by the decline in the number of non-resident counterparties. The crisis also contributed to changes in the structure of the swap stock. The average remaining maturity of the gross stock began to decline directly after the Lehman bankruptcy, at the time of global dollar liquidity problems, followed by a rise starting from early 2009, principally owing to transactions concluded with parent banks. Domestic subsidiary banks managed to increase maturity primarily through cross-currency swap transactions concluded with intra-group counterparties, but non-group counterparties also concluded transactions with longer maturity with domestic banks.
    Keywords: FX swap, currency swap, foreign currency based loan, crisis, counterparty limit, margin call, liquidity requirement
    JEL: E44 F31 F32 F34
    Date: 2011
  12. By: Ryan Bubb; Alex Kaufman
    Abstract: Mortgage originators use credit score cutoff rules to determine how carefully to screen loan applicants. Recent research has hypothesized that these cutoff rules result from a securitization rule of thumb. Under this theory, an observed jump in defaults at the cutoff would imply that securitization led to lax screening. We argue instead that originators adopted credit score cutoff rules in response to underwriting guidelines from Fannie Mae and Freddie Mac and offer a simple model that rationalizes such an origination rule of thumb. Under this alternative theory, jumps in default are not evidence that securitization caused lax screening. We examine loan-level data and find that the evidence is inconsistent with the securitization rule-of-thumb theory but consistent with the origination rule-of-thumb theory. There are jumps in the number of loans and in their default rate at credit score cutoffs in the absence of corresponding jumps in the securitization rate. We conclude that credit score cutoff rules provide evidence that large securitizers were to some extent able to regulate originators' screening behavior.
    Keywords: Mortgage loans ; Credit scoring systems
    Date: 2011
  13. By: Pederson, Glenn D.; Chu, Yu-Szu; Richardson, Wynn
    Keywords: Financial Economics, Risk and Uncertainty,
    Date: 2011–09
  14. By: Hoewer, Daniel; Schmidt, Tobias; Sofka, Wolfgang
    Abstract: Information economics has emerged as the primary theoretical lens for framing financing decisions in firm R&D investment. Successful outcomes of R&D projects are either ex-ante impossible to predict or the information is asymmetrically distributed between inventors and investors. As a result, bank lending for firm R&D has been rare. However, firms can signal the value of their R&D activities and as a result reduce the information deficits that block the availability of external funding. In this study we focus on three types of signals: Firm's existing patent stock, the presences of a joint venture investor and whether the firm has received a government R&D subsidy. We argue theoretically that all of these signals have the potential to alter the risk assessment of the firm's main bank. Additionally, we explore heterogeneities in these risk assessments arising from the industry level and the main bank's portfolio. We test our theoretical predictions for a sample of more than 7,000 firm observations in Germany over a multi-year period. Our theoretical predictions are only supported for firms' past patent activity while other signals fail to alter the risk assessment of a firm's main bank. Besides, we confirm that the risk evaluation is not randomly distributed across bank-firm dyads but depends on industry and bank characteristics. --
    Keywords: Innovation,banking,information asymmetry
    JEL: D82 G30
    Date: 2011
  15. By: Juan Carlos Hatchondo; Leonardo Martinez; Juan M. Sanchez
    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 accounts for non-targeted features of the data such as the distribution of down payments, the life-cycle prole of homeownership, 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 coefficients 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 percent reduces defaults on mortgages by 30 percent, reduces the homeownership 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 percent (if homeownership does not adjust). Garnishing defaulters' income in excess of 43 percent of median consumption for one year produces a similar decline in defaults; but, since it reduces the median equilibrium down payment from 19 percent to 9 percent, it boosts homeownership up to 4.3 percentage points (if the aggregate house price level does not adjust) and may increase house prices up to 16.1 percent (if homeownership does not adjust). The introduction of minimum down payments or income garnishment benefit a majority of the population.
    Keywords: Mortgages ; Default (Finance)
    Date: 2011
  16. By: Efraim Benmelech; Eyal Dvir
    Abstract: Does short-term debt increase vulnerability to financial crisis, or does short-term debt reflect -- rather than cause -- the incipient crisis? We study the role that short-term debt played in the collapse of the East Asian financial sector in 1997-1998. We alleviate concerns about the endogeneity of short-term debt by using long-term debt obligations that matured during the crisis. We find that debt obligations issued at least three years before the crisis had a negative, albeit sometimes insignificant, effect on the probability of failure. Our results are consistent with the view that short-term debt reflects, rather than causes, distress in financial institutions.
    JEL: F32 F34 G21 G32 G38
    Date: 2011–09
  17. By: Andrew Haughwout; Donghoon Lee; Joseph Tracy; Wilbert van der Klaauw
    Abstract: We explore a mostly undocumented but important dimension of the housing market crisis: the role played by real estate investors. Using unique credit-report data, we document large increases in the share of purchases, and subsequently delinquencies, by real estate investors. In states that experienced the largest housing booms and busts, at the peak of the market almost half of purchase mortgage originations were associated with investors. In part by apparently misreporting their intentions to occupy the property, investors took on more leverage, contributing to higher rates of default. Our findings have important implications for policies designed to address the consequences and recurrence of housing market bubbles.
    Keywords: Mortgages ; Financial leverage ; Real estate investment
    Date: 2011
  18. By: Jakob B Madsen; Sarah J Carrington
    Abstract: Microeconomic studies have found cash flow to be important for the investment decision and this result is often interpreted as is evidence of adverse selection in credit markets. Using direct survey evidence on banks’ willingness to lend, this research examines the role of credit in the investment decision while allowing for cash-flow, Tobin’s q, income, uncertainty and default risks. Regression analysis reveals that banks’ willingness to lend, income and uncertainty are the key drivers of cyclical fluctuations in corporate investment. These results have important implications for the conduct of monetary policy as well as research on business cycles.
    Keywords: credit constraints, corporate investment, Tobin’s q
    JEL: E22 E5
    Date: 2011–09

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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