New Economics Papers
on Banking
Issue of 2011‒11‒28
eighteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. On the importance of prior relationships in bank loans to retail customers By Manju Puri; Jörg Rocholl; Sascha Steffen
  2. On the Necessity of Five Risk Measures By Dominique Gu\'egan; Wayne Tarrant
  3. Making Banks Safer: Can Volcker and Vickers Do It? By Jay Surti; Julian T. S. Chow
  4. Bank capital and risk in the South Eastern European region By Panayiotis P. Athanasoglou
  5. Monetary Policy, Bank Leverage, and Financial Stability By Fabian Valencia
  6. Does the European Financial Stability Facility bail out sovereigns or banks? An event study By Horvath, Balint; Huizinga, Harry
  7. Estimating Liquidity Risk Using The Exposure-Based Cash-Flow-at-Risk Approach: An Application To the UK Banking Sector By Meilin Yan; Maximilian J. B. Hall; Paul Turner
  8. A Cost-Benefit Analysis of Basel III: Some Evidence from the UK By Meilin Yan; Maximilian J. B. Hall; Paul Turner
  9. Viewing Risk Measures as Information By Dominique Gu/'egan; Wayne Tarrant
  10. Industry Effects of Bank Lending in Germany By Ivo Arnold; Clemens Kool; Katharina Raabe
  11. Internal Corporate Governance and the Financial Crisis: Lessons for Banks,Regulators and Supervisors By Elisabetta Gualandri; Enzo Mangone; Aldo Stanziale
  12. The role of agency costs in financial conglomeration By Bourjade, Sylvain; Schindele, Ibolya
  13. Models for Moody’s bank ratings By Peresetsky, A. A.; Karminsky, A. M.
  14. Macroprudential Policy: What Instruments and How to Use Them? Lessons from Country Experiences By Cheng Hoon Lim; Alejo Costa; Torsten Wezel; Akira Otani; Francesco Columba; Mustafa Saiyid; X. Wu; Piyabha Kongsamut
  15. Should Derivatives be Privileged in Bankruptcy? By Patrick Bolton; Martin Oehmke
  16. Rapid Credit Growth: Boon or Boom-Bust? By Selim Elekdag; Yiqun Wu
  17. Financial Risk Measurement for Financial Risk Management By Torben G. Andersen; Tim Bollerslev; Peter F. Christoffersen; Francis X. Diebold
  18. Group lending with endogenous group size By Bourjade, Sylvain; Schindele, Ibolya

  1. By: Manju Puri (Duke University, Durham, NC 27708, USA, and NBER); Jörg Rocholl (European School of Management and Technology, Schloßplatz 1, 10178 Berlin, Germany.); Sascha Steffen (University of Mannheim, L5.2, 68131 Mannheim, Germany.)
    Abstract: This paper analyzes the importance of retail consumers’ banking relationships for loan defaults using a unique, comprehensive dataset of over one million loans by savings banks in Germany. We find that loans of retail customers, who have a relationship with their savings bank prior to applying for a loan, default significantly less than customers with no prior relationship. We find relationships matter in different forms, scope, and depth. Importantly, though, even the simplest forms of relationships such as transaction accounts are economically meaningful in reducing defaults, even after controlling for other borrower characteristics as well as internal and external credit scores. Our results suggest that relationships of all kinds have inherent private information and are valuable in screening, in monitoring, and in reducing consumers’ incentives to default. JEL Classification: G20, G21.
    Keywords: Retail banking, relationships, default rates, monitoring, screening.
    Date: 2011–11
  2. By: Dominique Gu\'egan; Wayne Tarrant
    Abstract: The banking systems that deal with risk management depend on underlying risk measures. Following the Basel II accord, there are two separate methods by which banks may determine their capital requirement. The Value at Risk measure plays an important role in computing the capital for both approaches. In this paper we analyze the errors produced by using this measure. We discuss other measures, demonstrating their strengths and shortcomings. We give examples, showing the need for the information from multiple risk measures in order to determine a bank's loss distribution. We conclude by suggesting a regulatory requirement of multiple risk measures being reported by banks, giving specific recommendations.
    Date: 2011–11
  3. By: Jay Surti; Julian T. S. Chow
    Abstract: This paper assesses proposals to redefine the scope of activities of systemically important financial institutions. Alongside reform of prudential regulation and oversight, these have been offered as solutions to the too-important-to-fail problem. It is argued that while the more radical of these proposals such as narrow utility banking do not adequately address key policy objectives, two concrete policy measures - the Volcker Rule in the United States and retail ring-fencing in the United Kingdom - are more promising while still entailing significant implementation challenges. A risk factor common to all the measures is the potential for activities identified as too risky for retail banks to migrate to the unregulated parts of the financial system. Since this could lead to accumulation of systemic risk if left unchecked, it appears unlikely that any structural engineering will lessen the policing burden on prudential authorities and on the banks.
    Keywords: Bank regulations , Bank supervision , Banking , Commercial banks , Fiscal risk , Risk management , Securities markets , United Kingdom , United States ,
    Date: 2011–10–13
  4. By: Panayiotis P. Athanasoglou (Bank of Greece)
    Abstract: This paper examines the simultaneous relationship between bank capital and risk. A model is set up which assumes that banks’ decisions regarding capital and risk are made endogenously in a dynamic pattern. A simultaneous equation system was estimated using an unbalanced panel of SEE banks from 2001 to 2009. A key result for the whole sample of banks is the relationship between regulatory (equity) capital and risk which is positive (negative). However, a positive two-way relationship between regulatory capital and risk was found only in less than-adequately capitalized banks, which also increased substantially their risk in 2009. Thus, banks’ decisions differentiate between equity capital and risk and regulatory capital and risk. A positive, significant and robust effect of liquidity on capital was identified. Both regulatory and equity capital exhibit procyclical behavior, whilst the relationship between risk and rate of growth of GDP is ambitious.
    Keywords: Banking; capital;risk;liquidity;regulation; dynamic panel estimation
    JEL: C33 G21 G32
    Date: 2011–08
  5. By: Fabian Valencia
    Abstract: This paper develops a model to assess how monetary policy rates affect bank risk-taking. In the model, a reduction in the risk-free rate increases lending profitability by reducing funding costs and increasing the surplus the monopolistic bank extracts from borrowers. Under limited liability, this increased profitability affects only upside returns, inducing the bank to take excessive leverage and hence risk. Excessive risk-taking increases as the interest rate decreases. At a broader level, the model illustrates how a benign macroeconomic environment can lead to excessive risk-taking, and thus it highlights a role for macroprudential regulation.
    Keywords: Monetary policy , Bank rates , Profits , Interest rates on loans , Interest rates on deposits , Credit risk , Bank supervision ,
    Date: 2011–10–25
  6. By: Horvath, Balint; Huizinga, Harry
    Abstract: On May 9, 2010 euro zone countries announced the creation of the European Financial Stability Facility as a response to the sovereign debt crisis. This paper investigates the impact of this announcement on bank share prices, bank CDS spreads and sovereign CDS spreads. The main private beneficiaries were bank creditors, especially of banks heavily exposed to southern Europe and Ireland and located in countries characterized by weak public finances. Furthermore, countries with weak public finances and banking systems heavily exposed to southern Europe and Ireland benefited, as evidenced by lower sovereign CDS spreads. The combined gains of bank debt holders and shareholders exceed the increase in the value of their sovereign debt exposures, suggesting that banks saw their contingent claim on the financial safety net increase in value.
    Keywords: Bailout; Banking; CDS spreads; Sovereign debt
    JEL: G21 G28 H63
    Date: 2011–11
  7. By: Meilin Yan (School of Business and Economics, Loughborough University, UK); Maximilian J. B. Hall (School of Business and Economics, Loughborough University, UK); Paul Turner (School of Business and Economics, Loughborough University, UK)
    Abstract: This paper uses a relatively new quantitative model for estimating UK banks' liquidity risk. The model is called the Exposure-Based Cash-Flow-at-Risk (CFaR) model, which not only measures a bank's liquidity risk tolerance, but also helps to improve liquidity risk management through the provision of additional risk exposure information. Using data for the period 1997-2010, we provide evidence that there is variable funding pressure across the UK banking industry, which is forecasted to be slightly illiquid with a small amount of expected cash outflow (i.e. £0.06 billion) in 2011. In our sample of the six biggest UK banks, only the HSBC maintains positive CFaR with 95% confidence, which means that there is only a 5% chance that HSBC's cash flow will drop below £0.67 billion by the end of 2011. RBS is expected to face the largest liquidity risk with a 5% chance that the bank will face a cash outflow that year in excess of £40.29 billion. Our estimates also suggest Lloyds TSB's cash flow is the most volatile of the six biggest UK banks, because it has the biggest deviation between its downside cash flow (i.e. CFaR) and expected cash flow.
    Keywords: Liquidity risk, Exposure-based CFaR, Risk Management, Funding Pressure
    JEL: C15 C22 C87 G21 G32
    Date: 2011–11
  8. By: Meilin Yan (School of Business and Economics, Loughborough University, UK); Maximilian J. B. Hall (School of Business and Economics, Loughborough University, UK); Paul Turner (School of Business and Economics, Loughborough University, UK)
    Abstract: This paper provides a long-term cost-benefit analysis for the United Kingdom of the Basel III capital and liquidity requirements proposed by the Basel Committee on Banking Supervision (BCBS, 2010a). We provide evidence that the Basel III reforms will have a significant net positive long-term effect on the United Kingdom economy. The estimated optimal tangible common equity capital ratio is 10% of risk-weighted assets, which is larger than the Basel III target of 7%. We also estimate the maximum net benefit when banks meet the Basel III longterm liquidity requirements. Our estimated permanent net benefit is larger than the average estimates of the BCBS. This significant marginal benenfit suggests that UK banks need to increase their reliance on common equity in their capital base beyond the level required by Basel III as well as boosting customer deposits as a funding source.
    Keywords: Basel III, Cost-Benefit analysis, Tangible Common Equity Capital, Liquidity
    JEL: C32 C53 G21 G28
    Date: 2011–11
  9. By: Dominique Gu/'egan; Wayne Tarrant
    Abstract: Regulation and risk management in banks depend on underlying risk measures. In general this is the only purpose that is seen for risk measures. In this paper we suggest that the reporting of risk measures can be used to determine the loss distribution function for a financial entity. We demonstrate that a lack of sufficient information can lead to ambiguous risk situations. We give examples, showing the need for the reporting of multiple risk measures in order to determine a bank's loss distribution. We conclude by suggesting a regulatory requirement of multiple risk measures being reported by banks, giving specific recommendations.
    Date: 2011–11
  10. By: Ivo Arnold; Clemens Kool; Katharina Raabe
    Abstract: We investigate the industry dimension of bank lending and its role in the monetary transmission mechanism in Germany. We use dynamic panel methods to estimate bank lending functions for eight industries for the period 1992-2002. Our evidence shows that bank lending growth predominantly depends on the industry composition of bank loan portfolios, both through the underlying cyclical fluctuations in industry-specific bank credit demand and through industry-specific credit supply effects.
    Keywords: Monetary policy transmission, credit channel, industry structure, dynamic panel data
    JEL: C23 E52 G21 L16
    Date: 2011–11
  11. By: Elisabetta Gualandri; Enzo Mangone; Aldo Stanziale
    Abstract: This paper aims to highlight the importance of banks’ Internal Corporate Governance (ICG), viewed as an operational mitigation instrument, in a context where banks enjoy a high degree of organisational flexibility due to principle-based regulatory and risk-based supervisory approaches. The recent crisis has shown, on the one hand, that financial mitigations (i.e. capital requirements) are, per se, not sufficient to ensure the stability of the banks (which underpins the soundness of the entire financial system) and, on the other hand, the failure of the light-touch supervisory approach. The main research question is whether the improvement of ICG, involving proper protection for stakeholders and the switch to a more intrusive supervisory model, will be able to offset the failures of market discipline revealed by the crisis and, together with Basel 3’s reinforced capital adequacy regime, strengthen the resilience of the financial system, without the reintroduction of structural reforms. In the European Union, the new European Systemic Risk Board (ESRB) and, above all, the three new European Supervisory Authorities (ESAs) will play a crucial role in this process.
    Keywords: Banks’ Internal Corporate Governance, Financial Crisis, Operational mitigation,Supervisory approaches, European Supervisory Authorities
    JEL: G21 G28 G34 G38 M4 M42
    Date: 2011–11
  12. By: Bourjade, Sylvain; Schindele, Ibolya
    Abstract: This paper focuses on the role of managerial agency costs in financial conglomeration. We model conglomeration as the integration of commercial and investment banking in one organizational unit where bank managers accomplish both activities. We assume that managers differ in their abilities to undertake the individual tasks. The higher is a manager's ability in undertaking one task, the lower is her disutility of effort for that activity and the higher is her disutility of effort for the other task. When there is no managerial moral hazard, it is not optimal for the bank to form a conglomerate. We show that under managerial moral hazard, forming a conglomerate may be in the bank's interest because it may entail lower agency costs and a larger group of borrowers to fund.
    Keywords: Financial Conglomerates; Commercial Banking; Investment Banking; Banking Organization; Multi-task; Moral Hazard
    JEL: D82 G24 G21
    Date: 2011
  13. By: Peresetsky, A. A.; Karminsky, A. M.
    Abstract: The paper presents an econometric study of the two bank ratings assigned by Moody's Investors Service. According to Moody’s methodology, foreign-currency long-term deposit ratings are assigned on the basis of Bank Finan-cial Strength Ratings (BFSR), taking into account “external bank support factors” (joint-default analysis, JDA). Models for the (unobserved) external support are presented, and we find that models based solely on public infor-mation can approximate the ratings reasonably well. It appears that the ob-served rating degradation can be explained by the growth of the banking sys-tem as a whole. Moody’s has a special approach for banks in developing countries in general and for Russia in particular. The models help reveal the factors that are important for external bank support.
    Keywords: Banks; Ratings; Rating model; Risk evaluation; Early Warning System
    JEL: G32 G21
    Date: 2011
  14. By: Cheng Hoon Lim; Alejo Costa; Torsten Wezel; Akira Otani; Francesco Columba; Mustafa Saiyid; X. Wu; Piyabha Kongsamut
    Abstract: This paper provides the most comprehensive empirical study of the effectiveness of macroprudential instruments to date. Using data from 49 countries, the paper evaluates the effectiveness of macroprudential instruments in reducing systemic risk over time and across institutions and markets. The analysis suggests that many of the most frequently used instruments are effective in reducing pro-cyclicality and the effectiveness is sensitive to the type of shock facing the financial sector. Based on these findings, the paper identifies conditions under which macroprudential policy is most likely to be effective, as well as conditions under which it may have little impact.
    Keywords: Banks , Capital inflows , Credit risk , Cross country analysis , Developed countries , Emerging markets , Exchange rate regimes , Financial risk , Financial sector , Fiscal policy , Liquidity , Monetary policy ,
    Date: 2011–10–19
  15. By: Patrick Bolton; Martin Oehmke
    Abstract: Derivative contracts, swaps, and repos enjoy "super-senior" status in bankruptcy: they are exempt from the automatic stay on debt and collateral collection that applies to virtually all other claims. We propose a simple corporate finance model to assess the effect of this exemption on firms' cost of borrowing and incentives to engage in swaps and derivatives transactions. Our model shows that while derivatives are value-enhancing risk management tools, super-seniority for derivatives can lead to inefficiencies: collateralization and effective seniority of derivatives shifts credit risk to the firm's creditors, even though this risk could be borne more efficiently by derivative counterparties. In addition, because super-senior derivatives dilute existing creditors, they may lead firms to take on derivative positions that are too large from a social perspective. Hence, derivatives markets may grow inefficiently large in equilibrium.
    JEL: G21 G33
    Date: 2011–11
  16. By: Selim Elekdag; Yiqun Wu
    Abstract: Episodes of rapid credit growth, especially credit booms, tend to end abruptly, typically in the form of financial crises. This paper presents the findings of a comprehensive event study focusing on 99 credit booms. Loose monetary policy stances seem to have contributed to the build-up of credit booms across both advanced and emerging economies. In particular, domestic policy rates were below trend during the pre-peak phase of credit booms and likely fuelled macroeconomic and financial imbalances. For emerging economies, while credit booms are associated with episodes of large capital inflows, international interest rates (a proxy for global liquidity) are virtually flat during these periods. Therefore, although external factors such as global liquidity conditions matter, and possibly increasingly so over time, domestic factors (especially monetary policy) also appear to be important drivers of real credit growth across emerging economies.
    Keywords: Asia , Credit expansion , Monetary policy , Liquidity , Capital inflows , Financial crisis , Interest rates , Bank soundness , Corporate sector , International liquidity ,
    Date: 2011–10–20
  17. By: Torben G. Andersen (Kellogg School of Management, Northwestern University); Tim Bollerslev (Department of Economics, Duke University); Peter F. Christoffersen (Rotman School of Management, University of Toronto); Francis X. Diebold (Department of Economics, University of Pennsylvania)
    Abstract: Current practice largely follows restrictive approaches to market risk measurement, such as historical simulation or RiskMetrics. In contrast, we propose flexible methods that exploit recent developments in financial econometrics and are likely to produce more accurate risk assessments, treating both portfolio-level and asset-level analysis. Asset-level analysis is particularly challenging because the demands of real-world risk management in financial institutions - in particular, real-time risk tracking in very high-dimensional situations - impose strict limits on model complexity. Hence we stress powerful yet parsimonious models that are easily estimated. In addition, we emphasize the need for deeper understanding of the links between market risk and macroeconomic fundamentals, focusing primarily on links among equity return volatilities, real growth, and real growth volatilities. Throughout, we strive not only to deepen our scientific understanding of market risk, but also cross-fertilize the academic and practitioner communities, promoting improved market risk measurement technologies that draw on the best of both.
    Keywords: Market risk, volatility, GARCH
    JEL: C1 G1
    Date: 2011–11–02
  18. By: Bourjade, Sylvain; Schindele, Ibolya
    Abstract: This paper focuses on the size of the borrower group in group lending. We show that, when social ties in a community enhance borrowers' incentives to exert effort, a profit-maximizing financier chooses a group of limited size. Borrowers that would be fundable under moral hazard but have insufficient social ties do not receive funding. The result arises because there is a trade-off between raising profits through increased group size and providing incentives for borrowers with less social ties. The result may explain why many micro-lending institutions and rural credit cooperatives lend to groups of small size.
    Keywords: Group Lending; Moral Hazard; Social Capital
    JEL: D82 G21
    Date: 2011

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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