New Economics Papers
on Banking
Issue of 2012‒01‒10
nine papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Consumer credit and payment cards By Wilko Bolt; Elizabeth Foote; Heiko Schmiedel
  2. Credit rating changes’ impact on banks: evidence from the US banking industry By Apergis, Nicholas; Payne, James E.; Tsoumas, Chris
  3. Is the Financial Safety Net a Barrier to Cross-Border Banking? By Bertay, Ata Can; Demirguc-Kunt, Asli; Huizinga, Harry
  4. A smoke screen theory of financial intermediation By Breton, R.
  5. Dependent default and recovery: MCMC study of downturn LGD credit risk model By Pavel V. Shevchenko; Xiaolin Luo
  6. A tale of three countries: recovery after banking crises By Zsolt Darvas
  7. Financial distortions and the distribution of global volatility By Eden, Maya
  8. Resilience to Contagion in Financial Networks By Hamed Amini; Rama Cont; Andreea Minca
  9. Pricing in Retail Payment Systems: A Public Policy Perspective on Pricing of Payment Cards By Wilko Bolt; Sujit Chakravorti

  1. By: Wilko Bolt; Elizabeth Foote; Heiko Schmiedel
    Abstract: We consider debit and credit card networks. Our contribution is to introduce the role of consumer credit into these payment networks, and to assess the way this affects competition and equilibrium fees. We analyze a situation in which overdrafts are associated with current accounts and debit cards, and larger credit lines with ‘grace’ periods are associated with credit cards. If we just introduce credit cards, we find their merchant fees depend not only on the networks’ cost of funds and the probability of default, but also on the interest rates of overdrafts. Whilst debit card merchant fees do not depend on funding costs or default risk in a debit-card only world, this changes when they start to compete with credit cards. First, debit merchant acceptance increases with the default probability, even though merchant fees increase. Second, an increase in funding costs causes a surprising increase in debit merchant fees. Effectively, the bank offering the debit card benefits from consumers maintaining a positive current account balance, when they use their credit instead of their debit card. As a result, this complementarity may lead to relatively high debit card merchant fees as the bank discourages debit card acceptance at the margin.
    Keywords: Payment pricing; Card competition; Consumer credit; Complementarity
    JEL: L11 G21 D53
    Date: 2011–12
  2. By: Apergis, Nicholas; Payne, James E.; Tsoumas, Chris
    Abstract: This study examines the impact of credit rating upgrades and downgrades on six comprehensive banks’ asset classes, profitability, leverage and size using data from the Federal Deposit Insurance Corporation’s call reports and Bloomberg over the period 1989-2008. In summary, the results suggest that a downgrade has a lasting and relatively more severe impact on banks than an upgrade; however, downgraded banks do not seem to effectively reduce their appetite for risk over a longer horizon. It seems that the role of credit rating agencies as an integral part of banks’ prudential supervision through market discipline is, in a longer horizon, overstated.
    Keywords: Credit rating changes; banks; market discipline
    JEL: G28 C21 G21
    Date: 2011–12
  3. By: Bertay, Ata Can; Demirguc-Kunt, Asli; Huizinga, Harry
    Abstract: A bank’s interest expenses are found to increase with its degree of internationalization as proxied by its share of foreign liabilities in total liabilities or a Herfindahl index of international liability concentration, especially if the bank is performing badly. Our benchmark estimation suggests that an international bank’s cost of funds raised through a foreign subsidiary is between 1.5% and 2.4% higher than the cost of funds for a purely domestic bank, which is a sizeable difference given an overall mean cost of funds of 3.3%. These results are consistent with limited incentives for national authorities to bail out an international bank, but also with an international bank recovery and resolution process that is inefficient. In any event, the operation of the financial safety net appears to be a barrier to cross-border banking.
    Keywords: Bank bailouts; Cross-border banking; International burden sharing
    JEL: F36 G21 G28
    Date: 2011–12
  4. By: Breton, R.
    Abstract: This paper explores the role of diversification and size in protecting information. We present a simple two period credit market with a sophisticated lender faced with competitors who free ride on his screening activity. Absent commitment problems, the lender funds one borrower and exerts optimal evaluation. When borrowers cannot commit to a long term relationship, the free riding problem is responsible for too little evaluation. We show how this problem can be mitigated by simultaneously financing several borrowers. This effect provides a rationale for intermediaries as an `information garbling' device.
    Keywords: financial intermediation, informational rent, asymmetric information, free riding, diversification.
    JEL: D82 G00 G21
    Date: 2011
  5. By: Pavel V. Shevchenko; Xiaolin Luo
    Abstract: There is empirical evidence that recovery rates tend to go down just when the number of defaults goes up in economic downturns. This has to be taken into account in estimation of the capital against credit risk required by Basel II to cover losses during the adverse economic downturns; the so-called "downturn LGD" requirement. This paper presents estimation of the LGD credit risk model with default and recovery dependent via the latent systematic risk factor using Bayesian inference approach and Markov chain Monte Carlo method. This approach allows joint estimation of all model parameters and latent systematic factor, and all relevant uncertainties. Results using Moody's annual default and recovery rates for corporate bonds for the period 1982-2010 show that the impact of parameter uncertainty on economic capital can be very significant and should be assessed by practitioners.
    Date: 2011–12
  6. By: Zsolt Darvas
    Abstract: Three small, open European economies â?? Iceland, Ireland and Latvia â?? experienced serious trouble during the global financial crisis. Behind their problems were rapid credit growth and expansion of other banking activities in the years leading up to the crisis, largely financed by international borrowing. The crisis hit Latvia harder than any other country, and Ireland also suffered heavily, while Iceland exited the crisis with the smallest fall in employment, despite the greatest shock to the financial system. The purpose of this Policy Contribution is to compare the policy responses in, and the adjustments made by, the three countries. Based on this comparison, it draws lessons for exchange rate policy, internal devaluation, capital controls, banking sector restructuring and fiscal consolidation. It makes a strong case for a European banking federation.
    Date: 2011–12
  7. By: Eden, Maya
    Abstract: Why are emerging economies excessively vulnerable to shocks to external funding? What was the role of financial flows from emerging to developed economies in setting the stage for the subprime crisis? This paper addresses these questions in a simple general equilibrium framework that emphasizes the aggregate implications of the misallocation of funds on the micro level. The analysis shows that the misallocation of funds amplifies volatility even in a closed economy. Financial integration between relatively distorted emerging economies and relatively undistorted developed economies leads to a further divergence in volatility, thereby providing a new and simple explanation for the divergent trends in output volatility up to the recent crisis. In the integrated environment, cheap funding leads to an endogenous deterioration of the financial system in developed economies. These predictions are consistent with a wide variety of microfoundations, in which distortions cause productive projects to be relatively more sensitive to aggregate shocks. The paper provides some empirical evidence for these microfoundations.
    Keywords: Banks&Banking Reform,Emerging Markets,Debt Markets,Economic Theory&Research,Markets and Market Access
    Date: 2012–01–01
  8. By: Hamed Amini; Rama Cont; Andreea Minca
    Abstract: Propagation of balance-sheet or cash-flow insolvency across financial institutions may be modeled as a cascade process on a network representing their mutual exposures. We derive rigorous asymptotic results for the magnitude of contagion in a large financial network and give an analytical expression for the asymptotic fraction of defaults, in terms of network characteristics. Our results extend previous studies on contagion in random graphs to inhomogeneous directed graphs with a given degree sequence and arbitrary distribution of weights. We introduce a criterion for the resilience of a large financial network to the insolvency of a small group of financial institutions and quantify how contagion amplifies small shocks to the network. Our results emphasize the role played by "contagious links" and show that institutions which contribute most to network instability in case of default have both large connectivity and a large fraction of contagious links. The asymptotic results show good agreement with simulations for networks with realistic sizes.
    Date: 2011–12
  9. By: Wilko Bolt; Sujit Chakravorti
    Abstract: The provision of retail payment services is complex with many participants engaging in a series of interrelated bilateral transactions and subject to large economies of scale and scope along with strong adoption, usage and network externalities. This makes sound public policy difficult. We focus on three types of market interventions for various countries. We argue that intervention into payment markets should concentrate on the removal of entry barriers in payment markets and providing greater incentives to adopt efficient payment instruments without stifling private sector investment in more efficient payment technologies over the long term. While the theoretical literature on the economics of payment cards is growing, the empirical literature is yet too limited to provide much guidance to public authorities. Eventually, the outcomes from different types of market interventions will provide a useful “natural experiment” to refute or validate the various theories of the economics of payments.
    Keywords: Retail payments; market interventions; pricing; public policy
    JEL: L11 G21 D53
    Date: 2011–12

This issue is ©2012 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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