New Economics Papers
on Banking
Issue of 2012‒03‒28
37 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. The Procyclical Effects of Bank Capital Regulation By Repullo, Rafael; Suarez, Javier
  2. Financial Integration, Specialization, and Systemic Risk By Fecht, Falko; Grüner, Hans Peter; Hartmann, Philipp
  3. Sizing Up Repo By Krishnamurthy, Arvind; Nagel, Stefan; Orlov, Dmitry
  4. The Seeds of a Crisis: A Theory of Bank Liquidity and Risk-Taking over the Business Cycle By Acharya, Viral V; Naqvi, Hassan
  5. The Quality of Private Monitoring in European Banking: Completing the Picture By Adrian Pop; Diana Pop
  6. Precautionary hoarding of liquidity and inter-bank markets: Evidence from the sub-prime crisis By Acharya, Viral V; Merrouche, Ouarda
  7. Aggregate Investment Externalities and Macroprudential Regulation By Gersbach, Hans; Rochet, Jean-Charles
  8. The cross-country magnitude and determinants of collateral borrowing By Nguyen, Ha; Qian, Rong
  9. Caught between Scylla and Charybdis? Regulating bank leverage when there is rent-seeking and risk-shifting By Acharya, Viral V; Mehran, Hamid; Thakor, Anjan
  10. Efficiency of Commercial Banks in Sub-Saharan Africa: A Comparative Analysis of Domestic and Foreign Banks By Kiyota, Hiroyuki
  11. Securitization Without Risk Transfer By Acharya, Viral V; Schnabl, Philipp; Suarez, Gustavo
  12. International shock transmission after the Lehman Brothers collapse – evidence from syndicated lending By Ralph De Haas; Neeltje Van Horen
  13. Robust Capital Regulation By Acharya, Viral V; Mehran, Hamid; Schuermann, Til; Thakor, Anjan
  14. Contagion in financial networks: A threat index By Demange, Gabrielle
  15. Dividends and Bank Capital in the Financial Crisis of 2007-2009 By Acharya, Viral V; Gujral, Irvind; Kulkarni, Nirupama; Shin, Hyun Song
  16. Interactions between bank behavior and financial structure: evidence from a developing country By Bakis, Ozan; Karanfil, Fatih; Polat, Sezgin
  17. Monetary policy, bank size and bank lending: evidence from Australia(new version) By liu, luke
  18. Securitization and Bank Intermediation Function By Maxim Zagonov
  19. What role, if any, can market discipline play in supporting macroprudential policy? By María J. Nieto
  20. Measuring Systemic Risk By Acharya, Viral V; Pedersen, Lasse H; Philippon, Thomas; Richardson, Matthew P
  21. Determinants of Banking System Fragility: A Regional Perspective By Degryse, Hans; Elahi, Muhammad Ather; Penas, Maria Fabiana
  22. Vulnerable Banks By Greenwood, Robin; Landier, Augustin; Thesmar, David
  23. Determinants of default ratios in the segment of loans to households in Spain By Roberto Blanco; Ricardo Gimeno
  24. The contagious capacity of the international banking network: 1985-2009 By Garratt, Rodney; Mahadeva, Lavan; Svirydzenka, Katsiaryna
  25. Fiscal Policy in a Financial Crisis: Standard Policy vs. Bank Rescue Measures By Kollmann, Robert; Roeger, Werner; Veld, Jan in't
  26. Bank Bonuses and Bail-outs By Hakenes, Hendrik; Schnabel, Isabel
  27. The Role of Central Banks in Financial Stability: How has it changed? By Buiter, Willem H.
  28. Catalyst of Disaster: Subprime Mortgage Securitization and the Roots of the Great Recession By Fligstein, Neil; Goldstein, Adam
  29. How is financial regulation different for micro-finance? By M. Sahoo; Renuka Sane; Susan Thomas
  30. Pitfalls in Backtesting Historical Simulation VaR Models By Juan Carlos Escanciano; Pei Pei
  31. The ECB and the Interbank Market By Giannone, Domenico; Lenza, Michele; Pill, Huw; Reichlin, Lucrezia
  32. Mega-Banks' Self-Insurance with Cocos: A Work in Progress By George M. von Furstenberg
  33. What Explains the Rise in CEO Pay in Germany? A Panel Data Analysis for 1977-2009 By Fabbri, Francesca; Marin, Dalia
  34. The risk-Shifting Hypothesis : Evidence from Subprime Originations By Landier, Augustin; Sraer, David; Thesmar, David
  35. The Role of Equity Funds in the Financial Crisis Propagation By Hau, Harald; Lai, Sandy
  36. Economies of Scale in Banking, Confidence Shocks, and Business Cycles By Scott J. Dressler; Erasmus K. Kersting
  37. Central-banking challenges for the Riksbank: Monetary policy, financial-stability policy and asset management By Svensson, Lars E O

  1. By: Repullo, Rafael; Suarez, Javier
    Abstract: We develop and calibrate a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period and the business cycle is a Markov process that determines loans' probabilities of default. Banks anticipate that shocks to their earnings and the possible variation of capital requirements over the cycle can impair their future lending capacity and, as a precaution, hold capital buffers. We compare the relative performance of several capital regulation regimes, including one that maximizes a measure of social welfare. We show that Basel II is significantly more procyclical than Basel I, but makes banks safer. For this reason, it dominates Basel I in terms of welfare except for small social costs of bank failure. We also show that for high values of this cost, Basel III points in the right direction, with higher but less cyclically-varying capital requirements.
    Keywords: Banking regulation; Basel capital requirements; Capital market frictions; Credit rationing; Loan defaults; Relationship banking; Social cost of bank failure
    JEL: E44 G21 G28
    Date: 2012–03
  2. By: Fecht, Falko; Grüner, Hans Peter; Hartmann, Philipp
    Abstract: This paper studies the implications of cross-border financial integration for financial stability when banks' loan portfolios adjust endogenously. Banks can be subject to sectoral and aggregate domestic shocks. After integration they can share these risks in a complete interbank market. When banks have a comparative advantage in providing credit to certain industries, financial integration may induce banks to specialize in lending. An enhanced concentration in lending does not necessarily increase risk, because a well-functioning interbank market allows to achieve the necessary diversification. This greater need for risk sharing, though, increases the risk of cross-border contagion and the likelihood of widespread banking crises. However, even though integration increases the risk of contagion it improves welfare if it permits banks to realize specialization benefits.
    Keywords: financial contagion; Financial integration; interbank market; risk sharing; specialization
    JEL: D61 E44 G21
    Date: 2012–02
  3. By: Krishnamurthy, Arvind; Nagel, Stefan; Orlov, Dmitry
    Abstract: We measure the repo funding extended by money market funds (MMF) and securities lenders to the shadow banking system, including quantities, haircuts, and repo rates by type of underlying collateral. We find that repo played only a small role in funding private sector assets prior to the crisis, as most repos are backed by Treasury and Agency collateral. Repo with private sector collateral contracts during the crisis, but the magnitude is relatively insignificant compared with the contraction in asset-backed commercial paper (ABCP). While relatively small in aggregate, the contraction in repo particularly affected key dealer banks with large exposures to private sector securities, which then had knock-on effects on security markets, and led these dealer banks to resort to the Fed's emergency lending programs. We also find that haircuts in MMF-to-dealer repo rise less than the dealer-to-dealer or dealer-to-hedge fund repo haircuts reported in earlier papers. This finding suggests that the contraction in repo led dealers to take defensive actions, given their own capital and liquidity problems, raising credit terms to their borrowers. The picture that emerges from these findings looks less like a traditional bank run of depositors and more like a credit crunch among dealer banks.
    Keywords: Dealer Banks; Financial Crisis; Repurchase Agreements; Shadow Banking
    JEL: E51 G01 G21 G24
    Date: 2012–02
  4. By: Acharya, Viral V; Naqvi, Hassan
    Abstract: We examine how the banking sector may ignite the formation of asset price bubbles when there is access to abundant liquidity. Inside banks, to induce effort, loan officers are compensated based on the volume of loans. Volumebased compensation also induces greater risk-taking; however, due to lack of commitment, loan officers are penalized ex post only if banks suffer a high enough liquidity shortfall. Outside banks, when there is heightened macroeconomic risk, investors reduce direct investment and hold more bank deposits. This ‘flight to quality’ leaves banks flush with liquidity, lowering the sensitivity of bankers’ payoffs to downside risks and inducing excessive credit volume and asset price bubbles. The seeds of a crisis are thus sown.
    Keywords: bubbles; flight to quality; moral hazard
    JEL: E32 G21
    Date: 2012–02
  5. By: Adrian Pop (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Diana Pop (GRANEM - Department of Law, Economics, and Management - Université d'Angers)
    Abstract: The philosophy behind the debt market discipline approach to banking regulation presumes that the pricing of bank debt securities, if accurate, conveys reliable signals to supervisors. In this paper, we take a critical look at the feasibility of such an approach by exploring empirically the possibility that markets may price differently the risk profile of bank issuers along the empirical distribution of credit spread. The paper proposes a quantile regression framework to draw novel inferences about the functioning of market discipline and the quality of private monitoring in European banking and provides a more comprehensive picture of the distribution of spreads conditional on its main explanatory factors. We find that the spread-risk relationship is systematically steeper and more significant at the "right-tail" of the conditional distribution of credit spread, which suggests that the market is somewhat tougher with "high-risk" banks.
    Keywords: Banking regulation and supervision; Market discipline; Subordinated debt; Private monitoring; Credit spreads; Quantile regression
    Date: 2012–03–14
  6. By: Acharya, Viral V; Merrouche, Ouarda
    Abstract: We study the liquidity demand of large settlement (first-tier) banks in the UK and its effect on the Sterling Money Markets before and during the sub-prime crisis of 2007-08. Liquidity holdings of large settlement banks experienced on average a 30% increase in the period immediately following 9th August, 2007, the day when money markets froze, igniting the crisis. In the UK, unlike in the US until October 2008, the remuneration of reserves accounts provides strong incentives for banks to park liquidity at the central bank rather than lend in the market. We show that following this structural break, settlement bank liquidity had a precautionary nature in that it rose on calendar days with a large amount of payment activity and for banks with greater credit risk. We establish that the liquidity demand by settlement banks caused overnight inter-bank rates to rise and volumes to decline, an effect virtually absent in the pre-crisis period. This liquidity effect on inter-bank rates occurred in both unsecured borrowing as well as borrowing secured by UK government bonds. Further, using bilateral data we show that the effect was more strongly linked to lender risk than to borrower risk.
    Keywords: cash; contagion; counterparty risk; funding risk; money markets; rollover risk; systemic risk
    JEL: E42 E58 G21 G28
    Date: 2012–02
  7. By: Gersbach, Hans; Rochet, Jean-Charles
    Abstract: Evidence suggests that banks tend to lend a lot during booms, and very little during recessions. We propose a simple explanation for this phenomenon. We show that, instead of dampening productivity shocks, the banking sector tends to exacerbate them, leading to excessive fluctuations of credit, output and asset prices. Our explanation relies on three ingredients that are characteristic of modern banks' activities. The first ingredient is moral hazard: banks are supposed to monitor the small and medium sized enterprises that borrow from them, but they may shirk on their monitoring activities, unless they are given sufficient informational rents. These rents limit the amount that investors are ready to lend them, to a multiple of the banks' own capital. The second ingredient is the banks' high exposure to aggregate shocks: banks' assets have positively correlated returns. Finally the third ingredient is the ease with which modern banks can reallocate capital between different lines of business. At the competitive equilibrium, banks offer privately optimal contracts to their investors but these contracts are not socially optimal: banks' decisions of reallocating capital react too strongly to aggregate shocks. This is because banks do not internalize the impact of their decisions on asset prices. This generates excessive fluctuations of credit, output and asset prices. We examine the efficacy of several possible policy responses to these properties of credit markets, and derive a rationale for macroprudential regulation.
    Keywords: Bank Credit Fluctuations; Investment Externalities; Macroprudential Regulation
    JEL: D86 G21 G28
    Date: 2012–01
  8. By: Nguyen, Ha; Qian, Rong
    Abstract: Using the World Bank Enterprise Survey covering 6,800 firms across 43 developing countries, this paper investigates the prevalence and determinants of collateralized borrowing. It focuses on the following two aspects: (1) whether firms'loans from financial institutions require collateral (the extensive margin) and (2) the collateral value relative to the loan value (the intensive margin). On the first aspect, it finds that collateral borrowing is prevalent. On average, 73 percent of loans from financial institutions require collateral. Firms that are small or sell domestically are significantly less likely to pledge collateral. Shorter loans and loans from non-bank financial institutions are also less often associated with collateral. On the second aspect, it finds that on average the loan value is at least 72 percent of the collateral value. The only robust and significant determinants of the collateral value are the type of assets used for collateral. The analysis also checks whether countries'income and institutions affect collateralized borrowing. It finds that firms in countries with higher income and better institutions and credit information are significantly less likely to pledge collateral. These factors, however, have little impact on collateral values.
    Keywords: Access to Finance,Debt Markets,Bankruptcy and Resolution of Financial Distress,Banks&Banking Reform,Emerging Markets
    Date: 2012–03–01
  9. By: Acharya, Viral V; Mehran, Hamid; Thakor, Anjan
    Abstract: We consider a model in which banks face two moral hazard problems: 1) asset substitution by shareholders, which can occur when banks make socially-inefficient, risky loans; and 2) managerial under-provision of effort in loan monitoring. The privately-optimal level of bank leverage is neither too low nor too high: It efficiently balances the market discipline that owners of risky debt impose on managerial shirking in monitoring loans against the asset substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank creditors. Anticipation of this action generates an equilibrium featuring systemic risk, in which all banks choose inefficiently high leverage to fund correlated, excessively risky assets. That is, regulatory forbearance itself becomes a source of systemic risk. Leverage can be reduced via a minimum equity capital requirement, which can rule out asset substitution. But this also compromises market discipline by making bank debt too safe. Optimal capital regulation requires that a part of bank capital be invested in safe assets and be attached with contingent distribution rights, in particular, be unavailable to creditors upon failure so as to retain market discipline and be made available to shareholders only contingent on good performance in order to contain risk-taking.
    Keywords: asset substitution; bailout; market discipline; systemic risk
    JEL: G21 G28 G32 G35 G38
    Date: 2012–02
  10. By: Kiyota, Hiroyuki
    Abstract: Utilizing the stochastic frontier approach, this study conducts a comparative analysis of profit efficiency and cost inefficiency of commercial banks operating in 29 sub-Saharan African (SSA) countries by bank ownership (domestic bank, SSA foreign bank or non-SSA foreign bank), as well as by the bank size during 2000-07. Tobit regressions are employed to assess the impact of environmental factors on the efficiency of commercial banks. The key findings of this empirical analysis suggest that foreign banks tend to outperform domestic banks in terms of profit efficiency. In terms of efficiency by bank size, the smaller the bank, the more profit efficient the bank will be; medium or relatively large banks tend to be the most cost efficient.
    Keywords: banking, stochastic frontier, Tobit regression, Africa
    Date: 2011
  11. By: Acharya, Viral V; Schnabl, Philipp; Suarez, Gustavo
    Abstract: We analyze asset-backed commercial paper conduits, which experienced a shadow-banking "run" and played a central role in the early phase of the financial crisis of 2007-09. We document that commercial banks set up conduits to securitize assets worth $1.3 trillion while insuring the newly securitized assets using explicit guarantees. We show that regulatory arbitrage was the main motive behind setting up conduits: the guarantees were structured so as to reduce regulatory capital requirements, more so by banks with less capital, and while still providing recourse to bank balance sheets for outside investors. Consistent with such recourse, we find that conduits provided little risk transfer during the "run": losses from conduits remained with banks rather than outside investors and banks with more exposure to conduits had lower stock returns.
    Keywords: asset-backed commercial paper (ABCP); bank capital; conduits; regulatory arbitrage; shadow banking; structured investment vehicle (SIV)
    JEL: G01 G21 G28
    Date: 2012–01
  12. By: Ralph De Haas (EBRD); Neeltje Van Horen (De Nederlandsche Bank)
    Abstract: After Lehman Brothers filed for bankruptcy in September 2008, cross-border bank lending contracted sharply. To explain the severity and variation in this contraction, we analyse detailed data on cross-border syndicated lending by 75 banks to 59 countries. We find that banks that had to write down sub-prime assets, refinance large amounts of long-term debt, and experienced sharp declines in their market-to-book ratio, transmitted these shocks across borders by curtailing their lending abroad. While shocked banks differentiated among countries in much the same way as less constrained banks, they restricted their lending more to small borrowers.
    Keywords: Crisis transmission, cross-border lending, syndicated loans
    JEL: F36 F42 F52 G15 G21 G28
    Date: 2012–01
  13. By: Acharya, Viral V; Mehran, Hamid; Schuermann, Til; Thakor, Anjan
    Abstract: We address the following questions concerning bank capital: why are banks so highly levered, what are the consequences of this leverage for the economy as a whole, and how can robust capital regulation be designed to restrict bank leverage to levels that do not generate excessive systemic risk? Bank leverage choices are a delicate balancing act: credit discipline argues for more leverage so that creditors have adequate skin in the game, while balance-sheet opacity and ease of asset substitution by bank managers and shareholders argue for less. Disturbing this balance are regulatory safety nets that promote ex post financial stability but also create perverse incentives for banks to engage in correlated asset choices ex ante and thus hold little equity capital. We discuss how a two-tier capital requirement can cope with these distortions: a core capital requirement like existing capital requirements, and a special capital account that must be invested in Treasuries, accrues to the bank’s shareholders as long as the bank is solvent, and accrues to the regulators (rather than the creditors) if the bank fails. The special capital account requirement ensures creditors have skin in the game and also provides the second margin of safety in the calculation of capital adequacy--a buffer for the regulator’s own "model risk" in calculations of needed capital buffers.
    Keywords: capital requirements; leverage; market discipline; model risk; systemic risk
    JEL: G12 G21
    Date: 2012–01
  14. By: Demange, Gabrielle
    Abstract: An intricate web of claims and obligations ties together the balance sheets of a wide variety of financial institutions. Under the occurrence of default, these interbank claims generate externalities across institutions and possibly disseminate defaults and bankruptcy. Building on a simple model for the joint determination of the repayments of interbank claims, this paper introduces a measure of the threat that a bank poses to the system. Such a measure, called threat index, may be helpful to determine how to inject cash into banks so as to increase debt reimbursement, or to assess the contributions of individual institutions to the risk in the system. Although the threat index and the default level of a bank both reflect some form of weakness and are affected by the whole liability network, the two indicators differ. As a result, injecting cash into the banks with the largest default level may not be optimal.
    Keywords: bankruptcy; contagion; Contagion in financial networks : a threat index; financial linkages; systemic risk
    JEL: G01 G21 G28
    Date: 2012–02
  15. By: Acharya, Viral V; Gujral, Irvind; Kulkarni, Nirupama; Shin, Hyun Song
    Abstract: The headline numbers appear to show that even as banks and financial intermediaries suffered large credit losses in the financial crisis of 2007-09, they raised substantial amounts of new capital, both from private investors and through government-funded capital injections. However, on closer inspection the composition of bank capital shifted radically from one based on common equity to that based on debt-like hybrid claims such as preferred equity and subordinated debt. The erosion of common equity was exacerbated by large scale payments of dividends, in spite of widely anticipated credit losses. Dividend payments represent a transfer from creditors (and potentially taxpayers) to equity holders in violation of the priority of debt over equity. The dwindling pool of common equity in the banking system may have been one reason for the continued reluctance by banks to lend over this period. We draw conclusions on how capital regulation may be reformed in light of our findings.
    Keywords: asset substitution; crisis; regulatory capital; risk-shifting
    JEL: G21 G28 G32 G35 G38
    Date: 2012–02
  16. By: Bakis, Ozan (Galatasaray University Economic Research Center); Karanfil, Fatih (Galatasaray University Economic Research Center); Polat, Sezgin (Galatasaray University Economic Research Center)
    Abstract: We use time-series analysis to examine bank behavior with respect to credit supply employing both banking data and other financial variables for the Turkish economy over the 1990 – 2009 period. We provide a vector error-correction (VEC) model to test for multivariate cointegration and Granger causality. More specifically, this paper seeks to fill the gap on how the bank behavior interacts with the financial structure given the conditions of macroeconomic policy. Our findings suggest that Granger causality is present between credit-deposit ratio and maturity of time deposits which implies that depositor decision on maturity changes the composition of balance sheet of banks leading to low credit creation. This result implies that macroeconomic uncertainty and instability lead to a kind of credit contraction with the decrease of deposit maturity. Our results also reveal that economic cycles are credit-driven in Turkey.
    Keywords: Credit-deposit ratio; deposit maturity; Granger causality
    JEL: C32 E50 G21
    Date: 2012–03–21
  17. By: liu, luke
    Abstract: This study explores how monetary policy changes flow through the banking sector in Australia. Drawing on data between 2004 and 2010, we divide banks into three groups according to their size, and examine the impact of cash rate change on lending of different types of loans. We found the response of bank lending after a monetary policy change varies with the size of the bank as well as the types of loan.
    Keywords: monetary policy; transmission mechanism; bank size
    JEL: E42 E52 G32
    Date: 2012–03–19
  18. By: Maxim Zagonov (Toulouse Business School, University of Toulouse)
    Abstract: The move from the originate-to-hold to originate-to-distribute model of lending profoundly transformed the functioning of credit markets and weakened the natural asset transformation function performed by financial intermediaries for centuries. This shift also compromised the role of banks in channeling monetary policy initiatives, and undermined the importance of traditional asset-liability practices of interest rate risk management. The question is, therefore, whether securitisation is conducive to the optimal hedging of bank interest rate risk. The empirical results reported in this work suggest that banks resorting to securitisation do not, on average, achieve an unambiguous reduction in their exposure to the term structure fluctuations. Against this background, banks with very high involvement in the originate-to-distribute market enjoy lower interest rate risk. This however by no means implies superior risk management practices in these institutions but is merely a result of disintermediation.
    Keywords: Banks; Interest rate risk; Securitisation
    JEL: G21 G28 E52 C23
    Date: 2011–11–23
  19. By: María J. Nieto (Banco de España)
    Abstract: This paper focuses on market discipline as a necessary condition to preserve the signaling content of balance sheet indicators and market prices as macroprudential tools. It argues that market discipline enhances the information content of market prices by reflecting the expected private cost of financial distress, including the systemic importance of particular firms. This paper also argues that three conditions are necessary for market discipline to be effective: adequate and timely information on financial institutions’ risk profiles; financial institutions’ creditors must consider themselves at risk; and the reaction to market signals needs to be observable. The paper relies on the existing financial literature and it is particularly timely because policymakers are considering structural measures of banks’ systemic importance as a benchmark for macroprudential policy.
    Keywords: Financial crisis, international financial markets, financial regulation, financial institutions, bankruptcy, liquidation
    JEL: G17 G19 G21 G29 G34
    Date: 2012–03
  20. By: Acharya, Viral V; Pedersen, Lasse H; Philippon, Thomas; Richardson, Matthew P
    Abstract: We present a simple model of systemic risk and we show that each financial institution's contribution to systemic risk can be measured as its systemic expected shortfall (SES), i.e., its propensity to be undercapitalized when the system as a whole is undercapitalized. SES increases with the institution's leverage and with its expected loss in the tail of the system's loss distribution. Institutions internalize their externality if they are ‘taxed’ based on their SES. We demonstrate empirically the ability of SES to predict emerging risks during the financial crisis of 2007-2009, in particular, (i) the outcome of stress tests performed by regulators; (ii) the decline in equity valuations of large financial firms in the crisis; and, (iii) the widening of their credit default swap spreads.
    Keywords: bailout; financial regulation; systemic risk; value at risk
    JEL: G01 G18
    Date: 2012–02
  21. By: Degryse, Hans; Elahi, Muhammad Ather; Penas, Maria Fabiana
    Abstract: Banking systems are fragile not only within one country but also within and across regions. We study the role of regional banking system characteristics for regional banking system fragility. We find that regional banking system fragility reduces when banks in the region jointly hold more liquid assets, are better capitalized, and when regional banking systems are more competitive. For Asia and Latin-America, a greater presence of foreign banks also reduces regional banking fragility. We further investigate the possibility of contagion within and across regions. Within region banking contagion is important in all regions but it is substantially lower in the developed regions compared to emerging market regions. For cross-regional contagion, we find that the contagion effects of Europe and the US on Asia and Latin America are significantly higher compared to the effect of Asia and Latin America among themselves. Finally, the impact of cross-regional contagion is attenuated when the host region has a more liquid and more capitalized banking sector.
    Keywords: banking system stability; cross-regional contagion; financial integration
    JEL: G15 G20 G29
    Date: 2012–02
  22. By: Greenwood, Robin; Landier, Augustin; Thesmar, David
    Abstract: When a bank experiences an adverse shock to its equity capital, one way to return to target leverage is to sell assets. The price impact of the fire sale may impact other institutions with common exposures, resulting in contagion. We propose a simple framework that accounts for this effect. This framework explains how the distribution of leverage and risk exposures across banks contributes to systemic risk. We use it to compute a bank's exposure to sector-wide deleveraging, as well as the spillover of a bank's deleveraging onto other banks. We explain how the model can be used to evaluate a variety of policy proposals, such as caps on size or leverage, mergers of good and bad banks, and equity injections. We then apply the framework to measure (a) the vulnerability of European banks to sovereign risk in 2010 and 2011, and (b) the vulnerability of US financial institutions between 2001 and 2010. In our model, \microprudential" interventions, which target the solvency of individual banks are always less effective than \macroprudential", policies which aim to minimize spillovers across firms.
    Date: 2011–11
  23. By: Roberto Blanco (Banco de España); Ricardo Gimeno (Banco de España)
    Abstract: In this paper we present the estimation results of a dynamic panel data model that explains the dynamic behaviour of default ratios in Spain for loans extended to the household sector. We estimate the models for two alternative definitions of default and for two different loan categories. The dataset consists of a panel of 50 provinces and covers the period 1984-2009. The results of the models show that the dynamic behaviour of the default ratios of loans extended to Spanish households can be reasonably well characterised with the lagged LHS variable, and the contemporaneous and the lagged values of credit growth, the unemployment rate and the interest debt burden. We find that the increase in the unemployment rate was the main driver of the sharp rise in default ratios between 2007 and 2009 in Spain and that the fall in interest rates since the end of 2008 contributed to moderating the upward path of default ratios in 2009. We also find that there is strong evidence of asymmetrical effects of unemployment ratios on default ratios, and differences between banks and savings banks in their sensitivity to the cycle
    Keywords: Default ratios, non-performing loans, household finances, financial pressure
    JEL: D14 C23 G21
    Date: 2012–02
  24. By: Garratt, Rodney; Mahadeva, Lavan; Svirydzenka, Katsiaryna
    Abstract: Systemic risk among the network of international banking groups arises when financial stress threatens to crisscross many national boundaries and expose imperfect international coordination. To assess this risk, we use Rosvall and Bergstrom’s (PNAS, 2008, 1118-1123) information theoretic map equation to partition banking groups from 21 countries into modules. We consider a quarter of a century of data on the cross-border interbank market. We show that in the late 1980s four important financial centres formed one large super cluster that was highly contagious in terms of transmission of stress within its ranks, but less contagious on a global scale. But the expansion leading to the 2008 crisis left more transmitting hubs sharing the same total influence as a few large modules had previously. We show that this greater entanglement meant the network was more broadly contagious, and not that risk was more shared. Thus, our analysis contributes to our understanding as to why defaults in US sub-prime mortgages spread quickly through the network.
    Keywords: International Economics, Economics, General, Contagion, Finance, Networks
    Date: 2011–10–16
  25. By: Kollmann, Robert; Roeger, Werner; Veld, Jan in't
    Abstract: A key dimension of fiscal policy during the financial crisis was massive government support for the banking system. The macroeconomic effects of that support have, so far, received little attention in the literature. This paper fills this gap, using a quantitative dynamic model with a banking sector. Our results suggest that state aid for banks may have a strong positive effect on real activity. Bank state aid multipliers are in the same range as conventional fiscal spending multipliers. Support for banks has a positive effect on investment, while a rise in government purchases crowds out investment.
    Keywords: financial crisis; fiscal stimulus; real activity; state support for banks
    JEL: E62 E63 G21 G28 H25
    Date: 2012–02
  26. By: Hakenes, Hendrik; Schnabel, Isabel
    Abstract: This paper shows that bonus contracts may arise endogenously as a response to agency problems within banks, and analyzes how compensation schemes change in reaction to anticipated bail-outs. If there is a risk-shifting problem, bail-out expectations lead to steeper bonus schemes and even more risk-taking. If there is an effort problem, the compensation scheme becomes flatter and effort decreases. If both types of agency problems are present, a sufficiently large increase in bail-out perceptions makes it optimal for a welfare-maximizing regulator to impose caps on bank bonuses. In contrast, raising managers’ liability is counterproductive.
    Keywords: bank bail-outs; bank management compensation; bonus payments; limited and unlimited liability; risk-shifting; underinvestment
    JEL: G21 G28 J33 M52
    Date: 2012–02
  27. By: Buiter, Willem H.
    Abstract: The roles of central banks in the advanced economies have expanded and multiplied since the beginning of the crisis. The conventional monetary policy roles - setting interest rates in the pursuit of macroeconomic stability and acting as lender of last resort and market maker of last resort to provide funding liquidity and market liquidity to illiquid but insolvent counterparties - have both been transformed. With official policy rates near or at the effective lower bound, the size of the central bank's balance sheet and the composition of its assets and liabilities have become the new, 'poor man's', monetary policy instruments. The LLR and MMLR roles have expanded to include solvency support for SIFIs and, in the euro area, the provision of liquidity support and solvency support for sovereigns also. Concentrating too many financial stability responsibilities, including macro-prudential and micro-prudential regulation, in the central bank risks undermining the independence of the central bank where it is likely to be useful -- the conventional monetary policy roles. The non-inflationary loss-absorption capacity (NILAC) of the leading central banks is vast. For the ECB/Eurosystem we estimate it at no less than EUR3.2 trillion, for the Fed at over $7 trillion. This is tax payers' money that is not under the effective control of the fiscal authorities. The central banks have used their balance sheets and their NILACs to engage in quasi-fiscal actions that have been essential to prevent even greater financial turmoil and possible disaster, but that also have important distributional impacts between sectors, financial institutions, individuals and nations. The ECB was forced into this illegitimate role by the fiscal vacuum at the heart of the euro area; the Fed by the fiscal paralysis of the US Federal government institutions.
    Keywords: Accountability; Central banks; Financial stability; Non-inflationary loss absorption capacity
    JEL: E41 E52 E58 E63 G01 H63
    Date: 2012–01
  28. By: Fligstein, Neil; Goldstein, Adam
    Keywords: Social Sciences, Mortgage Crisis, Securitization, Subprime Lending
    Date: 2011–09–02
  29. By: M. Sahoo; Renuka Sane (Indira Gandhi Institute of Development Research); Susan Thomas (Indira Gandhi Institute of Development Research)
    Abstract: What is the role of financial regulation in the field of micro-finance? This paper identiles two features of micro-finance which call for unique treatment in policy considerations as compared to policy thinking in the mainstream body of financial law. These features are credit recovery and the credit risk of the MFI, when credit access is enabled through the structure of the joint liability group. The paper goes on to offer draft law which embeds a regulatory treatment of micro-finance that flows from this analysis.
    Date: 2012–01
  30. By: Juan Carlos Escanciano (Indiana University); Pei Pei (Indiana University and Chinese Academy of Finance and Development, Central University of Finance and Economics)
    Abstract: Historical Simulation (HS) and its variant, the Filtered Historical Simulation (FHS), are the most widely used Value-at-Risk forecast methods at commercial banks. These forecast methods are traditionally evaluated by means of the unconditional backtest. This paper formally shows that the unconditional backtest is always inconsistent for backtesting HS and FHS models, with a power function that can be even smaller than the nominal level in large samples. Our ndings have fundamental implications in the determination of market risk capital requirements, and also explain Monte Carlo and empirical ndings in previous studies. We also propose a data-driven weighted backtest with good power properties to evaluate HS and FHS forecasts. Finally, our theoretical ndings are conrmed in a Monte Carlo simulation study and an empirical application with three U.S. stocks. The empirical application shows that multiplication factors computed under the current regulatory framework are downward biased, as they inherit the inconsistency of the unconditional backtest.
    Date: 2012–02
  31. By: Giannone, Domenico; Lenza, Michele; Pill, Huw; Reichlin, Lucrezia
    Abstract: This paper analyses the impact on the macroeconomy of the ECB’s non-standard monetary policy implemented in the aftermath of the collapse of Lehman Brothers in the Fall of 2008. We study in particular the effect of the expansion of the intermediation of transactions across central bank balance sheets as dysfunctional financial markets seize up, which we regard as a key channel of transmission for non-standard monetary policy measures. Our approach is similar to Lenza et al., 2009 but we introduce the important innovation of distinguishing between private intermediation of interbank transactions in the money market and central bank intermediation of bank-to-bank transactions across the Eurosystem balance sheet. We do this by exploiting data drawn from the aggregate Monetary and Financial Institutions (MFI) balance sheet which allows us to construct a new measure of the ‘policy shock’ represented by the ECB’s increasing role as a financial intermediary. We find that bank loans to households and, in particular, to non-financial corporations are higher than would have been the case without the ECB’s intervention. In turn, the ECB’s support has a significant impact on economic activity: two and a half years after the failure of Lehman Brothers, the level of industrial production is estimated to be 2% higher, and the unemployment rate 0.6 percentage points lower, than would have been the case in the absence of the ECB’s non-standard monetary policy measures.
    Keywords: interbank market; Non-standard monetary policy measures
    JEL: E5 E58
    Date: 2012–02
  32. By: George M. von Furstenberg (Indiana University and Hong Kong Institute for Monetary Research)
    Abstract: When contingently convertible debt securities trigger and convert into common equity well before the capital ratio of a financial institution has reached its regulatory minimum, they are known as going-concern or go-cocos. Their objective is to recapitalize an institution under stress and not to facilitate its resolution as would be the task of low-trigger goner-cocos. Because cocos are an "infant instrument" that grew out of the 2007-2009 crisis, few of their design features, their tax treatment or role in bond indexes are settled. Their portfolio fit with unsecured senior non-contingent debt on the one hand and common equity on the other is also an open question. Its resolution has much to do with how adding go-cocos may affect debt overhang in a firm. This paper attempts to clarify such underexposed open issues. Its chief contribution, however, lies in sifting through the experience with cocos triggers and conversion methods in order to link both actual, and one proposed, conversion methods to the recovery rates on cocos likely to be obtained from the common shares received by conversion. Experimenting with sparsely parameterized survival patterns that reach specified survival-rate levels after 10-years, and with the implied hazard rates and default rates conditional on survival, then allows a schedule of CDS premiums to be derived. These provide insight into the competitiveness of pricing the loss-of-value risk in go-cocos, instead of in the common-equity premium, over AAA-rated bonds.
    Date: 2012–03
  33. By: Fabbri, Francesca; Marin, Dalia
    Abstract: The compensation of executive board members in Germany has become a highly controversial topic since Vodafone's hostile takeover of Mannesmann in 2000 and it is again in the spotlight since the outbreak of the financial crisis of 2009. Based on unique panel data evidence of the 500 largest firms in Germany in the period 1977-2009 we test two prominent hypothesis in the literature on executive pay: the manager power hypothesis and the efficient pay hypothesis. We find support for the manager power hypothesis for Germany as executives tend to be rewarded when the sector is doing well rather than the firm they work for. We reject, however, the efficient pay hypothesis as CEO pay and the demand for managers increases in Germany in difficult times when the typical firm size shrinks. We find further that domestic and global competition for managers has contributed to the rise in executive pay in Germany. Lastly, we show that CEOs in the banking sector are provided with incentives for performance and that the great recession of 2009 acted as a disciplining device on CEO pay in Germany.
    Keywords: CEO pay in banks; CEO pay in the financial crisis; domestic and global competition for managers; efficient pay hypothesis; manager power hypothesis
    JEL: F23 J3 M12 M52
    Date: 2012–03
  34. By: Landier, Augustin; Sraer, David; Thesmar, David
    Abstract: Using loan level data, we provide evidence consistent with risk-shifting in the lending behavior of a large subprime mortgage originator { New Century Financial Corporation { starting in 2004. This change follows the monetary policy tightening implemented by the Fed in the spring of 2004, which resulted in an adverse shock to the large portfolio of loans New Century was holding for investment. New Century reacted to this shock by massively resorting to deferred amortization loan contracts (\interest-only" loans). We show that these loans were not only riskier, but also that their returns were by design more sensitive to real estate prices than standard contracts. New Century was thus financing projects with a high beta on its own survival, as predicted by a standard model of portfolio selection in financial distress. Our findings shed new light on the relationship between monetary policy and risk taking by financial institutions. They also contribute to better characterizing the type of risk taken by financially distressed firms.
    Date: 2011–08
  35. By: Hau, Harald; Lai, Sandy
    Abstract: The early stage of the recent financial crisis was marked by large value losses for bank stocks. This paper identifies the equity funds most affected by this valuation shock and examines its consequences for the non-financial stocks owned by the respective funds. We find that (i) ownership links to these 'distressed equity funds' lead to large underperformance of the most exposed non-financial stocks, and in aggregate this contributes an additional 10.9% to the overall stock market downturn; (ii) distressed fire sales and the associated price discounts are concentrated among those exposed stocks which perform relatively well; and (iii) stocks with higher fund ownership generally performed much better throughout the crisis.
    Keywords: Financial Crisis Propagation; Fire Sales; Mutual Funds
    JEL: G11 G14 G23
    Date: 2012–02
  36. By: Scott J. Dressler (Department of Economics and Statistics, Villanova School of Business, Villanova University); Erasmus K. Kersting (Department of Economics and Statistics, Villanova School of Business, Villanova University)
    Abstract: Equilibrium indeterminacy due to economies of scale (ES) in financial intermediation is quantitatively examined in a monetary business-cycle environment. Financial intermediation provides deposits which serve as a substitute for currency to purchase consumption, and depositing decisions are susceptible to non-fundamental shocks to confidence. The analysis considers various assumptions on nominal rigidities and the timing of deposit decisions. The results suggest that indeterminacy arises for small degrees of ES, and the resulting confidence shocks qualitatively mimic monetary shocks. A calibration exercise concludes that US economic volatility from this non-fundamental source has increased over time while volatility from fundamental sources has decreased.
    Keywords: Firms; Financial Intermediation, Inside Money, Indeterminacy, Business Cycles
    JEL: C68 E32 E44
    Date: 2012–02
  37. By: Svensson, Lars E O
    Abstract: The Riksbank faces challenges with regard to each of its three core functions, conducting monetary policy with the objective of stabilising inflation around the inflation target and resource utilisation around a sustainable level, promoting a safe and efficient payment system and thereby conducting a policy for financial stability, and managing its financial assets to attain a good risk-adjusted rate of return without prejudice to the first two core functions. I conclude that the challenges are best met by focusing monetary policy exclusively on stabilising inflation around the inflation target and resource utilisation around a sustainable level and not treating the policy rate, housing prices or household debt as separate explicit or implicit target variables, by not confusing monetary policy with financial-stability policy but treating them as separate policies, and by eliminating the large unnecessary currency risk in the Riksbank’s balance sheet.
    Keywords: central bank asset management; macroprudential policy; monetary policy
    JEL: E42 E52 E58 G18 G28
    Date: 2012–02

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