New Economics Papers
on Banking
Issue of 2012‒04‒10
twenty papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Does Discretion in Lending Increase Bank Risk? Borrower Self-Selection and Loan Officer Capture Effects By Gropp, R.; Grundl, C.; Guttler, A.
  2. Financial Regulation in General Equilibrium By Charles Goodhart; Anil K Kashyap; Dimitrios Tsomocos; Alexandros Vardoulakis
  3. When good investments go bad: the contraction in community bank lending after the 2008 GSE takeover By Tara Rice; Jonathan Rose
  4. Federal Reserve lending to troubled banks during the financial crisis, 2007-10 By R. Alton Gilbert; Kevin L. Kliesen; Andrew P. Meyer; David C. Wheelock
  5. International credit cycles: a regional perspective By Stolbov, Mikhail
  6. A proposal for the resolution of systemically important assets and liabilities: The case of the repo market By Acharya, Viral V; Öncü, T Sabri
  7. Capital Requirements under Basel III in Andean Countries: The Cases of Bolivia, Colombia, Ecuador and Peru By Arturo Galindo; Liliana Rojas-Suárez; Marielle del Valle
  8. Liquidity Hoarding By Douglas Gale; Tanju Yorulmazer
  9. Business credit information sharing and default risk of private firms By Maik Dierkes; Carsten Erner; Thomas Langer; Lars Norden
  10. Repo Runs By Antoine Martin; David Skeie; Ernst-Ludig von Thadden
  11. Systemic losses in banking networks: indirect interaction of nodes via asset prices By Igor Tsatskis
  12. The impact of state guarantees on banks' debt issuing costs, lending and funding policy By Patrice Muller; Shaan Devnani; Rasmus Flytkjaer
  13. Debt Financing in Asset Markets By Zhiguo He; Wei Xiong
  14. Securities lending By Paul C. Lipson; Bradley K. Sabel; Frank M. Keane
  15. Financial Intermediation, Markets, and Alternative Financial Sectors By Franklin ALLEN; Elena CARLETTI; Jun 'QJ' QIAN; Patricio VALENZUELA
  16. Trading Strategies in the Overnight Money Market: Correlations and Clustering on the e-MID Trading Platform By Daniel Fricke
  17. Modelling Household Debt and Financial Assets: A Bayesian Approach to a Bivariate Two-Part Model By Li Su; Sarah Brown; Pulak Ghosh; Karl Taylor
  18. Mortgage Rate and the Choice of Mortgage Length: Quasi-experimental Evidence from Chinese Transaction-level Data By Guoying Deng; Zhigang Li; Guangliang Ye
  19. Transparency in the financial system: rollover risk and crises By Matthieu Bouvard; Pierre Chaigneau; Adolfo de Motta
  20. A Personal Touch: Text Messaging for Loan Repayment By Dean Karlan; Melanie Morten; Jonathan Zinman

  1. By: Gropp, R.; Grundl, C.; Guttler, A. (Tilburg University, Center for Economic Research)
    Abstract: In this paper we analyze whether discretionary lending increases bank risk. We use a panel dataset of matched bank and borrower data. It offers the chief advantages that we can directly identify soft information in banks’ lending decisions and that we observe ex post defaults of borrowers.Consistent with the previous literature, we find that smaller banks use more discretion in lending. We also show that borrowers self-select to banks depending on whether their soft information is positive or negative. Financially riskier borrowers with positive soft information are more likely to obtain credit from relationship banks. Risky borrowers with negative soft information have the same chance to receive a loan from a relationship or a transaction bank. These selection effects are stronger in more competitive markets, as predicted by theory. However, while relationship banks have financially riskier borrowers, ex post default is not more probable compared to borrowers at transaction banks. As a consequence, relationship banks do not have higher credit risk levels. Loan officers at relationship banks thus do not use discretion in lending to grant loans to ex post riskier borrowers.
    Keywords: soft information;discretionary lending;relationship bank;bank risk.
    JEL: G21 G28 G32
    Date: 2012
  2. By: Charles Goodhart; Anil K Kashyap; Dimitrios Tsomocos; Alexandros Vardoulakis
    Abstract: This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when net worth of potential buyers is low, the ensuing price dynamics can be described as a fire sale. The proposed framework can assess five different policy options that officials have advocated for combating defaults, credit crunches and fire sales,namely: limits on loan to value ratios, capital requirements for banks, liquidity coverage ratios for banks, dynamic loan loss provisioning for banks, and margin requirements on repurchase agreements used by shadow banks. The paper aims to develop some general intuition about the interactions between the tools and to determine whether they act as complements and substitutes.
    Date: 2012–03
  3. By: Tara Rice; Jonathan Rose
    Abstract: In September 2008, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were placed into conservatorship and dividend payments on common and preferred shares were suspended. As a result, share prices fell to nearly zero and many banks across the country lost the value of their investments in the preferred shares. We estimate more than 600 depository institutions in the United States were exposed to at least $8 billion in investment losses from these securities. In addition, fifteen failures and two distressed mergers either directly or indirectly resulted from the takeover. Since these GSE investments were considered to be safe investments by banks, regulators, and rating agencies, we consider these losses to be exogenous shocks to bank capital, and use this event to examine the relationship between community bank condition and lending during this crisis. We find that in the quarter following the takeover of Fannie Mae and Freddie Mac, the measured Tier 1 capital ratio at exposed banks fell about three percent on average, and loan growth at exposed banks with median capitalization was about 2 percentage points lower compared to other banks in the following quarter. Consequently, considering the set of community banks that incurred about $2 billion in GSE-related losses, and assuming that each bank reduced loan growth by 2 percentage points, the estimated aggregate lending drop among these banks would be roughly $4 billion. .
    Date: 2012
  4. By: R. Alton Gilbert; Kevin L. Kliesen; Andrew P. Meyer; David C. Wheelock
    Abstract: Numerous commentaries have questioned both the legality and appropriateness of Federal Reserve lending to banks during the recent financial crisis. This article addresses two questions motivated by such commentary: 1) Did the Federal Reserve violate either the letter or spirit of the law by lending to undercapitalized banks? 2) Did Federal Reserve credit constitute a large fraction of the deposit liabilities of failed banks during their last year prior to failure? The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) imposed limits on the number of days that the Federal Reserve may lend to undercapitalized or critically undercapitalized depository institutions. We find no evidence that the Federal Reserve ever exceeded statutory limits during the recent financial crisis, recession and recovery periods. In most cases, the number of days that Federal Reserve credit was extended to an undercapitalized or critically undercapitalized depository institution was appreciably less than the number of days permitted under law. Furthermore, compared with patterns of Fed lending during 1985-90, we find that few banks that failed during 2008-10 borrowed from the Fed during their last year prior to failure, and only a few had outstanding Fed loans when they failed. Moreover, Federal Reserve loans averaged less than 1 percent of total deposit liabilities among nearly all banks that did borrow from the Fed during their last year. It is impossible to know whether the enactment of FDICIA explains differences in Federal Reserve lending practices during 2007-10 and the previous period of financial distress in the 1980s. However, it does seem clear that Federal Reserve lending to depository institutions during the recent episode was consistent with the Congressional intent of this legislation.
    Keywords: Financial crises ; Discount window ; Federal Deposit Insurance Corporation Improvement Act of 1991
    Date: 2012
  5. By: Stolbov, Mikhail
    Abstract: I use credit/GDP ratio to construct stylized credit cycles at global and regional levels over 1980-2010. Their average duration is between 12 and 15 years and for all the regions there is “a ceiling” and “a floor” curbing the amplitude of credit cycles. They are also largely interconnected, with the US credit cycle being the most influential and autonomous at the same time. The relationship between credit cycles and intensity of banking crises is also discussed. It appears that the regions exerting predominant influence over their counterparts and having a higher number of total connections at the same time experience fewer banking crises.
    Keywords: credit cycle; banking crisis; net spill-over index; Hodrick-Prescott filter; Poisson regression; macro-prudential regulation
    JEL: F37 G15 E50
    Date: 2012–03–29
  6. By: Acharya, Viral V; Öncü, T Sabri
    Abstract: One of the several regulatory failures behind the global financial crisis that started in 2007 has been the regulatory focus on individual, rather than systemic, risk of financial institutions. Focusing on systemically important assets and liabilities (SIALs) rather than individual financial institutions, we propose a set of resolution mechanisms, which is not only capable of inducing market discipline and mitigating moral hazard, but also capable of addressing the associated systemic risk, for instance, due to the risk of fire sales of collateral assets. Furthermore, because of our focus on SIALs, our proposed resolution mechanisms would be easier to implement at the global level compared to mechanisms that operate at the level of individual institutional forms. We, then, outline how our approach can be specialized to the repo market and propose a repo resolution authority for reforming this market.
    Keywords: crises; fire sales; macroprudential regulation; resolution authority; runs; sale and repurchase agreements; systemic risk
    JEL: E58 G01 G28
    Date: 2012–04
  7. By: Arturo Galindo; Liliana Rojas-Suárez; Marielle del Valle
    Abstract: Since the eruption of the global financial crisis in 2008 international setting bodies and local regulators around the world have been hard at work designing and implementing new regulatory frameworks to deal with the regulatory deficiencies that were exposed during the crisis. In particular, there is now a consensus that existing regulations in developed countries were not able to contain excessive risk-taking activities by financial institutions in this group of countries during the pre-crisis period. Among these regulations, the newly proposed set of reform measures developed by the Basel Committee on Banking Supervision (BCBS): "Basel III: A global regulatory framework for more resilient banks and banking systems" (2011) is perhaps the one that has attracted most attention worldwide because a central focus of the recommendations lies on important changes in banks' regulatory capital requirements. Where does Latin America stand with respect to capital requirements? Can banks in the region satisfy with ease the new capital requirements of Basel III or will the implementation of this new set of capital recommendations require large efforts from banks in the region? This paper deals with these questions for the case of four Andean countries: Bolivia, Colombia, Ecuador and Peru.
    Keywords: Financial Sector :: Financial Policy, Capital Requirements under Basel III, financial framework, financial reform
    Date: 2011–12
  8. By: Douglas Gale; Tanju Yorulmazer
    Abstract: Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planners problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash.
    Date: 2011–06
  9. By: Maik Dierkes (Finance Center Mnster, University of Mnster); Carsten Erner (Finance Center Mnster, University of Mnster); Thomas Langer (Finance Center Mnster, University of Mnster); Lars Norden (Rotterdam School of Management, Erasmus University)
    Abstract: We investigate whether and how business credit information sharing helps to better assess the default risk of private firms. Private firms represent an ideal testing ground because they are smaller, more informationally opaque, riskier, and more dependent on trade credit and bank loans than public firms. Based on a representative panel dataset that comprises private firms from all major industries, we find that business credit information sharing substantially improves the quality of default predictions. The improvement is stronger for older firms and those with limited liability, and depends on the sharing of firms' payment history and the number of firms covered by the local credit bureau office. The value of soft business credit information is higher for smaller and less distant firms. Furthermore, in spatial and industry analyses we show that the higher the value of business credit information the lower the realized default rates. Our study highlights the channel through which business credit information sharing adds value and the factors that influence its strength.
    Keywords: Asymmetric information, Credit bureau, Credit risk, Hard and soft information, Private firms
    JEL: D82 G21 G32 G33
    Date: 2012–03
  10. By: Antoine Martin; David Skeie; Ernst-Ludig von Thadden
    Abstract: This paper develops a dynamic model of financial institutions that borrow short-term and invest into long-term marketable assets. Because such intermediaries performmaturity transformation, they are subject to potential runs. We derive distinct liquidity and collateral constraints that characterize the fragility of such institutions as a result of changing market expectations. The liquidity constraint depends on the intermediary’s endogenous liquidity position that acts as a buffer against runs. The collateral constraint depends crucially on the microstructure of particular funding markets that we examine in detail. In particular, our model provides insights into the fragility and differences of the tri-party repo market and the bilateral repo market that were at the heart of the recent financial crisis.
    Date: 2011–07
  11. By: Igor Tsatskis (Financial Services Authority, London)
    Abstract: A simple banking network model is proposed which features multiple waves of bank defaults and is analytically solvable in the limiting case of an infinitely large homogeneous network. The model is a collection of nodes representing individual banks; associated with each node is a balance sheet consisting of assets and liabilities. Initial node failures are triggered by external correlated shocks applied to the asset sides of the balance sheets. These defaults lead to further reductions in asset values of all nodes which in turn produce additional failures, and so on. This mechanism induces indirect interactions between the nodes and leads to a cascade of defaults. There are no interbank links, and therefore no direct interactions, between the nodes. The resulting probability distribution for the total (direct plus systemic) network loss can be viewed as a modification of the well-known Vasicek distribution.
    Date: 2012–03
  12. By: Patrice Muller; Shaan Devnani; Rasmus Flytkjaer
    Abstract: The empirical study carried out by London Economics on behalf of the European Commission analysed the market value of state guarantees given to banks in 2008-10 on banks' issuing costs and whether there were significant differences visible in the balance sheets of banks that used state guarantees and those that refrained from using them. The report presents a comprehensive ex-post evaluation of one of the main tools to restore the functioning of wholesale financial markets after the Lehman bankruptcy. The results of the empirical research suggested that the guarantee schemes were successful in lowering the costs of bond issuance of participating banks while having relatively little distortionary impacts on non-participating banks. Moreover, cross-border spill-over appear to be non-existent.
    Date: 2012–01
  13. By: Zhiguo He; Wei Xiong
    Abstract: We study rollover risk and collateral value in a dynamic asset pricing model with endogenous debt financing by extending the framework of Geanakoplos (2009) with a generic binomial tree and time-varying heterogeneous beliefs. Optimistic borrowers face rollover risk if the belief dispersion between the borrowers and the pessimistic lenders widens after interim bad news. We demonstrate the optimality of the maximum riskless short-term debt financing for optimistic borrowers even in the presence of the rollover risk. We also highlight the role of interim trading which, by allowing creditors to sell seized collateral to other optimists with saved cashes, boosts the asset’s collateral value and equilibrium price.
    JEL: G01 G1 G32
    Date: 2012–03
  14. By: Paul C. Lipson; Bradley K. Sabel; Frank M. Keane
    Abstract: This paper, originally released in August 1989 as part of a Federal Reserve Bank of New York series on the U.S. securities markets, examines loans of Treasury and agency securities in the domestic market. It highlights some important institutional characteristics of securities loan transactions, in particular the common use of agents to arrange the terms of the loans. While we note that this characteristic sets securities lending apart from most repurchase agreement (repo) transactions, which occur bilaterally between a borrower and a lender, we observe that repo and securities loan transactions ultimately serve the same important economic purpose—to cover short positions used for hedging or arbitrage in related cash markets. The data used here, though largely informal, were provided by knowledgeable market participants.
    Keywords: Securities ; Government securities ; Loans ; Hedging (Finance) ; Repurchase agreements
    Date: 2012
  15. By: Franklin ALLEN; Elena CARLETTI; Jun 'QJ' QIAN; Patricio VALENZUELA
    Abstract: We provide a comprehensive review of firms’ financing channels (internal and external, domestic and international) around the globe, with the focus on alternative finance—financing from all the nonmarket, non-bank external sources. We argue that while traditional financing channels, including financial markets and banks, provide significant sources of funds for firms in developed countries, alternative financing channels provide an equally important source of funds in both developed and developing countries. Alternative finance is often the dominant source of funds for firms in fastgrowing economies. We compare market- and bank-finance with alternative finance, along with the supporting mechanisms such as legal and institutional structures. Much more research is needed to better understand alternative finance and its role in corporate financing. We suggest ways to obtain firm-level data on various forms of alternative finance and thus overcome the main obstacle in the field.
    Keywords: alternative finance; markets; banks; trade credits; governance; growth
    JEL: O5 K0 G2
    Date: 2012
  16. By: Daniel Fricke
    Abstract: We analyze the correlations in patterns of trading for members of the Italian interbank trading platform e-MID. The trading strategy of a particular member institution is defined as the sequence of (intra-) daily net trading volumes within a certain semester. Based on this definition, we show that there are significant and persistent bilateral correlations between institutions' trading strategies. In most semesters we find two clusters, with positive correlations within the clusters and negative correlations between them. We show that the two clusters mostly contain continuous net buyers and net sellers of money, respectively, and that cluster memberships of individual banks are highly persistent. Additionally, we highlight some problems related to our definition of trading strategies. Our findings add further evidence on the fact that preferential lending relationships on the micro-level lead to community structure on the macro-level
    Keywords: interbank market, socio-economic networks, community identification
    JEL: G21 E42
    Date: 2012–03
  17. By: Li Su (MRC Biostatistics Unit, Cambridge, UK); Sarah Brown (Department of Economics, The University of Sheffield); Pulak Ghosh (Department of Quantitative Methods and Information Systems, Indian Institute of Management at Bangalore, India); Karl Taylor (Department of Economics, The University of Sheffield)
    Abstract: In this paper, we contribute to the empirical literature on household finances by introducing a Bayesian bivariate two-part model. With correlated random effects, the proposed approach allows for the potential interdependence between the holding of assets and debt at the household level and also encompasses a two-part process to allow for differences in the influences of the independent variables on the decision to hold debt or assets and the influences of the independent variables on the amount of debt or assets held. Finally, we also incorporate joint modelling of household size into the framework to allow for the fact that the debt and asset information is collected at the household level and hence household size may be strongly correlated with household debt and assets. Our findings endorse our joint modelling approach and, furthermore, confirm that certain explanatory variables exert different influences on the binary and continuous parts of the model.
    Keywords: Assets; Bayesian Approach; bridge distribution; debt; two-Part model
    JEL: C11 C33 D14
    Date: 2012
  18. By: Guoying Deng; Zhigang Li; Guangliang Ye
    Abstract: Utilizing a large transaction-level dataset on housing mortgages in China, this study estimates the effect of the mortgage rate spread between long- and short-term loans on property purchasers’ choice of loan length. Our identification of the causal effect of this spread on loan length hinges on a unique institutional feature of China, that is, its “dual-track†mortgage scheme. We observe two types of mortgagors in this setting: “normal†mortgagors who face floating mortgage rates spread and “special mortgagors†who are entitled to a fixed mortgage rate spread. Using the latter as a comparison group to address the confounding effects of omitted factors, we find that the change in interest rates significantly affects the mortgage decisions of normal mortgagors. When the prime mortgage rate spread increases by 10 basis points, the likelihood of such a mortgagor choosing a shortterm loan increases by 8.4 percent.
    Keywords: Mortgage rates; Loan decision; Quasi-experiment; China housing market
    JEL: E58 R21 R28
    Date: 2012–01
  19. By: Matthieu Bouvard; Pierre Chaigneau; Adolfo de Motta
    Abstract: The paper presents a theory of optimal transparency in the nancial system when nancial institutions have short-term liabilities and are exposed to rollover risk. Our analysis indicates that transparency enhances the stability of the - nancial system during crises but may have a destabilizing eect during normal economic times. Thus, the optimal level of transparency is contingent on the state of the economy, with the regulator increasing disclosure in times of crises. Under this policy, however, an increase in disclosure signals a deterioration of the economy's fundamentals, so the regulator has incentives to withhold information ex-post. In that case, the regulator may have to commit ex-ante to a degree of transparency which trades o the frequency and magnitude of nancial crises. The analysis also considers the possibility that nancial institutions, in an attempt to deal with rollover risk, either diversify their risks or increase the liquidity of their balance sheets.
    Date: 2012–02
  20. By: Dean Karlan; Melanie Morten; Jonathan Zinman
    Abstract: We worked with two microlenders to test impacts of randomly assigned reminders for loan repayments in the “text messaging capital of the world”. We do not find strong evidence that loss versus gain framing or messaging timing matter. Messages only robustly improve repayment when they include the loan officer’s name. This effect holds for clients serviced by the loan officer previously but not for first-time borrowers. Taken together, the results highlight the potential and limits of communications technology for mitigating moral hazard, and suggest that personal obligation/reciprocity between borrowers and bank employees can be harnessed to help overcome market failures.
    JEL: D21 D92 G21 O16 O17
    Date: 2012–03

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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