New Economics Papers
on Banking
Issue of 2012‒04‒17
sixteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Financial Regulation in General Equilibrium By Goodhart, Ch. A. E.; Kashyap, A. K.; Tsomocos, D. P.; Vardoulakis, A. P.
  2. "Shadow Banking and the Limits of Central Bank Liquidity Support: How to Achieve a Better Balance between Global and Official Liquidity" By Thorvald Grung Moe
  3. Problems with the Measurement of Banking Services in a National Accounting Framework By Diewert, Erwin; Fixler, Dennis; Zieschang, Kimberly
  4. The bank lending channel of monetary policy transmission: evidence from an emerging aarket, India By Saumitra, Bhaduri; Toto, Goyal
  5. Asymmetric information in credit markets, bank leverage cycles and macroeconomic dynamics By Ansgar Rannenberg
  6. Model Implied Credit Spreads By Gunnar Grass
  7. Description of the Operational Mechanics of a Basel Regulated Banking System By Jacky Mallett
  8. Loan loss reserves, accounting constraints, and bank ownership structure By Eliana Balla; Morgan J. Rose
  9. Why do banking crises occur? The American subprime crisis compared with the Norwegian banking crisis 1987-92 By Sverre Knutsen
  10. Banking Bubbles and Financial Crisis By Jianjun Miao; PENGFEI WANG
  11. Are private banks the better banks? An insight into the principal-agent structure and risk-taking behavior of German banks. By Frank Schmielewski; Thomas Wein
  12. Offre optimale de liquidité bancaire par la Banque Centrale : une approche microéconomique By TINANG NZESSEU, Jules Valery
  13. Funding vs. real economy shock : the impact of the 2007-2009 crisis on small firms’ credit availability By Berg, Gunhild; Kirschenmann, Karolin
  14. Workers’ motivation: the italian case of cooperative credit banks By Troisi, Roberta; Nese , Annamaria
  15. Loan loss provisioning practices of Asian banks By Frank Packer; Haibin Zhu
  16. "Control of Finance as a Prerequisite for Successful Monetary Policy: A Reinterpretation of Henry Simons's Rules versus Authorities in Monetary Policy" By Thorvald Grung Moe

  1. By: Goodhart, Ch. A. E.; Kashyap, A. K.; Tsomocos, D. P.; Vardoulakis, A. P.
    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.
    Keywords: Price setting, changeover, euro, inflation.
    JEL: G28 L51
    Date: 2012
  2. By: Thorvald Grung Moe
    Abstract: Global liquidity provision is highly procyclical. The recent financial crisis has resulted in a flight to safety, with severe strains in key funding markets leading central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot's advice to "lend freely at high rates against good collateral" has been stretched to the limit in order to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask, How elastic should the supply of central bank currency be? Even when the central bank has the ability to create abundant official liquidity, there should be some limits to its support for the financial sector. Traditionally, the misuse of the fiat money privilege has been limited by self-imposed rules that central bank loans must be fully backed by gold or collateralized in some other way. But since the onset of the crisis, we have seen how this constraint has been relaxed to accommodate the demand for market support. My suggestion is that there has to be some upper limit, and that we should work hard to find guidelines and policies that can limit the need for central bank liquidity support in future crises. In this paper, I review the recent expansion of central bank liquidity support during the crisis, before discussing the collateral polices related to central banks' lender-of-last-resort and market-maker-of-last-resort policies and their rationale. I then examine the relationship between the central bank and the treasury, and the potential threat to central bank independence if they venture into too much risky balance sheet expansion. A discussion about the exceptional growth of the shadow banking system follows. I introduce the concept of "liquidity illusion" to describe the fragility upon which much of the sector is based, and note that market growth has been based largely on a "fair-weather" view that central banks will support the market on rainy days. I argue that we need a better theoretical framework to understand the growth in the shadow banking system and the role of central banks in providing liquidity in a crisis. Recently, the concept of "endogenous finance" has been used to explain the strong procyclical tendencies of the global financial system. I show that this concept was central to Hyman P. Minsky's theory of financial instability, and suggest that his insights should be integrated into the ongoing search for a better theoretical framework for understanding the growth of the shadow banking system and how we can limit official liquidity support for this system. I end the paper with a summary and a discussion of some of the policy issues. I note that the Basel III "package" will hopefully reduce the need for central bank liquidity support in the future, but suggest that further structural reforms of the financial sector are needed to ease the tension between freewheeling private credit expansion and the limited ability or willingness of central banks to provide unlimited official liquidity support in a future crisis.
    Keywords: Financial Regulation; Financial Stability; Monetary Policy; Central Bank Policy
    JEL: E44 E52 E58 G28
    Date: 2012–04
  3. By: Diewert, Erwin; Fixler, Dennis; Zieschang, Kimberly
    Abstract: The paper considers some of the problems associated with the indirectly measured components of financial service outputs in the System of National Accounts (SNA), termed FISIM (Financial Intermediation Services Indirectly Measured). The paper utilizes a user cost and supplier benefit approach to the determination of the value of various financial services in the banking sector. The present paper also attempts to integrate the balance sheet accounts in the SNA with the usual flow accounts. An empirical example of various nominal output concepts that could be applied to the U.S. commercial banking sector is presented.
    Keywords: User costs, banking services, deposit services, loan services, production accounts, System of National Accounts, FISIM, Financial Intermediation Servi
    JEL: C43 C67 C82 D24 D57 E22 E41
    Date: 2012–04–04
  4. By: Saumitra, Bhaduri; Toto, Goyal
    Abstract: This study analyzes the monetary policy transmission in India with the help of bank lending channel hypothesis. We test the shift in loan supply emanating from the changes in the prime policy rate used by the Reserve Bank of India. Using yearly bank balance sheet data from 1996 to 2007, the paper provides evidence of an operational BLC in India. Further, segregating banks by asset size and liquidity, we find that small, illiquid banks are more affected by policy changes, and the effect is more pronounced in areas of non-priority sector lending. Finally, the domestically owned banks are more sensitive to policy rate changes vis-à-vis foreign banks.
    Keywords: Bnak lending Channel India
    JEL: G38
    Date: 2012–04–10
  5. By: Ansgar Rannenberg (Deutsche Bundesbank, Economics Department)
    Abstract: The paper adds a moral hazard problem between banks and depositors as in Gertler and Karadi (2011) to a DSGE model with a costly state verification problem between entrepreneurs and banks as in Bernanke, Gertler and Girlchrist (1999, BGG). This modification amplifies the response of the external finance premium and the overall economy to monetary policy and productivity shocks. It allows the model to match the volatility and correlation with output of the external finance premium, bank leverage, entrepreneurial leverage and other variables in US data better than a BGG-type model. A reasonably calibrated simulation of a bank balance sheet shock produces a downturn of a magnitude similar to the "Great Recession".
    Keywords: Financial accelerator, bank leverage, DSGE model
    JEL: E44 G21
    Date: 2012–04
  6. By: Gunnar Grass
    Abstract: I propose a new measure of credit risk, model implied credit spreads (MICS), which can be extracted from any structural credit risk model in which debt values are a function of asset risk and the payout ratio. I implement MICS assuming a barrier option framework nesting the Merton (1974) model of capital structure. MICS are the increase in the payout to creditors necessary to offset the impact of an increase in asset variance on the option value of debt. Endogenizing asset payouts, my measure (i) predicts higher credit risk for safe firms and lower credit risk for firms with high volatility and leverage than a standard distance to default (DD) measure and (ii) clearly outperforms the DD measure when used to predict corporate default or to explain variations in credit spreads.
    Keywords: Structural Credit Risk Models, Bankruptcy Prediction, Risk-Neutral Pricing
    JEL: G33 G13 G32
    Date: 2012
  7. By: Jacky Mallett
    Abstract: This paper presents a description of the mechanical operations of banking as used in modern banking systems regulated under the Basel Accords, in order to provide support for a verifiable and complete description of the banking system suitable for computer simulation. Feedback is requested on the contents of this document, both with respect to the operations described here, and any known national, regional or local variations in their structure and practice.
    Date: 2012–04
  8. By: Eliana Balla; Morgan J. Rose
    Abstract: This paper examines how the tightening of accounting constraints associated with the SunTrust bank decision in 1998 impacted the loan loss reserve policies of banks differently based on ownership structure. The SunTrust case, the result of an SEC inquiry over possible overstating of loan loss reserves, represented a strengthening of accounting priorities, which stress the importance of the reserve account for financial statement objectivity and comparability, relative to supervisory priorities, which emphasize the role of reserves for bank solvency through changing economic environments. The evidence presented indicates that publicly held banks, which fall directly under the SECs purview, reduced their loan loss reserve and provisions relative to privately held banks. Evidence also indicates that the positive relationship between bank earnings and provisions weakened, consistent with a reduction in either earnings management or early recognition of losses.
    Date: 2011
  9. By: Sverre Knutsen (Norwegian Business School and Norges Bank (Central Bank of Norway))
    Abstract: This paper analyses the causes of banking crises by the way of a historical comparative case study. Moreover, the analysis draws on theories elaborated by the economist Hyman Minsky. The evidence presented suggests that the fundamental causes of the compared crises are found in the macroeconomic boom-bust fluctuation and the building up of asset market bubble(s) preceding the breakdown and the crisis. We also find boom-bust cycles as depicted in a basic Minsky-cycle, where financial instability and the outbreak of crisis is a consequence of an unbalanced mix of hedge, speculative and Ponzi financial positions. In both cases we have observed a pattern where stabilizing or thwarting institutions, as Minsky denoted them, were eroded over time. Each case demonstrates that structural economic shifts were interacting with major institutional changes and created processes that effectively removed institutional stabilizers. Hence, systemic risk was allowed to fill up the financial system. These processes were essential for building up financial imbalances of such a magnitude that the particular booms ended in systemic banking crises.
    Keywords: Financial Crises, business cycles, Institutional Stabilizers, Structural Economic
    JEL: E32 E51 G01 G18 N10 N12 N14
    Date: 2012–03–20
  10. By: Jianjun Miao (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University); PENGFEI WANG (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.)
    Abstract: This paper develops a macroeconomic model with a banking sector in which banks face endogenous borrowing constraints. There is no uncertainty about economic fundamentals. Banking bubbles can emerge through a positive feedback loop mechanism. Changes in household confidence can cause the collapse of bubbles, resulting in a financial crisis. Credit policy can mitigate economic downturns but also incur an efficiency loss. Bank capital requirements can prevent the formation of banking bubbles by limiting leverage. But a too restrictive requirement leads to less lending and hence less production.
    Keywords: Banking Bubble, Multiple Equilibria, Financial Crisis, Self-ful?lling Prophecy, Credit Policy, Capital Requirements, Borrowing Constraints
    JEL: E2 E44 G01 G20
    Date: 2012–01
  11. By: Frank Schmielewski (Leuphana University of Lüneburg, Germany); Thomas Wein (Leuphana University of Lueneburg, Germany)
    Abstract: In this study, we propose our hypothesis that the distinguishable principal-agent relationships of German banks are significantly influencing the risk-taking attitudes of bank managers. Particularly, we intend to substantiate the theory that banks owned by dispersed shareholders or federal state authorities face a higher relevance of principal-agent problems than other banking sectors due to a missing ability to monitor bank managers. Our results underline that these problems appear to mislead bank managers showing an unreasonable risk-taking behavior. In a first stage, we rely on a theoretical model explaining that from the bank owners’ viewpoint three factors of the principal-agent relationships are determining the probability of choosing the optimal portfolio of risky assets. These factors cover the ability to control bank managers, the risk pooling capabilities of bank owners and bank managers, and the incentives of seeking high returns. To support our hypothesis we apply an empirical study to the distances-to-default of different German banking sectors. This demonstrates that risktaking attitudes of banks are closely related to banks’ ownership. Consequently, our findings offer evidence, that legislative and regulatory authorities should increase their vigilance in terms of principal-agent problems within certain sectors of the banking industry.
    Keywords: Financial crises; risk-taking behavior; risk aversion; efficient portfolios; information asymmetries and market efficiency; government policy and regulation; risk pooling; seeking for high returns; monitoring capabilities; capital and ownership structure; distance-to-default; capital asset ratio; return on assets
    JEL: G01 G12 G14 G28 G15 G32
    Date: 2012–04
  12. By: TINANG NZESSEU, Jules Valery
    Abstract: The excess liquidity of commercial banks is very often mentioned in the CEMAC as one of the limits of monetary policy implementation by BEAC. In this paper, we tried to address excess reserves in the CEMAC banking system looking from the point of view of commercial banks. Indeed, commercial banks may decide to hold reserves above the level required by the regulator for costs minimization perspectives. By minimising the cost function of each commercial bank, we derived the optimal level of excess liquidity desired by it. The obtained results allow classifying the banks of the CEMAC zone into two categories depending on the level of excess reserves necessary to minimize their costs and provide the amounts of liquidity desired by them. The Central Bank can then use this information to improve its liquidity supply to the banking system by anticipating the demands of liquidity by commercial banks during open market operations.
    Keywords: réserves excessives; coût d'opportunité; coût d'ajustement; optimisation; fonction de densité
    JEL: C14 E51 C02 C61 C15
    Date: 2012–03–12
  13. By: Berg, Gunhild; Kirschenmann, Karolin
    Abstract: This paper analyzes the impact of two distinct shocks stemming from the cross-border transmission of the 2007-2009 crisis on credit availability for small firms. The paper uses data from AccessBank Azerbaijan which was affected in its liquidity position during the second and third quarters of 2008 by delays in its refinancing. The Azeri real economy was hit by the global crisis from the fourth quarter of 2008 onwards with a combined decline in oil prices, exports, remittances, and domestic demand. Therefore, a pure supply side shock con be contrasted with a real economy shock that hit exactly when the bank's funding position strengthened again. The paper finds that during the funding shock (potential) borrowers are discouraged from applying for loans. However, for those applications made, the likelihood of loan approval is not affected. The real economy shock, in contrast, reduces the approval likelihood for SME loans in particular, while agro and micro loans are considerably less affected. Finally, bank relationships increase credit availability in good as well as in bad times.
    Keywords: Access to Finance,Debt Markets,Microfinance,Bankruptcy and Resolution of Financial Distress,Banks&Banking Reform
    Date: 2012–04–01
  14. By: Troisi, Roberta; Nese , Annamaria
    Abstract: The role of the cooperative credit banks in the European financial system is growing, particularly during the current period of financial crisis. Nevertheless, these cooperative banks have not received a great deal of attention from scholars. This lack of attention has resulted from two factors: i) the lack of empirical data and ii) the fact that the organizational structures and multiple goals of these cooperative banks are “generally more difficult to understand than the corporate governance of the commercial banks with their more easily interpretable and single goal of profit maximizing”(Groeneveld, 2011). This paper contributes to the understanding of Italian cooperative credit banks (Bccs) and their activity by describing their main characteristics and by providing a comparison with different cooperative bank models. Second, it analyzes the job satisfaction of Italian Bccs’ employees, which is a crucial factor because human resources, along with the Bccs’ unique structural elements, facilitate long-term relationships with the local communities where Bccs are located.
    Keywords: Non profit organizations; Workers' motivation; Firm Objectives;
    JEL: D21 L31 J54
    Date: 2012–01
  15. By: Frank Packer; Haibin Zhu
    Abstract: In the wake of the Asian financial crisis, many regimes in Asia adopted stricter provisioning requirements, as well as discretionary measures, with the objective of increasing provisioning in good times in response to rising levels of risk. Based on a final sample of 240 banks in 12 Asian economies, the evidence is that countercyclical loan loss provisioning has dominated throughout emerging Asia, most strikingly so in the case of India. Thus, loan loss provisioning did not simply become more conservative at all points in time subsequent to the Asian financial crisis, but actively leaned in a fashion that ameliorated swings in earnings and the macroeconomy.
    Keywords: Loan loss provisioning, financial system procyclicality, international accounting standards, earnings smoothing, macroprudential policy
    Date: 2012–04
  16. By: Thorvald Grung Moe
    Abstract: Henry Simons's 1936 article "Rules versus Authorities in Monetary Policy" is a classical reference in the literature on central bank independence and rule-based policy. A closer reading of the article reveals a more nuanced policy prescription, with significant emphasis on the need to control short-term borrowing; bank credit is seen as highly unstable, and price level controls, in Simons's view, are not be possible without limiting banks' ability to create money by extending loans. These elements of Simons's theory of money form the basis for Hyman P. Minsky's financial instability hypothesis. This should not come as a surprise, as Simons was Minsky's teacher at the University of Chicago in the late 1930s. I review the similarities between their theories of financial instability and the relevance of their work for the current discussion of macroprudential tools and the conduct of monetary policy. According to Minsky and Simons, control of finance is a prerequisite for successful monetary policy and economic stabilization.
    Keywords: Monetary Policy; Financial Stability; Narrow Banking; Financial Regulation
    JEL: B22 E42 E52 G28
    Date: 2012–04

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