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on Banking |
| By: | Rose, Andrew (Haas School of Business); Wieladek, Tomasz (Bank of England) |
| Abstract: | During the 2007-09 financial crisis, the banking sector received an extraordinary level of public support. In this empirical paper, we examine the determinants of a number of public sector interventions: government funding or central bank liquidity insurance schemes, public capital injections, and nationalisations. We use bank-level data spanning all British and foreign banks operating within the United Kingdom. We use multinomial logit regression techniques and find that a bank’s size, relative to the size of the entire banking system, typically has a large positive and non-linear effect on the probability of public sector intervention for a bank. We also use instrumental variable techniques to show that British interventions helped; there is fragile evidence that the wholesale (non-core) funding of an affected institution increased significantly following capital injection or nationalisation. |
| Keywords: | nationalisation; capital injection; liquidity; crisis; foreign; empirical; data; logit |
| JEL: | G38 |
| Date: | 2012–08–21 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0460&r=ban |
| By: | Tatiana Damjanovic (Department of Economics, University of Exeter); Vladislav Damjanovic (Department of Economics, University of Exeter); Charles Nolan (University of Glasgow) |
| Abstract: | A stylized macroeconomic model is developed with an indebted, heterogeneous Investment Banking Sector funded by borrowing from a retail banking sector. The government guarantees retail deposits. Investment banks choose how risky their activities should be. We find that the financial sector can move very sharply from safe to risky investment strategies and that the degree of competitiveness is important for risk premia. We also compared the benefits of separated vs. universal banking modelled as a vertical integration of the retail and investment banks. The incidence of banking default is considered under different constellations of shocks and degrees of competitiveness. The benefits of universal banking rise in the volatility of idiosyncratic shocks to trading strategies and are positive even for very bad common shocks, even though government bailouts, which are costly, are larger compared to the case of separated banking entities. The benefits of universal banking are positive but decreasing in the value and volatility of shocks to the quality of financial capital. When shock is moderate, competition improves the welfare. However, banks with some market power have a cushion of profits against adverse shocks which is beneficial since there is an excess burden associated with government bailouts. Hence, when a worse shock hits the economy, the optimal degree of competitiveness of separate banking firms is higher than for universal firms. So, the welfare assessment of the structure of banks may depend crucially on the kinds of shock hitting the economy as well as on the efficiency of government intervention. |
| Keywords: | Risk in DSGE models, investment banking, financial intermediation, separating commercial and investment banking, competition and risk, moral hazard in banking, prudential regulation, systematic vs. idiosyncratic risks. |
| JEL: | E13 E44 G11 G24 G28 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:exe:wpaper:1201&r=ban |
| By: | Andrew Smith |
| Keywords: | Fractional reserve banking, financial crises, costs of banking crises |
| JEL: | D12 D31 I32 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:gri:epaper:economics:201206&r=ban |
| By: | Bhaskar DasGupta; Lakshmi Kaligounder |
| Abstract: | Involvements of major financial institutions in the recent financial crisis have generated renewed interests in fragility of global financial networks among economists and regulatory authorities. In particular, one potential vulnerability of the financial networks is the "financial contagion" process in which insolvencies of individual entities propagate through the "web of dependencies" to affect the entire system. In this paper, we formalize a banking network model originally proposed by researchers from Bank of England and elsewhere that may be applicable to scenarios such as the OTC derivatives market, define a global stability measure for this model, and comprehensively evaluate the stability measure over more than 700,000 combinations of networks types and parameter combinations. Based on such comprehensive evaluations, we discuss some interesting implications of our evaluations of this stability measure, and derive topological properties and parameters combinations that may be used to flag the network as a possible fragile network. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1208.3789&r=ban |
| By: | Bholat, David; Gray, Joann |
| Abstract: | Systemic risk now occupies centre stage in discussions of bank regulatory reform. Systemic risk is often seen as a problem of size, operational complexity, interconnectivity and contagion. It is less often discussed in terms of the institutional framework of legal rules and principles within which financial intermediation takes place, and the organizational culture promoted by those structures. In this article we redress this deficit through an appraisal of Northern Rock, illustrating the consequences of its transformation from mutually owned building society to publicly held company on organisational culture. These changes had profound effects on the incentive structure of its owners and managers, as profit-maximisation and shareholder value became the driving forces within the firm, as in much of the rest of the UK banking sector. Thus, in addition to grappling with risk and uncertainty - and taking care to distinguish between the two - current efforts to construct a new macro-prudential regulatory paradigm should recognize the importance of Frank Knight's third key conceptual category-profit. Furthermore, in seeking to understand systemic risk, it becomes necessary to delve into micro-legal concepts such as property, trust, and contract that govern different forms of business to discern whether or not some modes of financial association create a greater degree of systemic risk than others. This is especially so when one organizational model comes to dominate retail markets, as did the publicly held company in the UK banking sector at the turn of the twenty-first century. -- |
| Keywords: | Northern Rock,systemic risk,banks,building societies,UK residential mortgages |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:201235&r=ban |
| By: | Entrop, Oliver; Memmel, Christoph; Ruprecht, Benedikt; Wilkens, Marco |
| Abstract: | This paper explores the extent to which interest risk exposure is priced in bank margins. Our contribution to the literature is twofold: First, we present an extended model of Ho and Saunders (1981) that explicitly captures interest rate risk and returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit rates, but reduce these charges when they expect returns from maturity transformation. Second, using a comprehensive dataset covering the German universal banks between 2000 and 2009, we test the model-implied hypotheses not only for the commonly investigated net interest income, but additionally for interest income and expenses separately. Controlling for earnings from bank-individual maturity transformation strategies, we find all banks to charge additional fees for macroeconomic interest volatility exposure. Microeconomic on-balance interest risk exposure from maturity transformation, however, only affects the smaller savings and cooperative banks, but not private commercial banks. Returns are only priced in income margins. -- |
| Keywords: | Interest rate risk,Interest margins,Maturity transformation |
| JEL: | D21 G21 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:172012&r=ban |
| By: | Gürtler, Marc; Hibbeln, Martin |
| Abstract: | Two factors have proven to be strongly relevant for the subprime mortgage crisis. The first is the lack of screening incentives of originators, which had not been anticipated by investors. The second is that investors relied too much on credit ratings. We examine whether investors have learned from these shortcomings. On the basis of securitizations from 2010 and 2011, we find that investors require a significantly higher risk premium when there is a high degree of asymmetric information. The credit spreads of information sensitive tranches are significantly higher if originators do not retain a part of the securitization or if they choose vertical slice retention instead of retaining the equity tranche. Moreover, the relevance of credit ratings in comparison to other credit factors has significantly decreased. Apparently, investors mainly consider ratings to discriminate between information sensitive and information insensitive tranches, beyond that they rely on their own risk analysis. This suggests that investors have learned their lesson from the subprime mortgage crisis. -- |
| Keywords: | security design,asset-backed securities,retention,rating,credit spreads |
| JEL: | G21 G24 G28 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:tbsifw:if39v1&r=ban |
| By: | Paolo Gelain; Kevin J. Lansing; Caterina Mendicino |
| Abstract: | Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt that resemble the patterns observed in many developed countries over the past decade. We introduce excess volatility into an otherwise standard DSGE model by allowing a fraction of households to depart from fully-rational expectations. Specifically, we show that the introduction of simple moving-average forecast rules for a subset of households can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank’s interest rate rule, the imposition of more restrictive loan-to-value ratios, and the use of a modified collateral constraint that takes into account the borrower’s loan-to-income ratio. Of these, we find that a loan-to-income constraint is the most effective tool for dampening overall excess volatility in the model economy. We find that while an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation. |
| Keywords: | Housing - Prices ; Housing - Econometric models |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2012-11&r=ban |
| By: | Krones, Julia; Cremers, Heinz |
| Abstract: | -- In almost every financial market crisis we can observe widening credit spreads, especially in the last years during the subprime and sovereign debt crisis. But what exactly drives the credit spread? This paper will outline static components, i.e. default risk, liquidity, risk and the relative attractiveness of government bonds. Afterwards we will shed some light on the dynamic components that underlie the changes in static components. Dynamic components comprise the economic situation, a market component, interest rates, term structure, time to maturity and credit rating migration. In the second part, this paper aims to provide an insight on how the risk contained in the credit spread can be hedged appropriately. This includes the definition of an appropriate hedge and how diversification influences the riskiness of credit portfolios. For single-name credit and market component risk the applicability of CDS will be examined. However, iTraxx Index Swaps are considered to be the superior instrument regarding hedging systematic market component risk on single-name and portfolio level. Finally, an excursus will investigate ways to extract default probabilities from credit spreads. |
| Keywords: | Credit Spreads,static credit spread components,dynamic credit spread components,active credit portfolio management,Credit Default Swaps (CDS),iTraxx,iTraxx Index Swaps,Credit risk diversification |
| JEL: | G11 G12 G24 G32 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fsfmwp:195&r=ban |
| By: | Mihail Turlakov |
| Abstract: | Wrong-way risk in counterparty and funding exposures is most dramatic in the situations of systemic crises and tails events. A consistent model of wrong-way risk (WWR) is developed here with the probability-weighted addition of tail events to the calculation of credit valuation and funding valuation adjustments (CVA and FVA). This new practical model quantifies the tail risks in the pricing of CVA and FVA of derivatives and does not rely on a limited concept of linear correlation frequently used in many models. The application of the model is illustrated with practical examples of WWR arising in the case of a sovereign default for the most common interest-rate and foreign exchange derivatives. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1208.5382&r=ban |
| By: | Chamley, Christophe; Pinto, Brian |
| Abstract: | Institutional lending in crisis is evaluated from a theoretical point of view. First, the share of senior loans in new loans is irrelevant under a given probability distribution of the country's resources. Second, seniority may partially alleviate the inefficiency of debt contracts when the distribution of resources is endogenous to the country's physical investment and effort towards success. Third, with multiple lending rate equilibria, institutional lending may induce a switch to a lower private loan rate if it can be done in a sufficiently large amount. Fourth, conditions are analyzed under which debt forgiveness is efficient under a financial shock. |
| Keywords: | Debt Markets,Bankruptcy and Resolution of Financial Distress,Economic Theory&Research,Financial Intermediation,External Debt |
| Date: | 2012–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:6181&r=ban |
| By: | Abbas Valadkhani (University of Wollongong); Sajid Anwar (The University of the Sunshine Coast); Amir Arjonandi (University of Wollongong) |
| Abstract: | We present a new approach to evaluate the full extent of price stickiness in credit card interest rates by modifying the existing asymmetric models so that they can be adopted for testing both the amount and adjustment asymmetries as well as the lagged dynamic inertia. Consistent with similar studies, banks behave asymmetrically in response to changes in the Reserve Bank of Australia’s (RBA) target interest rate. Rate rises are passed onto the consumer faster than rate cuts and the credit card interest rate showed a very significant degree of downward rigidity. Based on the magnitude of the pass-through parameters obtained from short-run dynamic models, rate rises had a full one-to-one and instantaneous impact on credit card interest rates. However, in absolute terms the short-run effects of rate cuts were not only less than half of the rate rises but also were delayed on average by three months. |
| Keywords: | Interest rates; Asymmetric behaviour; Credit cards; Australia |
| JEL: | E43 E58 G21 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:uow:depec1:wp12-02&r=ban |
| By: | Luiz Awazu Pereira da Silva; Ricardo Eyer Harris |
| Abstract: | Brazil sailed well through the global financial storm, using counter-cyclical policies to engineer its fast V-shaped recovery in 2010. In order to deal with inflationary pressures arising from its strong recovery, after the peak of the crisis, it used standard aggregate demand management instruments (tight fiscal and monetary policies). Brazil had also to deal with the post-QE global environment of excess liquidity in 2010-2011 where excessive capital inflows were exacerbating domestic credit growth with potentially destabilizing effects for price and financial stability. In that front, Brazil maintained and strengthened its strong financial sector regulation and supervision to continue to ensure financial stability, in particular, using a set of macroprudential instruments. While combining monetary and macroprudential instruments to lean against the financial cycle, the Central Bank of Brazil has always made clear that macroprudential measures are not a substitute for monetary policy action and are primarily geared at addressing financial stability risks. In fact, many policy makers after the global financial crisis seem to see now a complementarity between macroprudential measures and monetary policy. Accordingly, the (new) separation principle seems to evolve into using two instruments (the central bank’s base rate and a set of macroprudential tools) to address two objectives (the inflation target and a composite set of financial stability indicators). Brazil’s recent experience with monetary and macroprudential policies is a successful example of this new approach. More time and other countries’ experiences are needed to assess properly if this policy option can be generalized and replicated with similar results elsewhere. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:290&r=ban |
| By: | Abbas Valadkhani (University of Wollongong); Sajid Anwar (The University of the Sunshine Coast) |
| Abstract: | There is an ongoing controversy over whether banks’ mortgage rates rise more readily than they fall due to their asymmetric responses to changes in the cash rate. This paper examines the dynamic interplay between the cash rate and the variable mortgage rate using monthly data in the post-1989 era. Unlike previous studies for Australia, our proposed threshold and asymmetric error-correction models account for both the amount and adjustment asymmetries. We found thatrate rises have much larger and more instantaneous impact on the mortgage rate than rate cuts, suggesting an urgent need for monitoring the banks’ lending behaviour in Australia. |
| Keywords: | Banks’ mortgage rates, Asymmetric and threshold error-correction models, Australia |
| JEL: | C24 C58 E43 E58 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:uow:depec1:wp12-01&r=ban |
| By: | Mehmke, Fabian; Cremers, Heinz; Packham, Natalie |
| Abstract: | -- Market risk management is one of the key factors to success in managing financial institutions. Underestimated risk can have desastrous consequences for individual companies and even whole economies, not least as could be seen during the recent crises. Overestimated risk, on the other side, may have negative effects on a company's capital requirements. Companies as well as national authorities thus have a strong interest in developing market risk models that correctly quantify certain key figures such as Value at Risk or Expected Shortfall. This paper presents several state of the art methods to evaluate the adequacy of almost any given market risk model. Existing models are enhanced by in-depth analysis and simulations of statistical properties revealing some previously unknown effects, most notably inconsistent behaviour of alpha and beta errors. Furthermore, some new market risk validation models are introduced. In the end, a simulation with various market patterns demonstrates strenghts and weaknesses of each of the models presented under realistic conditions. |
| Keywords: | Backtesting,Market Risk,Value at Risk,Expected Shortfall,Validation,Alpha Error,Beta Error,Time Until First Failure,Proportion of Failure,Traffic Light Approach,Magnitude of Loss Function,Markow-Test,Gauss-Test,Rosenblatt,Kuiper,Kolmogorov-Smirnov,Jarque-Bera,Regression,Likelihood Ratio,Truncated Distribution,Censored Distribution,Simulation |
| JEL: | C01 C02 C12 C13 C14 C15 C32 G32 G38 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fsfmwp:192&r=ban |
| By: | Daniel Kapp |
| Abstract: | This study presents a core-periphery model to determine the optimal size of the European Stability Mechanism (ESM), building on Jeanne and Ranciere (2011). While the periphery is subject to a probability of losing access to external credit, the core's incentive for setting up an ESM stems exclusively from the spillover effects present in the case of periphery default. The model develops regional best response functions, determining a set of feasible ranges for the total ESM size, given optimal regional contributions. The model is then calibrated to the European Economic and Monetary Union. If costs from default are reasonably high, the probability of the periphery not having access to external credit is sufficiently large, and spillover effects to the core are present, both the core and the periphery have an interest in contributing to the ESM. Calibration and sensitivity analysis suggest that the optimal ESM size is between the current and twice the size of the agreed-upon ESM. |
| Keywords: | ESM; ESFR; Financial Crisis; Insurance |
| JEL: | G01 G17 G22 G32 C15 |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:349&r=ban |
| By: | John Y. Campbell |
| Abstract: | This paper explores the causes and consequences of cross-country variation in mortgage market structure. It draws on insights from several fields: urban economics, asset pricing, behavioral finance, financial intermediation, and macroeconomics. It discusses lessons from the credit boom, the challenges of mortgage modification in the aftermath of the boom, consumer financial protection, and alternative mortgage forms and funding models. The paper argues that the US has much to learn from mortgage finance in other countries, and specifically from the Danish implementation of the European covered bonds system. |
| JEL: | G21 R21 R31 |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18339&r=ban |