New Economics Papers
on Banking
Issue of 2012‒09‒09
fifteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007-9 By Tobias Adrian; Paolo Colla; Hyun Song Shin
  2. Bank Leverage Shocks and the Macroeconomy: a New Look in a Data-Rich Environment By Jean-Stéphane Mésonnier; Dalibor Stevanovic
  3. Systemic Risk and the European Banking Sector By Nicola Borri; Marianna Caccavaio; Giorgio Di Giorgio; Alberto Maria Sorrentino
  4. Diversity among banks may increase systemic risk By Teruyoshi Kobayashi
  5. An Empirical Study of the Mexican Banking System's Network and its Implications for Systemic Risk By Serafín Martínez-Jaramillo; Biliana Alexandrova-Kabadjova; Bernardo Bravo-Benítez; Juan Pablo Solórzano-Margain
  6. Capital Adequacy and the Bank Lending Channel: Macroeconomic Implications By Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
  7. Algorithm for identifying systemically important banks in payment systems By Soramäki, Kimmo; Cook, Samantha
  8. An Early-warning and Dynamic Forecasting Framework of Default Probabilities for the Macroprudential Policy Indicators Arsenal By Xisong Jin; Francisco Nadal De Simone
  9. (Just) first time lucky ? The impact of single versus multiple bank lending relationships on firms and banks' behavior By Giorgia Barboni; Tania Treibich
  10. Financial Network Systemic Risk Contributions By Nikolaus Hautsch; Julia Schaumburg; Melanie Schienle;
  11. Finding communities in credit networks By Bargigli, Leonardo; Gallegati, Mauro
  12. Determinants of Short-term Consumer Lending Interest Rates By Richard W. Evans
  13. A New Look at Second Liens By Donghoon Lee; Christopher J. Mayer; Joseph Tracy
  14. How big is too big? Critical Shocks for Systemic Failure Cascades By Claudio J. Tessone; Antonios Garas; Beniamino Guerra; Frank Schweitzer
  15. Pricing of Variance Swaps under a Credit-Equity Modeling Framework By Matthew Lorig; Rafael Mendoza-Arriaga

  1. By: Tobias Adrian; Paolo Colla; Hyun Song Shin
    Abstract: The financial crisis of 2007-9 has sparked keen interest in models of financial frictions and their impact on macro activity. Most models share the feature that borrowers suffer a contraction in the quantity of credit. However, the evidence suggests that although bank lending to firms declines during the crisis, bond financing actually increases to make up much of the gap. This paper reviews both aggregate and micro level data and highlights the shift in the composition of credit between loans and bonds. Motivated by the evidence, we formulate a model of direct and intermediated credit that captures the key stylized facts. In our model, the impact on real activity comes from the spike in risk premiums, rather than contraction in the total quantity of credit.
    JEL: E2 E5 G01 G21
    Date: 2012–08
  2. By: Jean-Stéphane Mésonnier; Dalibor Stevanovic
    Abstract: The recent crisis has revealed the potentially dramatic consequences of allowing the build-up of an overstretched leverage of the financial system, and prompted proposals by bank supervisors to significantly tighten bank capital requirements as part of the new Basel 3 regulations. Although these proposals have been fiercely debated ever since, the empirical question of the macroeconomic consequences of shocks to banks’ leverage, be they policy induced or not, remains still largely unsettled. In this paper, we aim to overcome some longstanding identification issues hampering such assessments and propose a new approach based on a data-rich environment at both the micro (bank) level and the macro level, using a combination of bank panel regressions and macroeconomic factor models. We first identify bank leverage shocks at the micro level and aggregate them to an economy-wide measure. We then compute impulse responses of a large array of macroeconomic indicators to our aggregate bank leverage shock, using the new methodology developed by Ng and Stevanovic (2012). We find significant and robust evidence of a contractionary impact of an unexpected shock reducing the leverage of large banks. <P>
    Keywords: bank capital ratios, macroeconomic fluctuations, panel, dynamic factor models,
    JEL: C23 C38 E32 E51 G21 G32
    Date: 2012–09–01
  3. By: Nicola Borri (LUISS Guido Carli University, Department of Economics and Finance and CASMEF); Marianna Caccavaio (LUISS Guido Carli University, Department of Economics and Finance and CASMEF); Giorgio Di Giorgio (LUISS Guido Carli University, Department of Economics and Finance and CASMEF); Alberto Maria Sorrentino (University of Rome Tor Vergata and CASMEF)
    Abstract: Systemic risk is the risk of a collapse of the entire financial system, typically triggered by the default of one, or more, large and interconnected financial institutions. In this paper we estimate the systemic risk contribution of each financial institution in a large sample of European banks. We follow a recent methodology first proposed by Adrian and Brunnermeier (2011) based on the CoVaR and find that size is a predictor of a bank contribution to systemic risk, but it is not the only one. Leverage is important as well. Also, banks that have their headquarters in countries with a more concentrated banking system tend to contribute more to European wide systemic risk, even after controlling for their size. Therefore, any financial regulation designed only to curb banksÕ size would not completely eliminate systemic risk. On average, balance sheet variables are very weak predictors of banksÕ contribution to systemic risk, if compared to market based variables. Accounting rules provide enough degrees of freedom to make balance sheet less informative than market prices. As a result, measures of risk based on higher frequency market prices are more likely to anticipate systemic risk.
    Keywords: Systemic Risk, SIFIs, European Banking System, CoVaR.
    JEL: G01 G18 G21 G32
    Date: 2012
  4. By: Teruyoshi Kobayashi (Graduate School of Economics, Kobe University)
    Abstract: The problem of how to stabilize the financial system has attracted considerable attention since the global financial crisis of 2007-2009. Recently, Beal et al. (2011, gIndividual versus systemic risk and the regulatorfs dilemmah, Proc Natl Acad Sci USA 108: 12647-12652) demonstrated that higher portfolio diversity among banks would reduce systemic risk by decreasing the likelihood of simultaneous defaults. Here, I show that this result is overturned once a financial network comes into play. In a networked financial system, the failure of one bank can bring about a contagion of failure. The optimality of individual risk diversification, as opposed to economy-wide risk diversification, is thus restored. I also present a new method to quantify how the diversity of bank size affects the stability of a financial system. It is shown that a higher diversity of bank size itself makes the financial system more fragile even if external risk exposure is controlled for. The main reason for this is that larger banks are more likely to become a gsuper spreaderh of infectious defaults. In this situation the social cost of letting a bank fail is not uniform and depends on the size of the failing bank. This strongly implies that larger banks are systemically more important than smaller banks, and preventing large banks from being exposed to high external risks would therefore be the most effective vaccine against financial crisis.
    Keywords: Systemic risk, financial crisis, financial network
    JEL: C63 D85 G01
    Date: 2012–08
  5. By: Serafín Martínez-Jaramillo; Biliana Alexandrova-Kabadjova; Bernardo Bravo-Benítez; Juan Pablo Solórzano-Margain
    Abstract: With the purpose of measuring and monitoring systemic risk, some topological properties of the interbank exposures and the payments system networks are studied. We propose non-topological measures which are useful to describe the individual behavior of banks in both networks. The evolution of such networks is also studied and some important conclusions from the systemic risks perspective are drawn. A unified measure of interconnectedness is also created. The main findings of this study are: the payments system network is strongly connected in contrast to the interbank exposures network; the type of exposures and payment size reveal different roles played by banks; behavior of banks in the exposures network changed considerably after Lehmans failure; interconnectedness of a bank, estimated by the unified measure, is not necessarily related with its assets size.
    Keywords: Systemic risk, financial networks, payment systems.
    JEL: C01 C02 C44 C63 G21
    Date: 2012–08
  6. By: Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
    Abstract: This paper develops an analytically tractable dynamic general-equilibrium model with a banking system to examine the macroeconomic implications of capital adequacy requirements. In contrast to the hypothesis of a credit crunch, we find that increasing the strength of bank capital requirements does not necessarily reduce the equilibrium quantity of loans, provided that banks have the option to respond to the capital requirements by accumulating more equity instead of cutting back on lending. Accordingly, we show that there is an inverted-U-shaped relationship between CAR and capital accumulation (and consumption). Furthermore, the optimal capital adequacy ratio for social-welfare maximization is lower than that for capital-accumulation maximization. In accordance with general empirical findings, the capital- accumulation maximizing capital adequacy ratio is procyclical with respect to economic conditions. We also find that monetary policy affects the real macroeconomic activities via the so-called bank lending channel, but the effectiveness of monetary policy is weakened by bank capital requirements.
    Keywords: Banking capital regulation; bank lending channel; the loan-deposit rate
    JEL: E5 O4
    Date: 2012–09–05
  7. By: Soramäki, Kimmo; Cook, Samantha
    Abstract: The ability to accurately estimate the extent to which the failure of a bank disrupts the financial system is very valuable for regulators of the financial system. One important part of the financial system is the interbank payment system. This paper develops a robust measure, SinkRank, that accurately predicts the magnitude of disruption caused by the failure of a bank in a payment system and identifies banks most affected by the failure. SinkRank is based on absorbing Markov chains, which are well-suited to model liquidity dynamics in payment systems. Because actual bank failures are rare and the data is not generally publicly available, the authors test the metric by simulating payment networks and inducing failures in them. The authors use two metrics to evaluate the magnitude of the disruption: the duration of delays in the system (Congestion) aggregated over all banks and the average reduction in available funds of the other banks due to the failing bank (Liquidity dislocation). The authors test SinkRank on Barabasi-Albert types of scale-free networks modeled on the Fedwire system and find that the failing bank's SinkRank is highly correlated with the resulting disruption in the system overall; moreover, the SinkRank technology can identify which individual banks would be most disrupted by a given failure. --
    Keywords: Systemic risk,interbank payment system,liquidity,Markov chains,simulation
    JEL: C63 E58 G28
    Date: 2012
  8. By: Xisong Jin; Francisco Nadal De Simone
    Abstract: The estimation of banks? marginal probabilities of default using structural credit risk models can be enriched incorporating macro-financial variables readily available to economic agents. By combining Delianedis and Geske?s model with a Generalized Dynamic Factor Model into a dynamic t-copula as a mechanism for obtaining banks? dependence, this paper develops a framework that generates an early warning indicator and robust out-of-sample forecasts of banks? probabilities of default. The database comprises both a set of Luxembourg banks and the European banking groups to which they belong. The main results of this study are, first, that the common component of the forward probability of banks? defaulting on their long-term debt, conditional on not defaulting on their short-term debt, contains a significant early warning feature of interest for an operational macroprudential framework driven by economic activity, credit and interbank activity. Second, incorporating the common and the idiosyncratic components of macro-financial variables improves the analytical features and the out-of-sample forecasting performance of the framework proposed.
    Keywords: financial stability, macroprudential policy, credit risk, early warning indicators, default probability, Generalized Dynamic Factor Model, dynamic copulas, GARCH
    JEL: C30 E44 G1
    Date: 2012–07
  9. By: Giorgia Barboni; Tania Treibich
    Abstract: The widespread evidence of multiple bank lending relationships in credit markets suggests that firms are interested in setting up a diversity of banking links. However, it is hard to know from the empirical data whether a firm's observed number of lenders is symptomatic of financial constraints or rather a well-designed strategy. By setting up a model and testing it in a controlled laboratory experiment we are able to uncover the conditions favoring multiple versus single lending strategies of borrowers, as well as the probability to get funding from lenders. We find that borrowers adjust the way they signal their trustworthiness according to the experimental design: they do so by choosing a single lending strategy when the asymmetry of informations is high. Multiple lending is therefore strategically chosen by dishonest borrowers. Instead, when relationship building is possible, the single lending choice reinforces the positive effect of repeatedly interacting with the same lender. In this case, multiple lending is related to borrowers' financial constraints. Finally, when information upon borrowers' behavior is made available, lenders are more likely to punish free-riding behaviors than simple default due to project failure.
    Keywords: Repeated Games, Information Asymmetries, Multiple Lending, Relationship lending
    Date: 2012–08–27
  10. By: Nikolaus Hautsch; Julia Schaumburg; Melanie Schienle;
    Abstract: We propose the realized systemic risk beta as a measure for financial companies’ contribution to systemic risk given network interdependence between firms’ tail risk exposures. Conditional on statistically pre-identified network spillover effects and market and balance sheet information, we define the realized systemic risk beta as the total time-varying marginal effect of a firm’s Value-at-risk (VaR) on the system’s VaR. Suitable statistical inference reveals a multitude of relevant risk spillover channels and determines companies’ systemic importance in the U.S. financial system. Our approach can be used to monitor companies’ systemic importance allowing for a transparent macroprudential regulation.
    Keywords: Systemic risk contribution, systemic risk network, Value at Risk, network topology, two-step quantile regression, time-varying parameters
    JEL: G01 G18 G32 G38 C21 C51 C63
    Date: 2012–08
  11. By: Bargigli, Leonardo; Gallegati, Mauro
    Abstract: In this paper the authors focus on credit connections as a potential source of systemic risk. In particular, they seek to answer the following question: how do we find densely connected subsets of nodes within a credit network? The question is relevant for policy, since these subsets are likely to channel any shock affecting the network. As it turns out, a reliable answer can be obtained with the aid of complex network theory. In particular, the authors show how it is possible to take advantage of the community detection network literature. The proposed answer entails two subsequent steps. Firstly, the authors need to verify the hypothesis that the network under study truly has communities. Secondly, they need to devise a reliable algorithm to find those communities. In order to be sure that a given algorithm works, they need to test it over a sample of random benchmark networks with known communities. To overcome the limitation of existing benchmarks, the authors introduce a new model and test alternative algorithms, obtaining very good results with an adapted spectral decomposition method. To illustrate this method they provide a community description of the Japanese bank-firm credit network, getting evidence of a strengthening of communities over time and finding support for the well-known Japanese main bank system. Thus, the authors find comfort both from simulations and from real data on the possibility to apply community detection methods to credit markets. They believe that this method can fruitfully complement the study of contagious defaults, since the likelihood of intracommunity default contagion is expected to be high. --
    Keywords: Credit networks,communities,contagion,systemic risk
    JEL: C49 C63 D85 E51 G21
    Date: 2012
  12. By: Richard W. Evans (Department of Economics, Brigham Young University)
    Abstract: One of the most striking characteristics of the short-term consumer lending industry is the high level of interest rates. This study tests a theory of consumer lending interest rates in which fixed processing costs of short-term loans are the main determinant of interest-rate levels. I perform empirical tests using store-level data from payday and title lenders in the State of Utah from 2010, combined with zip-code level socioeconomic data from the U.S. Census Bureau and the Internal Revenue Service representing potential borrowers. I find that competition among lenders reduces average interest rates and that riskiness of borrowers, as measured by defaults, increases average interest rates. I also fnd that short-term consumer interest rates have a nonlinear and significant relationship to average income, consistent with anecdotal evidence from the payday lending industry but inconsistent with the hypothesis that short-term consumer lenders prey upon the poor. Lastly, I find no evidence that race or eduction affect the short-term lenders' interest rates.
    Keywords: Consumer lending, interest rates, payday lenders
    JEL: D91 E43 G29
    Date: 2012–08
  13. By: Donghoon Lee; Christopher J. Mayer; Joseph Tracy
    Abstract: We use data from credit report and deeds records to better understand the extent to which second liens contributed to the housing crisis by allowing buyers to purchase homes with small down payments. At the top of the housing market second liens were quite prevalent, with as many as 45 percent of home purchases in coastal markets and bubble locations involving a piggyback second lien. Owner-occupants were more likely to use piggyback second liens than investors. Second liens in the form of home equity lines of credit (HELOCs) were originated to relatively high quality borrowers and originations were declining near the peak of the housing boom. By contrast, characteristics of closed end second liens (CES) were worse on all these dimensions. Default rates of second liens are generally similar to that of the first lien on the same home, although HELOCs perform better than CES. About 20 to 30 percent of borrowers will continue to pay their second lien for more than a year while remaining seriously delinquent on their first mortgage. By comparison, about 40 percent of credit card borrowers and 70 percent of auto loan borrowers will continue making payments a year after defaulting on their first mortgage. Finally, we show that delinquency rates on second liens, especially HELOCs, have not declined as quickly as for most other types of credit, raising a potential concern for lenders with large portfolios of second liens on their balance sheet.
    JEL: G21 R3
    Date: 2012–08
  14. By: Claudio J. Tessone; Antonios Garas; Beniamino Guerra; Frank Schweitzer
    Abstract: External or internal shocks may lead to the collapse of a system consisting of many agents. If the shock hits only one agent initially and causes it to fail, this can induce a cascade of failures among neighoring agents. Several critical constellations determine whether this cascade remains finite or reaches the size of the system, i.e. leads to systemic risk. We investigate the critical parameters for such cascades in a simple model, where agents are characterized by an individual threshold \theta_i determining their capacity to handle a load \alpha\theta_i with 1-\alpha being their safety margin. If agents fail, they redistribute their load equally to K neighboring agents in a regular network. For three different threshold distributions P(\theta), we derive analytical results for the size of the cascade, X(t), which is regarded as a measure of systemic risk, and the time when it stops. We focus on two different regimes, (i) EEE, an external extreme event where the size of the shock is of the order of the total capacity of the network, and (ii) RIE, a random internal event where the size of the shock is of the order of the capacity of an agent. We find that even for large extreme events that exceed the capacity of the network finite cascades are still possible, if a power-law threshold distribution is assumed. On the other hand, even small random fluctuations may lead to full cascades if critical conditions are met. Most importantly, we demonstrate that the size of the "big" shock is not the problem, as the systemic risk only varies slightly for changes of 10 to 50 percent of the external shock. Systemic risk depends much more on ingredients such as the network topology, the safety margin and the threshold distribution, which gives hints on how to reduce systemic risk.
    Date: 2012–09
  15. By: Matthew Lorig; Rafael Mendoza-Arriaga
    Abstract: We compute the value of a variance swap when the underlying is modeled as a Markov process time changed by a L\'{e}vy subordinator. In this framework, the underlying may exhibit jumps with a state-dependent L\'{e}vy measure, local stochastic volatility and have a local stochastic default intensity. Moreover, the L\'{e}vy subordinator that drives the underlying can be obtained directly by observing European call/put prices. To illustrate our general framework, we provide an explicit formula for the value of a variance swap when the diffusion is modeled as (i) a L\'evy subordinated geometric Brownian motion with default and (ii) a L\'evy subordinated Jump-to-default CEV process (see \citet{carr-linetsky-1}). Our results extend the results of \cite{mendoza-carr-linetsky-1}, by allowing for joint valuation of credit and equity derivatives as well as variance swaps.
    Date: 2012–09

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