New Economics Papers
on Banking
Issue of 2012‒10‒13
twenty-two papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Bank stability and market discipline: The effect of contingent capital on risk taking and default probability By Jens Hilscher; Alon Raviv
  2. Why solvency regulation of banks fails to reach its objective By Peter Zweifel; Dieter Pfaff; Jochen Kühn
  3. Determinants of US financial fragility conditions By Fabio C. Bagliano; Claudio Morana
  4. Countercyclical Capital Regulation and Bank Ownership Structure By Tommaso Trani
  5. Financial Conditions and the Money-Output Relationship in Canada By Maral Kichian
  6. Information theoretic description of the e-Mid interbank market: implications for systemic risk By Hatzopoulos, V.; Iori, G.
  7. In Search for a Credit Crunch in Germany By Torsten Schmidt; Lina Zwick
  8. Size and complexity in model financial systems By Arinaminpathy, Nimalan; Kapadia, Sujit; May, Robert
  9. The Ideal Loan and the Patterns of Cross-Border Bank Lending By Joern Kleinert; Bettina Brueggemann; Esteban Prieto
  10. Reputation, risk-taking and macroprudential policy By Aikman, David; Nelson, Benjamin; Tanaka, Misa
  11. Liquidity Contractions and Prepayment Risk on Collateralized Asset Markets By Miguel Angel Iraola; Juan Pablo Torres-Martinez
  12. House prices, credit growth, and excess volatility: Implications for monetary and macroprudential policy By Paolo Gelain; Kevin J. Lansing; Caterina Mendicino
  13. Informal influence in the Inter-American Development Bank By Elizabeth Bland; Kilby, Christopher
  14. A system-wide financial stress indicator for the Hungarian financial system By Dániel Holló
  15. Early warning indicators of asset price boom/bust cycles in emerging markets By Ponomarenko, Alexey
  16. Banking systems, central banks and international reserve accumulation in East Asian economies By Shrestha, Prakash Kumar
  17. A Stochastic Delay Model For Pricing Debt And Loan Guarantees: Theoretical Results By Elisabeth Kemajou; Salah-Eldin Mohammed; Antoine Tambue
  18. Is microcredit targeted to poor people? Evidences from a Cambodian microfinance institution. By Alberto Lanzavecchia
  19. Do SBA Loans Create Jobs? Estimates from Universal Panel Data and Longitudinal Matching Methods By J. David Brown; John S. Earle
  20. Consumer finance data generator - a new approach to Credit Scoring technique comparison By Karol Przanowski; Jolanta Mamczarz
  21. What lies behind credit rationing? A survey of the literature By Annie bellier; Wafa Sayeh; Stéphanie Serve
  22. Interaction between bank branches, local entrepreneurship and development on rural and suburban areas Regional Unity of Serres By CHRYSANTHI BALOMENOU; MARIANTHI MALIARI; DIMITRIS LAGOS

  1. By: Jens Hilscher (International Business School, Brandeis University); Alon Raviv (International Business School, Brandeis University)
    Abstract: This paper investigates the effects of financial institutions issuing contingent capital, a debt security that automatically converts into equity if assets fall below a predetermined threshold. We analyze a tractable form of contingent convertible bonds ("coco") and provide a closed-form solution for the price. We quantify the reduction in default probability associated with contingent capital as compared to subordinated debt. We then show that appropriate choice of contingent capital parameters (conversion ratio and threshold) can virtually eliminate stockholders' incentives to risk-shift, a motivation that is present when bank liabilities instead include either only equity or subordinated debt. Importantly, risk-taking incentives continue to be weak during times of financial distress. Our findings imply that contingent capital may be an effective tool for stabilizing financial institutions.
    Keywords: Contingent capital, Executive compensation, Risk taking, Banking regulation, Bank default probability, Financial crisis
    JEL: G13 G21 G28 E58
    Date: 2012–09
  2. By: Peter Zweifel (Department of Economics, University of Zurich); Dieter Pfaff (Department of Business Administration (IBW), University of Zurich); Jochen Kühn
    Abstract: This paper contains a critique of solvency regulation such as imposed on banks by Basel I and II. Banks’ investment divisions seek to maximize the expected rate of return on risk-adjusted capital. For them, a higher solvency level lowers the cost of refinancing but ties costly capital. Sequential decision making by banks is tracked over three periods. In period 1, exogenous changes in expected returns and volatility occur, causing a pair of optimal adjustments of solvency in period 2. In period 3, the actual adjustment of solvency constitutes an exogenous shock, triggering portfolio adjustments in terms of expected return and volatility which move the bank along an endogenous efficiency frontier. Both Basel I and II are shown to modify the slope of this frontier, inducing senior management to opt for higher volatility in several situations. Therefore, both types of solvency regulation can run counter their stated objective, which may also be true of Basel III.
    Keywords: regulation, banks, solvency, Basel I, Basel II, Basel III
    JEL: G15 G21 G28 L51
    Date: 2012–05
  3. By: Fabio C. Bagliano (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy); Claudio Morana (Department of Economics, University of Milan-Bicocca)
    Abstract: The recent financial crisis has highlighted the fragility of the US (and other countries') financial system under several respects. In this paper, the properties of a summary index of financial fragility, obtained by combining information conveyed by the "Agency", "Ted" and "BAA-AAA" spreads, timely capturing changes in credit and liquidity risk, distress in the mortgage market, and corporate default risk, are investigated over the 1986-2010 period. The empirical results show that observed fluctuations in the financial fragility index can be attributed to identified (global and domestic) macroeconomic (20%) and financial disturbances (40% to 50%), over both short- and long-term horizons, as well as to oil-supply shocks in the long-term (25%). The investigation of specific episodes of financial distress, occurred in 1987, 1998 and 2000, and, more recently, over the 2007-2009 period, shows that sizable fluctuations in the index are largely determined by financial shocks, while macroeconomic disturbances have generally had a stabilizing effect.
    Keywords: financial fragility, US, macro-?nance interface, international business cycle, factor vector autoregressive models, ?financial crisis, Great Recession
    JEL: C22 E32 G12
    Date: 2012–09
  4. By: Tommaso Trani (Graduate Institute of International Studies)
    Abstract: This paper develops a macroeconomic framework where the representative bank is owned by inside and outside owners and copes with capital requirements that vary countercyclically. The issuance of outside equity is characterized getting insights from the literature on corporate governance, especially that on corporate governance and investor protection. The insider receives utility benefits from the diversion of dividends, but the costs of diversion increase with the size of bank equity owned by outsiders. The goal is to see to what extent the willingness of insiders to share the bank with outsiders is affected by capital regulation. I find a negative link, which holds only if capital restrictions vary countercyclically. Thinking of a positive shock, the justification for such a negative link is that the shock leads not only to tighter regulation, but also to higher expected dividends and, relatedly, to higher agency costs affecting the distribution of earnings.
    Keywords: macroprudential policy, bank regulation, insider-outsider, bank shareholding
    JEL: E60 G28 G32
    Date: 2012–09–21
  5. By: Maral Kichian
    Abstract: We propose a drifting-coefficient model to empirically study the effect of money on output growth in Canada and to examine the role of prevailing financial conditions for that relationship. We show that such a time-varying approach can be a useful way of modelling the impact of money on growth, and can partly reconcile the lack of concensus in the literature on the question of whether money affects growth. In addition, we find that credit conditions also play a role in that relationship. In particular, there is an additional negative short-run impact of money on growth when credit is not readily available, supporting the precautionary motive for holding money. Finally, money is found to have no effect on output growth in the long-run.
    Keywords: Monetary aggregates; Credit and credit aggregates; Business fluctuations and cycles
    JEL: E44 E51
    Date: 2012
  6. By: Hatzopoulos, V.; Iori, G.
    Abstract: We present an empirical analysis of the European electronic interbank market of overnight lending (e-MID) during the years 1999–2009. The main goal of the paper is to explain the observed changes of the cross-sectional dispersion of lending/borrowing conditions before, during and after the 2007–2008 subprime crisis. Unlike previous contributions, that focused on banks’ dependent and macro information as explanatory variables, we address the role of banks’ behaviour and market microstructure as determinants of the credit spreads.
    Keywords: interbank lending; market microstructure; subprime crisis; credit spreads; liquidity management
    Date: 2012
  7. By: Torsten Schmidt; Lina Zwick
    Abstract: The purpose of this paper is to investigate whether a credit crunch occurred in Germany during the recent financial crisis and to analyze the underlying factors. In order to disentangle credit supply and demand we specify a theory-based dynamic disequilibrium model of the German credit market. To estimate this model we use a new approach based on Bayesian Inference suggested by Bauwens and Lubrano (2007). Besides the analysis of the whole banking sector we will apply the model to five groups of banks (big private banks, “Landesbanken”, savings banks, credit cooperatives, regional institutions of credit cooperatives) that were affected differently by the financial crisis. The results suggest that a credit crunch did not occur in Germany during the recent economic crisis as well as during the following recovery starting in 2010. Furthermore, we find that especially those banks that were more affected by the financial crisis through huge impairments restricted their credit supply more than others. Both supply and demand side factors contributed to the stabilization of credit financing. This suggests that the structure of the German banking sector as well as economic policy measures avoided a credit crunch.
    Keywords: Credit Crunch; Bank Lending; Financial Crisis
    JEL: C32 E51 G21
    Date: 2012–08
  8. By: Arinaminpathy, Nimalan (Princeton University); Kapadia, Sujit (Bank of England); May, Robert (Oxford University)
    Abstract: The global financial crisis has precipitated an increasing appreciation of the need for a systemic perspective towards financial stability. For example: What role do large banks play in systemic risk? How should capital adequacy standards recognize this role? How is stability shaped by concentration and diversification in the financial system? We explore these questions using a deliberately simplified, dynamical model of a banking system which combines three different channels for direct spillovers from one bank to another: liquidity hoarding, asset price contagion, and the propagation of defaults via counterparty credit risk. Importantly, we also introduce a mechanism for capturing how swings in ‘confidence’ in the system may contribute to instability. Our results highlight that the importance of relatively large, well-connected banks in system stability scales more than proportionately with their size: the impact of their collapse arises not only from their connectivity, but also from their effect on confidence in the system. Imposing tougher capital requirements on larger banks than smaller ones can thus enhance the resilience of the system. Moreover, these effects are more pronounced in more concentrated systems, and continue to apply even when allowing for potential diversification benefits which may be realised by larger banks. We discuss some tentative implications for policy, as well as conceptual analogies in ecosystem stability, and in the control of infectious diseases.
    Keywords: Systemic risk; financial crises; contagion; network models; liquidity risk; confidence
    JEL: D85 G01 G21 G28
    Date: 2012–10–07
  9. By: Joern Kleinert (Karl-Franzens University of Graz); Bettina Brueggemann (University of Frankfurt); Esteban Prieto (University of Tuebingen)
    Abstract: A typical loan offer is a differentiated product with various negotiated characteristics (maturity, amount, timing, collateral, disclosure requirements) which involve costs that go beyond the mere interest rate. Taking into account all costs, a firm chooses the cost minimizing loan offer. Based on this decision criterion, we derive the probability of a firm from country i to choose a loan contract from a bank in country j. We use this probability to derive a gravity equation for cross-border bank loans. Finally, we estimate the gravity equation based on the theoretical model controlling for the unobserved heterogeneity proposed by our theoretical model.
    Keywords: Product differentiation, Gravity Equation, Cross-border bank lending
    JEL: L14 F34 G21
    Date: 2012–09
  10. By: Aikman, David (Bank of England); Nelson, Benjamin (Bank of England); Tanaka, Misa (Bank of England)
    Abstract: This paper examines the role of macroprudential capital requirements in preventing inefficient credit booms in a model with reputational externalities. Unprofitable banks have strong incentives to invest in risky assets and generate inefficient credit booms when macroeconomic fundamentals are good in order to signal high ability. We show that across-the-system countercyclical capital requirements that deter credit booms are constrained optimal when fundamentals are within an intermediate range. We also show that when fundamentals are deteriorating, a public announcement of that fact can itself play a powerful role in preventing inefficient credit booms, providing an additional channel through which macroprudential policies can improve outcomes.
    Keywords: Macroprudential policy; credit booms; bank capital regulation
    JEL: E60 G10 G38
    Date: 2012–10–07
  11. By: Miguel Angel Iraola (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM)); Juan Pablo Torres-Martinez (Department of Economics, Universidad de Chile)
    Abstract: This paper presents a dynamic general equilibrium model with default and collateral requirements. In contrast with previous literature, our model allows for liquidity contractions and general prepayment specifications. We show that liquidity substantially affects credit and prepayment risks, and that different borrowers may follow differentiated payment strategies: whereas some pay, others prepay or default. The lack of liquidity increases debtors' willingness to continue paying, even thought prepayment cost could be higher than the collateral value. This mechanism rationalizes underwater mortgages. We prove existence of equilibrium, and provide a numerical example illustrating the main determinants of optimal payment strategies.
    Keywords: Collaterized asset markets, Liquidity constraints, prepayment risk
    JEL: D50 D52
    Date: 2012
  12. By: Paolo Gelain (Norges Bank (Central Bank of Norway)); Kevin J. Lansing (FRB San Francisco and Norges Bank (Central Bank of Norway)); Caterina Mendicino (Bank of Portugal)
    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 thatresemble 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 theintroduction 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: Asset pricing, Excess volatility, Credit cycles, Housing bubbles, Monetary policy, Macroprudential policy
    JEL: E32 E44 G12 O40
    Date: 2012–08–20
  13. By: Elizabeth Bland (Department of Economics and Statistics, Villanova School of Business, Villanova University); Kilby, Christopher (Department of Economics and Statistics, Villanova School of Business, Villanova University)
    Abstract: This paper investigates U.S. informal influence in the Inter-American Development Bank (IDB) by testing whether IDB loans disburse faster when the borrowing country is geopolitically or economically important to the U.S. The methodology is similar to that in earlier work on the World Bank and the Asian Development Bank and relies on the governance structure in which formal donor influence ends with loan approval, i.e., prior to loan disbursement. In contrast to findings for the World Bank and the Asian Development Bank, we do not uncover convincing evidence of consistent U.S. informal influence in the Inter-American Development Bank.
    Keywords: Donor Influence; Inter-American Development Bank; United States; UN voting
    JEL: F35 F53 F55 O19
    Date: 2012–08
  14. By: Dániel Holló (Magyar Nemzeti Bank (central bank of Hungary))
    Abstract: In this study, a system-wide financial stress index (SWFSI) for the Hungarian financial system is developed. The indicator measures the joint stress level of the Hungarian financial system’s main segments: the spot foreign exchange market, the foreign exchange swap market, the secondary market of government bonds, the interbank unsecured money market, the equity market and the banking segment. Stress indices of the six financial system segments are aggregated on the basis of weights which reflect their time-varying cross-correlation structure. As a result, the system-wide financial stress indicator puts greater emphasis on periods in which stress presents permanently in several market segments at the same time. Our results indicate that after February 2005 the default of Lehman Brothers and its global consequences unambiguously acted as a lasting stress event with systemic risk importance from the perspective of the stability of the Hungarian financial system. Finally, the results suggest that the Hungarian financial system’s stress level in the period under review (February 1, 2005–September 16, 2011) was driven mainly by disorders in the banking and the foreign exchange swap market segments.
    Keywords: financial stress, system-wide financial stress index, financial stability, systemic risk
    JEL: G01 G10 G20 E44
    Date: 2012
  15. By: Ponomarenko, Alexey (BOFIT)
    Abstract: We apply recently developed early warning indicators systems to a cross-section of emerging markets. We find that, with little or no modification, models designed to predict asset price booms/busts in advanced countries may be useful for emerging markets. The concept of monitoring a set of asset prices, real activity (especially investment) and financial (especially credit) indicators is generally found to be efficacious.
    Keywords: early warning indicators; asset prices; emerging markets
    JEL: E37 E44 E51
    Date: 2012–10–02
  16. By: Shrestha, Prakash Kumar
    Abstract: This paper examines changes in the balance sheets of the banking system in five East Asian economies which were affected by the 1997 Asian Crisis. These countries have persistently accumulated foreign currency reserves since the crisis. This paper estimates the impact of reserve accumulation on some important balance sheet variables such as liquid assets, credits and deposits of the banking system by applying panel data techniques. Estimates using data from Thailand, South Korea, Malaysia, Philippines and Indonesia show that reserve accumulation has a positive impact on the liquid assets and deposits of the banking system, but not on credit flows, after controlling for the effect of other potential variables. --
    Keywords: international reserves,central banks,banking systems and East Asian countries
    JEL: F31 E58 G21
    Date: 2012
  17. By: Elisabeth Kemajou; Salah-Eldin Mohammed; Antoine Tambue
    Abstract: We consider that the price of a firm follows a non linear stochastic delay differential equation. We also assume that any claim value whose value depends on firm value and time follows a non linear stochastic delay differential equation. Using self-financed strategy and duplication we are able to derive a Random Partial Differential Equation (RPDE) that any claim whose value depends on firm value and time should satisfy. We solve the RPDE for debt and loan guarantees under the assumption that there are no coupon payment nor dividends prior to the maturity of the debt.
    Date: 2012–10
  18. By: Alberto Lanzavecchia (University of Padova)
    Abstract: This study extends research on the social performance of microfinance institutions. The research methodology is based on Grameen Progress out of Poverty IndexTM (PPITM) for Cambodia applied to a sample of borrowers randomly extracted from a Cambodian microfinance institutionÕs loan portfolio. Dataset has been directly collected through in-house interviews. Main questions discussed here are: (1) Is microcredit targeted to poor people? (2) Has the poverty rate of the sample changed in last six months? and (3) What percentage of male vs. female clients is poor? We found an average poverty likelihood of about 8.1%, estimated at the day of the interview, steady over a period of six months and not statistically different between male and female borrowers. This evidence might be related to business geographical location or targeting. Actually, PPI too much relies on asset ownership rather than on cash flows and saving capacity. Despite the general wisdom microcredit is targeted to the Òpoorest among the poor peopleÓ, this is utterly consistent with a sound and safe (micro)banking activity, aimed at sustainable results. Here comes a call for a triple bottom line performance evaluation on microfinance institutions: economic, social and environmental effects of their activities.
    Keywords: microcredit, social performance, poverty index, case study, Cambodia.
    JEL: G29 O16 I32
    Date: 2012–09
  19. By: J. David Brown; John S. Earle
    Abstract: This pape reports estimates of the effects of the Small Business Administration (SBA) 7(a) and 504 loan programs on employment. The database links a complete list of all SBA loans in these programs to universal data on all employers in the U.S. economy from 1976 to 2010. Our method is to estimate firm fixed effect regressions using matched control groups for the SBA loan recipients we have constructed by matching exactly on firm age, industry, year, and pre-loan size, plus kernel-based matching on propensity scores estimated as a function of four years of employment history and other variables. The results imply positive average effects on loan recipient employment of about 25 percent or 3 jobs at the mean. Including loan amount, we find little or no impact of loan receipt per se, but an increase of about 5.4 jobs for each million dollars of loans. When focusing on loan recipients and control firms located in high-growth counties (average growth of 22 percent), places where most small firms should have excellent growth potential, we find similar effects, implying that the estimates are not driven by differential demand conditions across firms. Results are also similar regardless of distance of control from recipient firms, suggesting only a very small role for displacement effects. In all these cases, the results pass a "pre-program" specification test, where controls and treated firms look similar in the pre-loan period. Other specifications, such as those using only matching or only regression imply somewhat higher effects, but they fail the pre-program test.
    Date: 2012–09
  20. By: Karol Przanowski; Jolanta Mamczarz
    Abstract: This paper aims to present a general idea of method comparison of Credit Scoring techniques. Any scorecard can be made in various methods based on variable transformations in the logistic regression model. To make a comparison and come up with the proof that one technique is better than another is a big challenge due to the limited availability of data. The same conclusion cannot be guaranteed when using other data from another source. The following research challenge can therefore be formulated: how should the comparison be managed in order to get general results that are not biased by particular data? The solution may be in the use of various random data generators. The data generator uses two approaches: transition matrix and scorings. Here are presented both: results of comparison methods and the methodology of these comparison techniques creating. Before building a new model the modeler can undertake a comparison exercise that aims at identifying the best method in the case of the particular data. Here are presented various measures of predictive model like: Gini, Delta Gini, VIF and Max p-value, emphasizing the multi-criteria problem of a "Good model". The idea that is being suggested is of particular use in the model building process where there are defined complex criteria trying to cover the important problems of model stability over a period of time, in order to avoid a crisis. Some arguments for choosing Logit or WOE approach as the best scorecard technique are presented.
    Date: 2012–09
  21. By: Annie bellier; Wafa Sayeh; Stéphanie Serve (THEMA, Universite de Cergy-Pontoise; THEMA, Universite de Cergy-Pontoise; THEMA, Universite de Cergy-Pontoise)
    Abstract: Since World War II, the concept of credit rationing (CR) has been a topic of extensive investigations, both theoretical and empirical. From the theoretical point of view, several attempts have been made to define the extent to which a firm can be identified as credit rationed in macroeconomic and microeconomic financial frameworks. In the context of the current financial crisis, CR is strategically important given the financial difficulties faced by small business firms. The first purpose of this article is to provide an historical context for the theoretical frameworks of CR to analyze the existing definitions and typologies. From an empirical point of view, the main obstacle is that a direct measure of CR is not directly observable, considering that the answer is given by the firm and/or the bank. In light of the previously defined typology, the second purpose of this article is to present both the measures of CR and the main driving factors that have been tested in the empirical literature. Special attention is paid to the supply-demand interaction via the impact of the bank relationship on CR.
    Keywords: credit rationing, small business, bank relationship
    JEL: G14 G21 G32
    Date: 2012
    Abstract: This paper is divided into two parts, one theoretical and one empirical and attempts to examine the interaction between bank branches, local entrepreneurship and development on rural and suburban areas at Regional Unity of Serres, Central Macedonia, Greece. More particularly, in the first part of our paper are presented loan providing funds for SMEs in Greece, the new law for local authorities named “Kallikratis†on Regional Unity of Serres, local demographic characteristics and the existing bank branches network on this area. Analyzing the data we conclude to the characterization of the region as rural and underdevelopment. At the second part are presented the results of our questionnaire-based research from 74 entrepreneurs in Regional Unity of Serres. It is noticeable that businessmen’s answers are similar to those deduced from the results of the researches that have been referred to in bibliography Finally we will end this presentation with the main conclusions providing that an extensive network of bank branches on rural and suburban areas support local entrepreneurship and contribute to local development.
    Date: 2012–10

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