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on Banking |
| By: | Joseph P. Hughes; Loretta J. Mester |
| Abstract: | The unique capital structure of commercial banking – funding production with demandable debt that participates in the economy’s payments system – affects various aspects of banking. It shapes banks’ comparative advantage in providing financial products and services to informationally opaque customers, their ability to diversify credit and liquidity risk, and how they are regulated, including the need to obtain a charter to operate and explicit and implicit federal guarantees of bank liabilities to reduce the probability of bank runs. These aspects of banking affect a bank’s choice of risk vs. expected return, which, in turn, affects bank performance. Banks have an incentive to reduce risk to protect the valuable charter from episodes of financial distress and they also have an incentive to increase risk to exploit the cost-of-funds subsidy of mispriced deposit insurance. These are contrasting incentives tied to bank size. Measuring the performance of banks and its relationship to size requires untangling cost and profit from decisions about risk versus expected-return because both cost and profit are functions of endogenous risktaking. ; This chapter gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature. One application explains how better diversification available at a larger scale of operations generates scale economies that are obscured by higher levels of risk-taking. Studies of banking cost that ignore endogenous risk-taking find little evidence of scale economies at the largest banks while those that control for this risk-taking find large scale economies at the largest banks – evidence with important implications for regulation. ; Prepared for the Oxford Handbook of Banking, 2nd edition |
| Keywords: | Banks and banking ; Risk ; Profit ; Economies of scale |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:13-31&r=ban |
| By: | Lamont Black; Ricardo Correa; Xin Huang; Hao Zhou |
| Abstract: | We propose a hypothetical distress insurance premium (DIP) as a measure of the European banking systemic risk, which integrates the characteristics of bank size, default probability, and interconnectedness. Based on this measure, the systemic risk of European banks reached its height in late 2011 around € 500 billion. We find that the sovereign default spread is the factor driving this heightened risk in the banking sector during the European debt crisis. The methodology can also be used to identify the individual contributions of over 50 major European banks to the systemic risk measure. This approach captures the large contribution of a number of systemically important European banks, but Italian and Spanish banks as a group have notably increased their systemic importance. We also find that bank-specific fundamentals predict the one-year-ahead systemic risk contribution of our sample of banks in an economically meaningful way. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1083&r=ban |
| By: | Uluc Aysun (University of Central Florida, Orlando, FL) |
| Abstract: | This paper investigates the transmission of macroeconomic shocks to production in a model that includes a large and a small bank. The two banks are differentiated by parameters that govern their sensitivities to their own and their borrowers’ balance sheets and simulations show that the large (small) bank responds more to demand/financial (supply) shocks. Bank-level evidence generally supports the model’s assumptions but indicates that the large banks’ sensitivities and the sensitivity to borrower balance sheets are more important. Incorporating U.S. macroeconomic shocks into the empirical model illustrates a stronger transmission through large bank lending. Shrinking banks can, therefore, decrease volatility. |
| Keywords: | bank size, economic fluctuations, call report data, too big to fail, DSGE model |
| JEL: | E44 E32 G21 E02 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:cfl:wpaper:2013-02&r=ban |
| By: | Solange Maria Guerra; Benjamin Miranda Tabak; Rodrigo Andrés de Souza Penaloza; Rodrigo César de Castro Miranda |
| Abstract: | In this paper we present systemic risk measures based on contingent claims approach, banking sector multivariate density and cluster analysis. These indicators aim to capture credit risk stress and its potential to become systemic. The proposed measures capture not only individual bank vulnerability, but also the stress dependency structure between them. Furthermore, these measures can be quite useful for identifying systematically important banks. The empirical results show that these indicators capture with considerable fidelity the moments of increasing systemic risk in the Brazilian banking sector in recent years. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:321&r=ban |
| By: | Rene Carmona; Jean-Pierre Fouque; Li-Hsien Sun |
| Abstract: | We propose a simple model of inter-bank borrowing and lending where the evolution of the log-monetary reserves of $N$ banks is described by a system of diffusion processes coupled through their drifts in such a way that stability of the system depends on the rate of inter-bank borrowing and lending. Systemic risk is characterized by a large number of banks reaching a default threshold by a given time horizon. Our model incorporates a game feature where each bank controls its rate of borrowing/lending to a central bank. The optimization reflects the desire of each bank to borrow from the central bank when its monetary reserve falls below a critical level or lend if it rises above this critical level which is chosen here as the average monetary reserve. Borrowing from or lending to the central bank is also subject to a quadratic cost at a rate which can be fixed by the regulator. We solve explicitly for Nash equilibria with finitely many players, and we show that in this model the central bank acts as a clearing house, adding liquidity to the system without affecting its systemic risk. We also study the corresponding Mean Field Game in the limit of large number of banks in the presence of a common noise. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1308.2172&r=ban |
| By: | Rodrigo César de Castro Miranda; Benjamin Miranda Tabak |
| Abstract: | This paper proposes a novel way to model a network of firm-bank and bank-bank interrelationships using a unique dataset for the Brazilian economy. We show that distress originating from firms can be propagated through the interbank network. Furthermore, we present evidence that the distribution of distress can have contagious effects due to correlated exposures. Our modeling approach and empirical results provide useful tools and information for policy makers and contribute to the discussion on assessing systemic risk in an interconnected world. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:322&r=ban |
| By: | Ronald Fischer; Nicolás Inostroza; Felipe J. Ramírez |
| Abstract: | We consider a two-period model of a banking system to explore the effects of competition on the stability and efficiency of economic activity. In the model, competing banks lend to entrepreneurs. After entrepreneurs receive the loans for their projects, there is a probability of a shock. The shock implies that a fraction of firms will default and be unable to pay back their loans. This will require banks to use their capital and reserves to pay back depositors, restricting restrict second period lending, thus amplifying the economic effect of the initial shock. There are two possible types of equilibria, a prudent equilibrium in which banks do not collapse after the shock, and an imprudent equilibrium where banks collapse. We examine the effects of increased competition in this setting. First, we find existence conditions for prudent equilibria. Second, we showthat the effect of increased banking competition is to increase the efficiency of the economy at the expense of increased variance in second period economic results. In particular, if the probability of a shock is small, increased competition raises both expected GDP over the two period and expected activity in the second period, after the shock. Increased competition also increases the attractiveness of imprudent equilibria. Unpredicted regulatory forbearance in the aftermath of a shock can be used to reduce or eliminate the variance in economic activity. However, if regulatory forbearance is expected in response to a shock, the effect on the variance after the shock is ambiguous and can even lead to increased variance after a shock. We also show the expected result that as the size of a shock increases, there is less lending in a prudent equilibrium. Finally we show that independently of the type of equilibria or the possibility of a switch among types of equilibria, increased banking competition increases the amplification effect after a shock. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edj:ceauch:296&r=ban |
| By: | Miller, Marcus (University of Warwick); Zhang, lei (University of Warwick) |
| Abstract: | The classic Diamond-Dybvig model of banking assumes perfect competition and abstracts from issues of moral hazard,hardly appropriate when considering modern UK banking.We therefore modify the classic model to ncorporate franchise values due to market power; and risk-taking by banks with limited liability.We go further to show how the capacity of franchis evalues to mitigate risk taking maybe undermined by the bailout option; with explicit analytical results provided for the case of extreme risk-aversion.After a brief discussion of how this may impact on the distribution of income, we outline the ways in which the Vickers Report seeks to remedy these problems. |
| Keywords: | Money and banking,Seigniorage,Risk-taking,Bailouts,Regulation |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:cge:warwcg:134&r=ban |
| By: | Pintus, P. A.; Suda, J. |
| Abstract: | This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning their economic environment. When agents update their beliefs about the unobserved process driving financial shocks to the leverage ratio, the responses of output and other aggregates under adaptive learning are significantly larger than under rational expectations. In our benchmark case calibrated using US data on leverage, debt-to-GDP and land value-to-GDP ratios for 1996Q1-2008Q4, learning amplifies leverage shocks by a factor of about three, relative to rational expectations. When fed with the actual leverage innovations, the learning model predicts the correct magnitude for the Great Recession, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the impact of learning and, accordingly, that macro-prudential policies enforcing countercyclical leverage dampen the effects of leverage shocks. Finally, we illustrate how learning with a misspecified model that ignores real/financial linkages also contributes to magnify financial shocks. |
| Keywords: | Borrowing Constraints, Collateral, Leverage, Learning, Financial Shocks, Recession |
| JEL: | E32 E44 G18 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:440&r=ban |
| By: | Gan, Li; Hernandez, Manuel A.; Liu, Yanyan |
| Abstract: | Group lending has been widely adopted in the past thirty years by many microfinance institutions as a means to mitigate information asymmetries when delivering credit to the poor. This paper proposes an empirical method to address the potential omitted-variable problem resulting from unobserved group types when modeling the repayment behavior of group members. |
| Keywords: | group lending, heterogenous types, repayment, social behaviour, Credit, loan repayment, Modeling, |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fpr:ifprid:1268&r=ban |
| By: | Bruno Martins; Ricardo Schechtman |
| Abstract: | This paper investigates the consequences on loan spreads of a within-sector macro prudential capital measure in Brazil. Due to concerns related to a possibly too fast and unbalanced expansion of the auto-loan sector, regulatory capital was raised for auto-loans with specific long maturities and high LTVs. Our results show that Brazilian banks, after the regulatory measure, increased spreads charged on the same borrower for similar auto loans whose regulatory risk weights have increased. In comparison to the set of untargeted loans, the increase was at least of 13%. On the other hand, evidence on increase of spreads also for loans whose risk weights have not been altered is not robust. Finally, this paper shows that the later withdrawal of the regulatory capital measure was associated, similarly, to lower spreads charged on auto loans whose risk weights have decreased. Nevertheless, when measured relatively, this reduction in spreads was smaller than the original increase. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:323&r=ban |
| By: | Sergio R. S. Souza; Benjamin M. Tabak; Solange M. Guerra |
| Abstract: | This paper analyzes the financial institutions (FIs) that operate in the Brazilian Interbank Market, investigating, through simulations, the potential contagion that they present, the contagion losses' and the contagion route associated to FIs' bankruptcies, and the value of the 1-year expected loss of the financial system. The paper also computes the possibility of contagion of other markets triggered by FIs' defaults in the interbank market. Besides, it identifies contagion transmitter FIs and losses amplifier FIs in the market studied. The analyses performed found no particularly important source of stress in the Brazilian financial system, in the period. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:320&r=ban |
| By: | Bijapur, Mohan |
| Abstract: | This paper provides new insights into the relationship between the supply of credit and the macroeconomy. We present evidence that credit shocks constitute shocks to aggregate supply in that they have a permanent effect on output and cause inflation to rise in the short term. Our results also suggest that the effects on aggregate supply have grown stronger in recent decades. |
| Keywords: | Financial crisis; Potential output; Inflation; Credit crunch. |
| JEL: | E31 E32 |
| Date: | 2013–07–21 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:49005&r=ban |