New Economics Papers
on Banking
Issue of 2013‒09‒24
twenty-one papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Competition Policy for Modern Banks By Lev Ratnovski
  2. Banks’ Liquidity Buffers and the Role of Liquidity Regulation By Clemens Bonner; Iman van Lelyveld; Robert Zymek
  3. Information Management in Banking Crises By Shapiro, Joel; Skeie, David
  4. Market-Based Structural Top-Down Stress Tests of the Banking System By Jorge A. Chan-Lau
  5. The "Greatest" Carry Trade Ever? Understanding Eurozone Bank Risks By Acharya, Viral V; Steffen, Sascha
  6. Market-Based Bank Capital Regulation By Bulow, Jeremy I.; Klemperer, Paul
  7. Risk Exposures and Financial Spillovers in Tranquil and Crisis Times: Bank-Level Evidence By Hélène Poirson; Jochen M. Schmittmann
  8. How Effective are Macroprudential Policies in China? By Bin Wang; Tao Sun
  9. Structured Debt Ratings: Evidence on Conflicts of Interest By Efing, Matthias; Hau, Harald
  10. Towards deeper financial integration in Europe: What the Banking Union can contribute By Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
  11. Bank Resolution Costs, Depositor Preference, and Asset Encumbrance By Daniel C. Hardy
  12. The Macroprudential Framework: Policy Responsiveness and Institutional Arrangements By Cheng Hoon Lim; Ivo Krznar; Fabian Lipinsky; Akira Otani; Xiaoyong Wu
  13. Credit Growth in Latin America: Financial Development or Credit Boom? By Niels-Jakob Harbo Hansen; Olga Sulla
  14. Improving access to banking : evidence from Kenya By Allen, Franklin; Carletti, Elena; Cull, Robert; Qian, Jun; Senbet, Lemma; Valenzuela, Patricio
  15. Belgium: Technical Note on Financial Conglomerate Supervision By International Monetary Fund. European Dept.
  16. Institutional Arrangements for Macroprudential Policy in Asia By Cheng Hoon Lim; Rishi S Ramchand; Hong Wang; Xiaoyong Wu
  17. Central Bank Screening, Moral Hazard, and the Lender of Last Resort Policy By Mei Li; Frank Milne; Junfen Qiu
  18. A Framework for Macroprudential Bank Solvency Stress Testing: Application to S-25 and Other G-20 Country FSAPs By Andreas A. Jobst; Li L. Ong; Christian Schmieder
  19. Creating a Safer Financial System: Will the Volcker, Vickers, and Liikanen Structural Measures Help? By José Vinãls; Ceyla Pazarbasioglu; Jay Surti; Aditya Narain; Michaela Erbenova; Julian T. S. Chow
  20. Liquidity and Welfare By Yi Wen
  21. Banking and the Macroeconomy in China: A Banking Crisis Deferred? By Le, Vo Phuong Mai; Matthews, Kent; Meenagh, David; Minford, Patrick; Xiao, Zhiguo

  1. By: Lev Ratnovski
    Abstract: Traditional bank competition policy seeks to balance efficiency with incentives to take risk. The main tools are rules guiding entry/exit and consolidation of banks. This paper seeks to refine this view in light of recent changes to financial services provision. Modern banking is largely market-based and contestable. Consequently, banks in advanced economies today have structurally low charter values and high incentives to take risk. In such an environment, traditional policies that seek to affect the degree of competition by focusing on market structure (i.e. concentration) may have limited effect. We argue that bank competition policy should be reoriented to deal with the too-big-to-fail (TBTF) problem. It should also focus on the permissible scope of activities rather than on market structure of banks. And following a crisis, competition policy should facilitate resolution by temporarily allowing higher concentration and government control of banks.
    Keywords: Banking;Banks;Competition;Risk management;Banks, Competition Policy, Macroprudential Policy, Systemic Risk.
    Date: 2013–05–23
  2. By: Clemens Bonner; Iman van Lelyveld; Robert Zymek
    Abstract: We assess the determinants of banks’ liquidity holdings using balance sheet data for nearly 7000 banks from 30 OECD countries over a ten-year period. We highlight the role of several bank-specific, institutional and policy variables in shaping banks’ liquidity risk management. Our main question is whether the presence of liquidity regulation substitutes or complements banks’ incentives to hold liquid assets. Our results reveal that in the absence of liquidity regulation, the determinants of banks’ liquidity buffers are a combination of bank-specific (business model, profitability, deposit holdings, size) and country-specific (disclosure requirements, concentration of the banking sector) variables. While most incentives are substituted by liquidity regulation, a bank’s disclosure requirement and size remain significant. A key takeaway from our analysis is that the complementary nature of disclosure and liquidity requirements provides a strong rationale for considering them jointly in the design of regulation.
    Keywords: Liquidity; Regulation; Disclosure; Business Models
    JEL: G20 G21 G28
    Date: 2013–09
  3. By: Shapiro, Joel; Skeie, David
    Abstract: A regulator resolving a bank faces two audiences: depositors, who may run if they believe the regulator will not provide capital, and banks, which may take excess risk if they believe the regulator will provide capital. When the regulator's cost of injecting capital is private information, it manages expectations by using costly signals: (i) A regulator with a low cost of injecting capital may forbear on bad banks to signal toughness and reduce risk taking, and (ii) A regulator with a high cost of injecting capital may bail out bad banks to increase confidence and prevent runs. Regulators perform more informative stress tests when the market is pessimistic.
    Keywords: bank regulation; financial crisis; reputation; sovereign debt crisis; stress tests
    JEL: G01 G21 G28
    Date: 2013–08
  4. By: Jorge A. Chan-Lau
    Abstract: Despite increased need for top-down stress tests of financial institutions, performing them is challenging owing to the absence of granular information on banks’ trading and loan portfolios. To deal with these data shortcomings, this paper presents a market-based structural top-down stress testing methodology that relies in market-based measures of a bank's probability of default and structural models of default risk to infer the capital losses they could experience in stress scenarios. As an illustration, the methodology is applied to a set of banks in an advanced emerging market economy.
    Keywords: Stress testing;Banking systems;Financial institutions;Emerging markets;Financial sector;Economic models;Stress tests, banks, default risk, systemic risk, structural models, market prices
    Date: 2013–04–10
  5. By: Acharya, Viral V; Steffen, Sascha
    Abstract: This paper argues that the European banking crisis can in part be explained by a “carry trade” behavior of banks. Factor loading estimates from multifactor models relating equity returns to GIPSI (Greece, Ireland, Portugal, Spain and Italy) and German government bond returns suggest that banks have been long peripheral sovereign bonds funded in short-term wholesale markets, a position that generated “carry” until the GIPSI bond returns deteriorated significantly inflicting significant losses on banks. We show that the positive GIPSI factor loadings reflect actual portfolio holdings of GIPSI bonds in the cross-section of banks; and, the negative German loading reflects funding risk (flight away from bank funding to German government bonds), a risk that is increasing in the US money market mutual fund exposures of European banks as well as various proxies for bank short-term debt. Large banks and banks with low Tier 1 ratios and high risk-weighted assets had particularly large exposures and even increased their exposures between the two European stress tests of March and December 2010 taking advantage of a widening of yield spreads in the sovereign bond market. Over time, there is an increase in “home bias” – greater exposure of domestic banks to its sovereign’s bonds – which is partly explained by the European Central Bank funding of these positions. On balance, our results are supportive of moral hazard in the form of risk-taking by under-capitalized banks to exploit low risk weights and central-bank funding of risky government bond positions.
    Keywords: banking crisis; home bias; regulatory arbitrage; risk-shifting; sovereign debt crisis
    JEL: F3 G01 G14 G15 G21 G28
    Date: 2013–04
  6. By: Bulow, Jeremy I.; Klemperer, Paul
    Abstract: Today’s regulatory rules, especially the easily-manipulated measures of regulatory capital, have led to costly bank failures. We design a robust regulatory system such that (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals (because the simplicity and clarity of such rules prevents gaming by firms, and forbearance by regulators, as well as because of the efficiency role of prices). One key innovation is “ERNs” (equity recourse notes--superficially similar to, but importantly distinct from, “cocos”) which gradually "bail in" equity when needed. Importantly, although our system uses market information, it does not rely on markets being “right”.
    Keywords: bail-in; bank; bank capital; bank crisis; capital requirements; contingent capital; contingent convertible bond; debt overhang; deposit insurance; living wills; regulatory capital; regulatory forbearance; SIFI; systemically important financial institution; too-big-to-fail
    JEL: G10 G21 G28 G32
    Date: 2013–08
  7. By: Hélène Poirson; Jochen M. Schmittmann
    Abstract: For a sample of 83 financial institutions during 2003–2011, this paper attempts to answer three questions: first, what is the evolution of banks’ stock price exposure to country-level and global risk factors as approximated by equity indices; second, which bank-specific characteristics explain these risk exposures; third, are there clusters of banks with equity price linkages beyond market risk factors. The paper finds a rise in sensitivities to both country and global risk factors in 2011, although on average to levels still below those of the subprime crisis. The average sensitivity to European risk, specifically, has been steadily rising since 2008. Banks that are reliant on wholesale funding, have weaker capital levels and low valuations, and higher exposures to crisis countries are found to be the most vulnerable to shocks. The analysis of bank-to-bank linkages suggests that any “globalization†of the euro area crisis is likely to be channelled through U.K. and U.S. banks, with little evidence of direct spillover effects to other regions.
    Keywords: Banks;Financial institutions;United States;United Kingdom;Germany;France;Europe;Financial risk;Stock prices;Spillovers;Financial crisis;Cross country analysis;Financial sector; financial institutions; banks; Europe; financial crisis; spillovers.
    Date: 2013–06–05
  8. By: Bin Wang; Tao Sun
    Abstract: This paper investigates macroprudential policies and their role in containing systemic risk in China. It shows that China faces systemic risk in both the time (procyclicality) and cross-sectional (contagion) dimensions. The former is reflected as credit and asset price risks, while the latter is reflected as the links between the banking sector and informal financing and local government financing platforms. Empirical analysis based on 171 banks shows that some macroprudential policy tools (e.g., the reserve requirement ratio and house-related policies) are useful, but they cannot guarantee protection against systemic risk in the current economic and financial environment. Nevertheless, better-targeted macroprudential policies have greater potential to contain systemic risk pertaining to the different sizes of the banks and their location in regions with different levels of economic development. Complementing macroprudential policies with further reforms, including further commercialization of large banks, would help improve the effectiveness of those policies in containing systemic risk in China.
    Keywords: Macroprudential Policy;China;Financial risk;Banking sector;Systemic risk, Macroprudential policies, Effectiveness
    Date: 2013–03–27
  9. By: Efing, Matthias; Hau, Harald
    Abstract: This paper tests for conflicts of interest in the rating process of European asset- and mortgage-backed securities based on a new aggregation method for a deal's different tranche ratings. Controlling for a large set of determinants of credit risk, we find that credit rating agencies provide better credit ratings for the structured products of those issuers that provide them with more overall bilateral rating business. This effect is particularly pronounced in the run-up to the subprime crisis and for structured products with the worst collateral. Rating favors to the largest clients generate economically significant competitive distortion, foster issuer concentration and contribute to the "too big to fail" status of large issuer banks.
    Keywords: conflicts of interest; credit ratings; ratings inflation; structured debt
    JEL: G01 G10 G24
    Date: 2013–05
  10. By: Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
    Abstract: The agreement to establish a Single Supervisory Mechanism in Europe is a major step towards a Banking Union, consisting of centralized powers for the supervision of banks, the restructuring and resolution of distressed banks, and a common deposit insurance system. In this paper, we argue that the Banking Union is a necessary complement to the common currency and the Internal Market for capital. However, due care needs to be taken that steps towards a Banking Union are taken in the right sequence and that liability and control remain at the same level throughout. The following elements are important. First, establishing a Single Supervisory Mechanism under the roof of the ECB and within the framework of the current EU treaties does not ensure a sufficient degree of independence of supervision and monetary policy. Second, a European institution for the restructuring and resolution of banks should be established and equipped with sufficient powers. Third, a fiscal backstop for bank restructuring is needed. The ESM can play a role but additional fiscal burden sharing agreements are needed. Direct recapitalization of banks through the ESM should not be possible until legacy assets on banks' balance sheets have been cleaned up. Fourth, introducing European-wide deposit insurance in the current situation would entail the mutualisation of legacy assets, thus contributing to moral hazard. --
    Keywords: Banking Union,Europe,Single Supervisory Mechanism,Risk Sharing
    JEL: E02 E42 G18
    Date: 2013
  11. By: Daniel C. Hardy
    Abstract: Depositor preference and collateralization of borrowing may reduce the cost of settling the conflicts among creditors that arises in case of resolution or bankruptcy. This net benefit, which may be capitalized into the value of the bank rather than affect creditors’ expected returns, should result in lower overall funding costs and thus a lower probability of distress despite increasing encumbrance of the bank’s balance sheet. The benefit is maximized when resolution is initiated early enough for preferred depositors to remain fully protected.
    Keywords: Bankruptcy;Bank resolution;Banks;Bankruptcy costs, bank resolution, depositor preference, asset encumbrance
    Date: 2013–07–18
  12. By: Cheng Hoon Lim; Ivo Krznar; Fabian Lipinsky; Akira Otani; Xiaoyong Wu
    Abstract: This paper gauges if, and how, institutional arrangements are correlated with the use of macroprudential policy instruments. Using data from 39 countries, the paper evaluates policy response time in various types of institutional arrangements for macroprudential policy and finds that the macroprudential framework that gives the central bank an important role is associated with more timely use of macroprudential policy instruments. Policymakers may also tend to use macroprudential instruments more quickly if the ability to conduct monetary policy is somehow constrained. This finding points to the importance of coordination between macroprudential and monetary policy.
    Keywords: Macroprudential Policy;Financial stability;Central banks;Monetary policy;Central bank role;macroprudential, institutions, instruments, systemic risk, credit, interest rate.
    Date: 2013–07–17
  13. By: Niels-Jakob Harbo Hansen; Olga Sulla
    Abstract: Banking credit to the private sector in Latin America has on average increased by 7 percent of GDP from primo 2004 to ultimo 2011, with real credit in some countries growing by up to 20 percent per year. This paper documents and analyzes the patterns of credit growth in 18 countries in Latin America and uses econometric methods to determine whether it is indicative of financial deepening or poses risks of credit booms. The strongest credit growth occurred for consumption and mortgages within the household sector and for construction within the corporate sector. At the same time credit has de-dollarized in most countries and there are some signs of maturity lengthening. To assess whether the recent credit growth is excessive two different methods are applied. First, by application of HP-filters the paper finds that credit-to-GDP levels in a number of countries are above their long-term trend. Second, using a panel co-integration approach on 107 high and mid-income countries the paper estimates a model for the credit-to-GDP levels. Comparing the actual levels of credit with the ones predicted by the model we find that some countries in Latin America show significant and positive deviations. These results indicate the existence of a certain level of risk in the recent credit developments.
    Keywords: Credit expansion;Latin America;Private sector;Bank credit;Household credit;Economic models;Cross country analysis;Credit boom; financial development; Latin America; panel co-integration
    Date: 2013–05–10
  14. By: Allen, Franklin; Carletti, Elena; Cull, Robert; Qian, Jun; Senbet, Lemma; Valenzuela, Patricio
    Abstract: Using household surveys and bank penetration data at the district-level in 2006 and 2009, this paper examines the impact of Equity Bank -- a leading private commercial bank focusing on microfinance -- on access to banking in Kenya. Unlike other commercial banks in Kenya, Equity Bank pursues distinct branching strategies that target underserved areas and less-privileged households. Equity Bank presence has a positive and significant impact on households'use of bank accounts and bank credit, especially for Kenyans with low income, no salaried job, and less education and those who do not own their own home. The findings are robust to using the district-level proportion of people speaking a minority language as an instrument for Equity Bank presence. It appears that Equity Bank's business model -- providing financial services to population segments typically ignored by traditional commercial banks and generating sustainable profits in the process -- can be a solution to the financial access problem that has hindered the development of inclusive financial sectors in many African countries.
    Keywords: Banks&Banking Reform,Access to Finance,Public Sector Corruption&Anticorruption Measures,Corporate Law,Debt Markets
    Date: 2013–09–01
  15. By: International Monetary Fund. European Dept.
    Keywords: Financial institutions;Banks;Insurance;Bank supervision;Insurance supervision;Financial Sector Assessment Program;Belgium;
    Date: 2013–05–24
  16. By: Cheng Hoon Lim; Rishi S Ramchand; Hong Wang; Xiaoyong Wu
    Abstract: This paper surveys institutional arrangements for macroprudential policy in Asia. Central banks in Asia typically have a financial stability mandate, and play a key role in the macroprudential framework. Smaller and more open economies with prudential regulation inside the central bank tend to have institutional arrangements that give the central bank a leading role. In larger and more complex economies where prudential regulation is outside the central bank, the financial stability mandate is usually shared with other agencies and the government tends to play a leading role. Domestic policy coordination is typically performed by a financial stability committee/other coordination body while cross-border cooperation is largely governed by Memoranda of Understanding.
    Keywords: Macroprudential Policy;Asia;Central banks;Financial stability;Central bank role;banking, financial stability, institutional arrangements, macroprudential, regulation
    Date: 2013–07–17
  17. By: Mei Li (University of Guelph); Frank Milne (Queen's University); Junfen Qiu (Central University of Finance and Economics)
    Abstract: This paper establishes a theoretical model to examine the LOLR policy when a central bank cannot distinguish between solvent and insolvent banks. We study two cases: a case where the central bank cannot screen insolvent banks and a case where the central bank can only imperfectly screen insolvent banks. The major results that our model produces are as follows: (1) It is impossible for any separating equilibrium to exist because insolvent banks always have an incentive to mimic solvent banks to gamble for resurrection. (2) The pooling equilibria in which, on one hand, all the banks borrow from the central bank and, on the other hand, all the banks do not borrow from the central bank, could exist given certain market beliefs off the equilibrium path. However, neither of the equilibria is socially efficient because insolvent banks will continue to hold their unproductive assets, rather than efficiently liquidating them. (3) When the central bank can screen banks imperfectly, the pooling equilibrium where all the banks borrow from the central bank becomes more likely, and the pooling equilibrium where all the banks do not borrow from the central bank becomes less likely. (4) Higher precision in central bank screening will improve social welfare not only by identifying insolvent banks and forcing them to efficiently liquidate their assets, but also by reducing moral hazard and deterring banks from choosing risky assets in the first place. (5) If a central bank can commit to a specific precision level before the banks choose their assets, rather than conducting a discretionary LOLR policy, it will choose a higher precision level to reduce moral hazard and will attain higher social welfare.
    Keywords: Central Bank Screening, Moral Hazard, Lender of Last Resort
    JEL: D82 G2
    Date: 2013–09
  18. By: Andreas A. Jobst; Li L. Ong; Christian Schmieder
    Abstract: The global financial crisis has placed the spotlight squarely on bank stress tests. Stress tests conducted in the lead-up to the crisis, including those by IMF staff, were not always able to identify the right risks and vulnerabilities. Since then, IMF staff has developed more robust stress testing methods and models and adopted a more coherent and consistent approach. This paper articulates the solvency stress testing framework that is being applied in the IMF’s surveillance of member countries’ banking systems, and discusses examples of its actual implementation in FSAPs to 18 countries which are in the group comprising the 25 most systemically important financial systems (“S-25â€) plus other G-20 countries. In doing so, the paper also offers useful guidance for readers seeking to develop their own stress testing frameworks and country authorities preparing for FSAPs. A detailed Stress Test Matrix (STeM) comparing the stress test parameters applie in each of these major country FSAPs is provided, together with our stress test output templates.
    Keywords: Banking sector;Stress testing;Financial systems;Group of Twenty;Economic models;Risk management;Financial Sector Assessment Program;Basel III, Financial Sector Assessment Plan (FSAP), G-20, macroprudential, S-25, satellite models, solvency, stress testing, surveillance.
    Date: 2013–03–13
  19. By: José Vinãls; Ceyla Pazarbasioglu; Jay Surti; Aditya Narain; Michaela Erbenova; Julian T. S. Chow
    Abstract: The U.S., the U.K., and more recently, the E.U., have proposed policy measures directly targeting complexity and business structures of banks. Unlike other, price-based reforms (e.g., Basel 3 and G-SIFI surcharges), these proposals have been developed unilaterally with material differences in scope, design and implementation schedules. This may exacerbate cross-border regulatory arbitrage and put a further burden on consolidated supervision and cross-border resolution. This paper provides an analysis of the potential implications of implementing different structural policy measures. It proposes a pragmatic and coordinated approach to development of these policies to reduce risk of regulatory arbitrage and minimize unintended consequences. In doing so, it also aims to identify a set of common policy measures that countries could adopt to re-scope bank business models and corporate structures.
    Keywords: Banking sector;Bank resolution;Bank supervision;Bank reforms;Risk management;International financial system;Bank business models, capital, least cost resolution, risk reduction, structural measures
    Date: 2013–05–14
  20. By: Yi Wen (Federal Reserve Bank of St. Louis)
    Abstract: This paper develops an analytically tractable Bewley model of money featuring capital and financial intermediation. It is shown that when money is a vital form of liquidity to meet uncertain consumption needs, the welfare costs of inflation can be extremely large. With log utility and parameter values that best match both the aggregate money demand curve suggested by Lucas (2000) and the variance of household consumption, agents in our model are willing to reduce consumption by 7%-10% (or more) to avoid 10% annual inflation. In other words, raising the U.S. inflation target from 2% to 3% amounts to roughly a 0.5 percentage reduction in aggregate consumption. The astonishingly large welfare costs of inflation arise because inflation tightens liquidity constraints by destroying the buffer-stock value of money, thus raising the volatility of consumption at the household level. Such an inflation-induced increase in the idiosyncratic consumption-volatility at the micro level cannot be captured by representative-agent models or the Bailey triangle. Although the development of a credit and banking system can reduce the welfare costs of inflation by alleviating liquidity constraints, with realistic credit limits the cost of moderate inflation still remains several times larger than estimations based on the Bailey triangle. Our finding not only provides a justification for adopting a low inflation target by central banks, but also offers a plausible explanation for the robust positive relationship between inflation and social unrest in developing countries where money is the major form of household financial wealth.
    Date: 2013
  21. By: Le, Vo Phuong Mai; Matthews, Kent; Meenagh, David; Minford, Patrick; Xiao, Zhiguo
    Abstract: The downturn in the world economy following the global banking crisis has left the Chinese economy relatively unscathed. This paper develops a model of the Chinese economy using a DSGE framework with a banking sector to shed light on this episode. It differs from other applications in the use of indirect inference procedure to test the fitted model. The model finds that the main shocks hitting China in the crisis were international and that domestic banking shocks were unimportant. However, directed bank lending and direct government spending was used to supplement monetary policy to aggressively offset shocks to demand. The model finds that government expenditure feedback reduces the frequency of a business cycle crisis but that any feedback effect on investment creates excess capacity and instability in output.
    Keywords: China; Crises; DSGE model; Financial Frictions; Indirect Inference
    JEL: C1 E3 E44 E52
    Date: 2013–04

This issue is ©2013 by Christian Calmès. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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