New Economics Papers
on Banking
Issue of 2013‒09‒28
twenty-six papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. The Federal Reserve and Financial Regulation: The First Hundred Years By Gary B. Gorton; Andrew Metrick
  2. Leverage and the Foreclosure Crisis By Dean Corbae; Erwan Quintin
  3. The Impact of the Federal Reserve's Large-Scale Asset Purchase Programs on Corporate Credit Risk By Simon Gilchrist; Egon Zakrajsek
  4. Supranational Supervision - How Much and for Whom? By Beck, Thorsten; Wagner, Wolf
  5. How do Global Banks Scramble for Liquidity? Evidence from the Asset-Backed Commercial Paper Freeze of 2007 By Acharya, Viral V; Afonso, Gara; Kovner, Anna
  6. Monetary Policy and Balance Sheets By Deniz Igan; Alain N. Kabundi; Francisco Nadal-De Simone; Natalia T. Tamirisa
  7. Balance Sheet Strength and Bank Lending During the Global Financial Crisis By Tümer Kapan; Camelia Minoiu
  8. Fiscal Policy and Lending Relationships By Giovanni Melina; Stefania Villa
  9. The Impact of Foreign Bank Deleveraging on Korea By Sonali Jain-Chandra; Min Jung Kim; Sung Ho Park; Jerome Shin
  10. On the Welfare Equivalence of Asset Markets and Banking in Diamond Dybvig Economies By Alexander Zimper
  11. Taxation, Bank Leverage, and Financial Crises By Ruud A. de Mooij; Michael Keen; Masanori Orihara
  12. Reputational Contagion and Optimal Regulatory Forbearance By Morrison, Alan; White, Lucy
  13. International Evidence on Government Support and Risk Taking in the Banking Sector By Luís Brandão Marques; Ricardo Correa; Horacio Sapriza
  14. Credit Contagion in Financial Markets: A Network-Based Approach By Steinbacher, Matjaz; Steinbacher, Mitja; Steinbacher, Matej
  15. Banking System Resilience and Financial Stability - An Evidence from Indian Banking By Swamy, Vighneswara
  16. Russia’s Banking Sector in 2012 By Michael Kromov
  17. Structural features and interest-rate dynamics of Russia’s interbank lending market By Egorov, Alexey; Kovalenko , Olga
  18. Near-Coincident Indicators of Systemic Stress By Ivailo Arsov; Elie Canetti; Laura E. Kodres; Srobona Mitra
  19. The neglected side of banking union: reshaping Europeâ??s financial system By André Sapir; Guntram B. Wolff
  20. Insolvency Resolution and the Missing High Yield Bond Markets By Bo Becker; Jens Josephson
  21. Heterogeneous Bank Lending Responses to Monetary Policy: New Evidence from a Real-time Identification By John C Bluedorn; Christopher Bowdler; Christoffer Koch
  22. Credibility and Crisis Stress Testing By Li L. Ong; Ceyla Pazarbasioglu
  23. Leaning Against the Wind and the Timing of Monetary Policy By Itai Agur; Maria Demertzis
  24. Rating Through-the-Cycle: What does the Concept Imply for Rating Stability and Accuracy? By John Kiff; Michael Kisser; Liliana Schumacher
  25. Financial Sector Reform After the Crisis: Has Anything Happened? By Schäfer, Alexander; Schnabel, Isabel; Weder di Mauro, Beatrice
  26. Group Lending Without Joint Liability By de Quidt, Jonathan; Fetzer, Thiemo; Ghatak, Maitreesh

  1. By: Gary B. Gorton; Andrew Metrick
    Abstract: This paper surveys the role of the Federal Reserve within the financial regulatory system, with particular attention to the interaction of the Fed’s role as both a supervisor and a lender-of-last-resort (LOLR). The institutional design of the Federal Reserve System was aimed at preventing banking panics, primarily due to the permanent presence of the discount window. This new system was successful at preventing a panic in the early 1920s, after which the Fed began to discourage the use of the discount window and intentionally create “stigma” for window borrowing – policies that contributed to the panics of the Great Depression. The legislation of the New Deal era centralized Fed power in the Board of Governors, and over the next 75 years the Fed expanded its role as a supervisor of the largest banks. Nevertheless, prior to the recent crisis the Fed had large gaps in its authority as a supervisor and as LOLR, with the latter role weakened further by stigma. The Fed was unable to prevent the recent crisis, during which its LOLR function expanded significantly. As the Fed begins its second century, there are still great challenges to fulfilling its original intention of panic prevention.
    JEL: E5 E6 G21 N0
    Date: 2013–08
  2. By: Dean Corbae; Erwan Quintin
    Abstract: How much of the recent rise in foreclosures can be explained by the large number of high-leverage mortgage contracts originated during the housing boom? We present a model where heterogeneous households select from a set of mortgage contracts and choose whether to default on their payments given realizations of income and housing price shocks. The set of mortgage contracts consists of loans with high downpayments and loans with low downpayments. We run an experiment where the use of low downpayment loans is initially limited by payment-to-income requirements but then becomes unrestricted for 8 years. The relaxation of approval standards causes homeownership rates, high-leverage originations and the frequency of high interest rate loans to rise much like they did in the US between 1998-2006. When home values fall by the magnitude observed in the US from 2007-08, default rates increase by over 180% as they do in the data. Two distinct counterfactual experiments where approval standards remain the same throughout suggest that the increased availability of high-leverage loans prior to the crisis can explain between 40% to 65% of the initial rise in foreclosure rates. Furthermore, we run policy experiments which suggest that recourse could have had significant dampening effects during the crisis.
    JEL: E44 G21 R3
    Date: 2013–08
  3. By: Simon Gilchrist; Egon Zakrajsek
    Abstract: Estimating the effect of Federal Reserve’s announcements of Large-Scale Asset Purchase (LSAP) programs on corporate credit risk is complicated by the simultaneity of policy decisions and movements in prices of risky financial assets, as well as by the fact that both interest rates of assets targeted by the programs and indicators of credit risk reacted to other common shocks during the recent financial crisis. This paper employs a heteroskedasticity-based approach to estimate the structural coefficient measuring the sensitivity of market-based indicators of corporate credit risk to declines in the benchmark market interest rates prompted by the LSAP announcements. The results indicate that the LSAP announcements led to a significant reduction in the cost of insuring against default risk—as measured by the CDX indexes—for both investment- and speculative-grade corporate credits. While the unconventional policy measures employed by the Federal Reserve to stimulate the economy have substantially lowered the overall level of credit risk in the economy, the LSAP announcements appear to have had no measurable effect on credit risk in the financial intermediary sector.
    JEL: E44 E58 G2
    Date: 2013–08
  4. By: Beck, Thorsten; Wagner, Wolf
    Abstract: We argue that the extent to which supervision of banks takes place on the supranational level should be guided by two factors: cross-border externalities from bank failures and heterogeneity in bank failure costs. Based on a simple model we show that supranational supervision is more likely to be welfare enhancing when externalities are high and country heterogeneity is low. This suggests that different sets of countries (or regions) should differ in their supranational orientation. We apply the insights of our model to discuss optimal supervisory arrangements for different regions of the world and contrast them with existing arrangements and current policy initiatives.
    Keywords: Bank regulation; bank resolution; cross-border banking
    JEL: G21 G28
    Date: 2013–07
  5. By: Acharya, Viral V; Afonso, Gara; Kovner, Anna
    Abstract: In August of 2007, banks faced a freeze in funding liquidity from the asset-backed commercial paper (ABCP) market. We investigate how banks scrambled for liquidity in response to this freeze and its implications for the real economy. Commercial banks in the United States raised deposits and took advances from Federal Home Loan Banks (FHLBs). In contrast, foreign banks – with limited access to the deposit market and FHLB advances – lent less in the overnight interbank market and borrowed more from the Federal Reserve’s Term Auction Facility (TAF) auctions. Relative to before the ABCP freeze and relative to their non US dollar lending, foreign banks with ABCP exposure charged higher interest rates on syndicated loan packages denominated in dollars. The results point to a funding risk in global banking, manifesting as currency shortages for banks engaged in maturity transformation in foreign countries.
    Keywords: ABCP freeze; credit crunch; liquidity
    JEL: G21 G28
    Date: 2013–04
  6. By: Deniz Igan; Alain N. Kabundi; Francisco Nadal-De Simone; Natalia T. Tamirisa
    Abstract: This paper evaluates the strength of the balance sheet channel in the U.S. monetary policy transmission mechanism over the past three decades. Using a Factor-Augmented Vector Autoregression model on an expanded data set, including sectoral balance sheet variables, we show that the balance sheets of various economic agents act as important links in the monetary policy transmission mechanism. Balance sheets of financial intermediaries, such as commercial banks, asset-backed-security issuers and, to a lesser extent, security brokers and dealers, shrink in response to monetary tightening, while money market fund assets grow. The balance sheet effects are comparable in magnitude to the traditional interest rate channel. However, their economic significance in the run-up to the recent financial crisis was small. Large increases in interest rates would have been needed to avert a rapid rise of house prices and an unsustainable expansion of mortgage credit, suggesting an important role for macroprudential policies.
    Keywords: Monetary transmission mechanism;United States;Monetary policy;Interest rates;Economic models;monetary policy transmission; balance sheets; FAVAR; generalized dynamic factor models
    Date: 2013–07–03
  7. By: Tümer Kapan; Camelia Minoiu
    Abstract: We examine the role of bank balance sheet strength in the transmission of financial sector shocks to the real economy. Using data from the syndicated loan market, we exploit variation in banks’ reliance on wholesale funding and their structural liquidity positions in 2007Q2 to estimate the impact of exposure to market freezes during 2007–08 on the supply of bank credit. We find that banks with strong balance sheets were better able to maintain lending during the crisis. In particular, banks that were ex-ante more dependent on market funding and had lower structural liquidity reduced the supply of credit more than other banks. However, higher and better-quality capital mitigated this effect. Our results suggest that strong bank balance sheets are key for the recovery of credit following crises, and provide support for regulatory proposals under the Basel III framework.
    Keywords: Global Financial Crisis 2008-2009;Banks;Loans;Liquidity;Banking sector;Financial crisis;Economic models;bank lending channel, wholesale funding, capital, net stable funding ratio, Basel III
    Date: 2013–05–08
  8. By: Giovanni Melina; Stefania Villa
    Abstract: This paper studies how fiscal policy affects loan market conditions in the US. First, it conducts a Structural Vector-Autoregression analysis showing that the bank spread responds negatively to an expansionary government spending shock, while lending increases. Second, it illustrates that these results are mimicked by a Dynamic Stochastic General Equilibrium model where the bank spread is endogenized via the inclusion of a banking sector exploiting lending relationships. Third, it shows that lending relationships represent a friction that generates a financial accelerator effect in the transmission of the fiscal shock.
    Keywords: Fiscal policy;United States;Banking sector;Loans;Economic models;Fiscal policy; deep habits; lending relationships
    Date: 2013–06–05
  9. By: Sonali Jain-Chandra; Min Jung Kim; Sung Ho Park; Jerome Shin
    Abstract: Korea was hit hard by the 2008 global financial crisis, with the foreign bank deleveraging channel coming prominently into play. The global financial crisis demonstrated that a sharp deleveraging can be transmitted to emerging markets through the bank lending channel to a slowdown in credit growth. The analysis finds that a sharp decline in external funding led to relatively modest decline in domestic credit by Korean banks, due to concerted policy efforts by the government in 2008. Impulse responses from a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to Korea shows that it appears better prepared to handle such shocks relative to 2008. Indeed, Korea is much more resilient to such shocks due to the efforts by the authorities, which has led to the strengthening of external buffers, such as higher foreign exchange reserves and bilateral and multilateral currency swap arrangements.
    Keywords: International banks;Korea, Republic of;Global Financial Crisis 2008-2009;External shocks;Banking sector;Liquidity;Financial crisis;Economic models;Global banks, liquidity shock, cross-border lending
    Date: 2013–05–08
  10. By: Alexander Zimper (Department of Economics, University of Pretoria)
    Abstract: Why do people choose bank deposit contracts over a direct participation in asset markets? In their seminal paper, Diamond and Dybvig (1983) answer this question by claiming that bank deposit contracts can implement allocations that are welfare superior to asset markets equilibria. The present paper demonstrates that this claim is false whenever the asset market participants are highly rational.
    Keywords: Demand deposit contract, Asset market, Asymmetric information
    JEL: G14 G21
    Date: 2013–09
  11. By: Ruud A. de Mooij; Michael Keen; Masanori Orihara
    Abstract: That most corporate tax systems favor debt over equity finance is now widely recognized as, potentially, amplifying risks to financial stability. This paper makes a first attempt to explore, empirically, the link between this tax bias and the probability of financial crisis. It finds that greater tax bias is associated with significantly higher aggregate bank leverage, and that this in turn is associated with a significantly greater chance of crisis. The implication is that tax bias makes crises much more likely, and, conversely, that the welfare gains from policies to alleviate it can be substantial—far greater than previous studies, which have ignored financial stability considerations, suggest.
    Keywords: Tax systems;Corporate taxes;Banks;Financial crisis;Corporate sector;Taxation;Bank taxation; corporate tax; debt bias; leverage
    Date: 2013–02–25
  12. By: Morrison, Alan; White, Lucy
    Abstract: Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank’s failure may undermine confidence in the banking regulator’s competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behaviour can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators’ ability to stem panics ex post.
    Keywords: bank regulation; contagion; reputation
    JEL: G21 G28
    Date: 2013–06
  13. By: Luís Brandão Marques; Ricardo Correa; Horacio Sapriza
    Abstract: Government support to banks through the provision of explicit or implicit guarantees affects the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of bank data and government support to banks for the periods 2003-2004 and 2009-2010. We find that more government support is associated with more risk taking by banks, especially during the financial crisis (2009-10). We also find that restricting banks' range of activities ameliorates the moral hazard problem. We conclude that strengthening market discipline in the banking sector is needed to address this moral hazard problem.
    Keywords: Banking sector;Bank supervision;Bank regulations;Risk management;Bank risk, Market Discipline, Government Support, Bank Regulation.
    Date: 2013–05–02
  14. By: Steinbacher, Matjaz; Steinbacher, Mitja; Steinbacher, Matej
    Abstract: We propose a network-based model of credit contagion and examine the e�ects of idiosyncratic and systemic shocks to individual banks and the banking system. The banking system is built as a network in which banks are connected to each other through the interbank market. The microstructure captures the relation between debtors and creditors, and the macroeconomic events capture the sensitivity of the banks' �nancial strenght to macroeconomic events, such as housing. We have demonstrated that while idiosyncratic shocks do not have a potential to substantially disturb the banking system, macroeconomic events of higher magnitudes could be highly harmful, especially if they also spur contagion. In a concerted default of more banks, the stability of a banking system tends to decrease disproportionately. In addition, credit risk analysis is highly sensitive to the network topology and exhibits a nonlinear characteristic. Capital ratio and recovery rates are two additional factors that contribute to the stability of the �nancial system.
    Keywords: credit contagion; network models; credit risk; structural models; fi�nancial stability; alpha-criticality index
    JEL: C63 G01
    Date: 2013
  15. By: Swamy, Vighneswara
    Abstract: This paper while emphasising the importance of the concept of financial stability in wake of recent global financial crisis in particular and other (banking and financial) crises in general attempts to highlight the significance of the soundness of banking sector in emerging economies where banking sector constitutes a lion’s share in the financial system. This study examines banking sector stability by constructing a micro vector auto regressive (VAR) model and establishes the significance of the interrelatedness of the bank-specific variables such as; Liquidity, Asset Quality, Capital Adequacy and Profitability. Further, the paper offers a substantive review of literature on the concept of financial stability in backdrop of the ongoing definition debate for financial stability. A significant contribution of this study is that, by employing the most appropriate key determinants of banking sector soundness, the paper constructs a recursive micro VAR model to explain the interdependence and comovement of the banking stability covariates in a bank-dominated financial system that aids in understanding the dynamics of financial stability of emerging economies
    Keywords: financial stability, instability, banks, financial institutions
    JEL: E44 E58 G1 G21 G28
    Date: 2013–06
  16. By: Michael Kromov (Gaidar Institute for Economic Policy)
    Abstract: This paper deals with Russia's banking sector in 2012. The author focuses on relationship between banks and corporate customers, foreign transactions in the banking sector, banking regulation.
    Keywords: Russian economy, banking sector, foreign transactions, banking regulation
    JEL: E41 E51 E58 G28 G21 G24
    Date: 2013
  17. By: Egorov, Alexey (BOFIT); Kovalenko , Olga (BOFIT)
    Abstract: Russian banks exhibit a range of behaviors that have led to distinct segmentation within the interbank lending market. This paper provides an overview of the core groups of banks operating in the market (state banks, private banks, and foreign-owned banks), as well as a discussion of their assets and liability structures. The 2007–2010 financial crisis had considerable impact on the Russian financial sector. As conditions deteriorated and recovered in global money markets, Russian banks adjusted their behavior with respect to other domestic banks and foreign banks. We conduct a comparative analysis of the Russian interbank lending market structure in the pre-crisis period and during recovery to reveal the tactical shifts in the various bank groups.
    Keywords: interbank markets; Russia; interest rates
    JEL: C22 E43 E44
    Date: 2013–08–28
  18. By: Ivailo Arsov; Elie Canetti; Laura E. Kodres; Srobona Mitra
    Abstract: The G-20 Data Gaps Initiative has called for the IMF to develop standard measures of tail risk, which we identify in this paper with systemic risk. To understand the conditions under which tail risk is present, it is first necessary to develop a measure of what constitutes a systemic stress, or tail, event. We develop such a measure and uses it to assess the performance of eleven near-term systemic risk indicators as ‘early’ warning of distress among top financial institutions in the United States and the euro area. Two indicators perform particularly well in both regions, and a couple of other simple indicators do well across a number of criteria. We also find that the sizes of institutions do not necessarily correspond with their contribution to spillover risk. Some practical guidance for policies is provided.
    Keywords: International financial system;Financial institutions;Financial risk;Risk management;Coincident Indicator; Early Warning; Financial Stress; Systemic Risk; Tail Risk
    Date: 2013–05–17
  19. By: André Sapir; Guntram B. Wolff
    Abstract: This policy contribution was presented at the informal ECOFIN in Vilnius on September 14. It discusses how Europe's financial system could and should be reshaped. It starts from two basic points: First, the banking system needs to be credibly de-linked from the sovereigns and banks should operate across borders. Europe needs fewer national champions. Second, other forms of financial intermediation need to be developed. Both steps require a significant stepping up of the policy system, including a single resolution mechanism. Together, this will render Europeâ??s financial system more stable, more efficient and more conducive to growth.
    Date: 2013–09
  20. By: Bo Becker; Jens Josephson
    Abstract: In many countries, bankruptcy is associated with low recovery by creditors. We develop a model of corporate credit markets in such an environment. Corporate credit is provided by either a bond market or risk-averse banks. Restructuring of insolvent firms happens out of court if in-court bankruptcy is inefficient, giving banks an advantage over bondholders. Riskier borrowers will use bank loans anywhere, but also bonds when bankruptcy is efficient. The model matches empirical debt mix patterns better than fixed-issuance-cost models. Across systems, efficient bankruptcy should be associated with more bond issuance by high-risk borrowers. This effect is small or absent for safe firms. We find that both predictions hold both cross-country and using insolvency reforms as natural experiments. Our empirical estimates suggest that a one-standard-deviation increase in the efficiency of bankruptcy is associated with an increase in the stock of corporate bonds equal to 5% of firm assets. This is equivalent to two thirds of the difference between the US and other countries.
    JEL: G32 G33
    Date: 2013–09
  21. By: John C Bluedorn; Christopher Bowdler; Christoffer Koch
    Abstract: We present new evidence on how heterogeneity in banks interacts with monetary policy changes to impact bank lending. Using an exogenous policy measure identified from narratives on FOMC intentions and real-time economic forecasts, we find much greater heterogeneity in U.S. bank lending responses than that found in previous research based on realized federal funds rate changes. Our findings suggest that studies using realized monetary policy changes confound the monetary policy’s effects with those of changes in expected macrofundamentals. We also extend Romer and Romer (2004)’s identification scheme, and expand the time and balance sheet coverage of the U.S. banking sample.
    Keywords: Monetary policy;Banking sector;Loans;Economic models;Monetary Transmission; Lending Channel; Monetary Policy Identification; Banking
    Date: 2013–05–22
  22. By: Li L. Ong; Ceyla Pazarbasioglu
    Abstract: Credibility is the bedrock of any crisis stress test. The use of stress tests to manage systemic risk was introduced by the U.S. authorities in 2009 in the form of the Supervisory Capital Assessment Program. Since then, supervisory authorities in other jurisdictions have also conducted similar exercises. In some of those cases, the design and implementation of certainelements of the framework have been criticized for their lack of credibility. This paper proposes a set of guidelines for constructing an effective crisis stress test. It combines financial markets impact studies of previous exercises with relevant case study information gleaned from those experiences to identify the key elements and to formulate their appropriate design. Pertinent concepts, issues and nuances particular to crisis stress testing are also discussed. The findings may be useful for country authorities seeking to include stress tests in their crisis management arsenal, as well as for the design of crisis programs.
    Keywords: Stress testing;Banking systems;Transparency;Bank supervision;Risk management;Asset quality review, crisis, disclosure, financial backstop, hurdle rates, liquidity risk, restructuring, solvency, transparency, CCAR, CEBS, EBA, PCAR, SCAP.
    Date: 2013–08–09
  23. By: Itai Agur; Maria Demertzis
    Abstract: If monetary policy is to aim also at financial stability, how would it change? To analyze this question, this paper develops a general-form framework. Financial stability objectives are shown to make monetary policy more aggressive: in reaction to negative shocks, cuts are deeper but shorter-lived than otherwise. By keeping cuts brief, monetary policy tightens as soon as bank risk appetite heats up. Within this shorter time span, cuts must then be deeper than otherwise to also achieve standard objectives. Finally, we analyze how robust this result is to the presence of a bank regulatory tool, and provide a parameterized example.
    Keywords: Monetary policy;Banking sector;Bank regulations;Financial stability;Economic models;Monetary policy, financial stability, bank risk, regulation
    Date: 2013–04–03
  24. By: John Kiff; Michael Kisser; Liliana Schumacher
    Abstract: Credit rating agencies face a difficult trade-off between delivering both accurate and stable ratings. In particular, its users have consistently expressed a preference for rating stability, driven by the transactions costs induced by trading when ratings change frequently. Rating agencies generally assign ratings on a through-the-cycle basis whereas banks' internal valuations are often based on a point-in-time performance, that is they are related to the current value of the rated entity's or instrument's underlying assets. This paper compares the two approaches and assesses their impact on rating stability and accuracy. We find that while through-the-cycle ratings are initially more stable, they are prone to rating cliff effects and also suffer from inferior performance in predicting future defaults. This is because they are typically smooth and delay rating changes. Using a through-the-crisis methodology that uses a more stringent stress test goes halfway toward mitigating cliff effects, but is still prone to discretionary rating change delays.
    Keywords: Credit risk;Business cycles;Forecasting models;Credit ratings; Credit rating agencies; Credit rating migration
    Date: 2013–03–08
  25. By: Schäfer, Alexander; Schnabel, Isabel; Weder di Mauro, Beatrice
    Abstract: We analyze the reactions of stock returns and CDS spreads of banks from Europe and the United States to four major regulatory reforms in the aftermath of the subprime crisis, employing an event study analysis. In contrast to the public perception that nothing has happened, we find that financial markets indeed reacted to the structural reforms enacted at the national level. All reforms succeeded in reducing bail-out expectations, especially for systemic banks. However, banks' profitability was also affected, showing up in lower equity returns. The strongest effects were found for the Dodd-Frank Act (especially the Volcker rule), whereas market reactions to the German restructuring law were small.
    Keywords: Dodd-Frank Act; event study; Financial sector reform; financial stability; German restructuring law; Swiss too-big-to-fail regulation; Vickers reform; Volcker rule
    JEL: G21 G28
    Date: 2013–06
  26. By: de Quidt, Jonathan; Fetzer, Thiemo; Ghatak, Maitreesh
    Abstract: This paper contrasts individual liability lending with and without groups to joint liability lending. By doing so, we shed light on an apparent shift away from joint liability lending towards individual liability lending by some microfinance institutions First we show that individual lending with or without groups may constitute a welfare improvement so long as borrowers have sufficient social capital to sustain mutual insurance. Second, we explore how a purely mechanical argument in favor of the use of groups - namely lower transaction costs - may actually be used explicitly by lenders to encourage the creation of social capital. We also carry out some simulations to evaluate quantitatively the welfare impact of alternative forms of lending, and how they relate to social capital.
    Keywords: group lending; joint liability; micro finance; mutual insurance
    JEL: G11 G21 O12 O16
    Date: 2013–07

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