nep-ban New Economics Papers
on Banking
Issue of 2014‒12‒13
29 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Lending standards, credit booms and monetary policy By Afanasyeva, Elena; Güntner, Jochen
  2. Housing Collateral, Credit Constraints and Entrepreneurship - Evidence from a Mortgage Reform By Thais Lærkholm Jensen; Søren Leth-Petersen; Ramana Nanda
  3. Contagion Risk in the Interbank Market: A Probabilistic Approach to Cope with Incomplete Structural Information By Montagna, Mattia; Lux, Thomas
  4. Stability and Identification with Optimal Macroprudential Policy Rules By Jean-Bernard Chatelain; Kirsten Ralf
  5. Incentive Pay and Bank Risk-Taking: Evidence from Austrian, German, and Swiss Banks By Matthias Efing; Harald Hau; Patrick Kampkötter; Johannes Steinbrecher
  6. Emergence of a Core-Periphery Structure in a Simple Dynamic Model of the Interbank Market By Lux, Thomas
  7. Assessing systemic fragility: A probabilistic perspective By Radev, Deyan
  8. Paying for payments: free payments and optimal interchange fees By Korsgaard, Søren
  9. Credit supply dynamics and economic activity in euro area countries: a time-varying parameter VAR analysis By Bijsterbosch, Martin; Falagiarda, Matteo
  10. Towards deeper financial integration in Europe: What the Banking Union can contribute By Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
  11. A Split-Population Duration Approach to Understanding Agricultural Banking Survival Strategies during the Late 2000s Recession By Li, Xiaofei; Escalante, Cesar L.; Epperson, James
  12. Innovation in Retail Payment Services in Major Economies By Retai Payment Systems Group, Payment and Settlement Systems Department
  13. Goodhart, Charles A.E. and Tsomocos, Dimitros P.: The challenge of financial stability: a new model and its applications By Jean-Bernard Chatelain
  14. Capital Flows, Financial Intermediation and Macroprudential Policies By Matteo Ghilardi; Shanaka J. Peiris
  15. Reconsidering Bank Capital Regulation: A New Combination of Rules, Regulators, and Market Discipline By Connel Fullenkamp; Céline Rochon
  16. The leverage ratio over the cycle By Michael Brei; Leonardo Gambacorta
  17. Methodological thoughts on expected loss estimates for IFRS 9 Impairment: hidden reserves, cyclical loss predictions and LGD backtesting By Wolfgang Reitgruber
  18. Measuring Bank Contagion in Europe Using Binary Spatial Regression Models By Raffaella Calabrese; Johan A. Elkink; Paolo Giudici
  19. Mitigating financial stress in a bank-financed economy: Equity injections into banks or purchases of assets? By Kühl, Michael
  20. Banks, Capital Flows and Financial Crises By Akinci, Ozge; Queraltó, Albert
  21. The Role of Dynamic Renegotiation and Asymmetric Information in Financial Contracting By Michael R. Roberts
  22. Rollover risk, liquidity, and macro-prudential regulation By Ahnert, Toni
  23. Financial reputation, market interventions and debt issuance by banks: a truncated two-part model approach By Camba-Méndez, Gonzalo; Carbó-Valverde, Santiago; Rodriguez-Palenzuela, Diego
  24. Entry and Exit in OTC Derivatives Markets By Andrew G. Atkeson; Andrea L. Eisfeldt; Pierre-Olivier Weill
  25. Mutual assistance between Federal Reserve Banks, 1913-1960 as prolegomena to the TARGET2 debate By Eichengreen, Barry; Mehl, Arnaud; Chiţu, Livia; Richardson, Gary
  26. Investor borrowing heterogeneity in a Kiyotaki-Moore style macro model By Maria Teresa Punzi; Katrin Rabitsch
  27. International Financial Integration and Crisis Contagion By Michael B. Devereux; Changhua Yu
  28. Welcoming Remarks By Bullard, James B.
  29. The Federal Reserve's Abandonment of its 1923 Principles By Julio J. Rotemberg

  1. By: Afanasyeva, Elena; Güntner, Jochen
    Abstract: This paper investigates the risk channel of monetary policy on the asset side of banks' balance sheets. We use a factoraugmented vector autoregression (FAVAR) model to show that aggregate lending standards of U.S. banks, such as their collateral requirements for firms, are significantly loosened in response to an unexpected decrease in the Federal Funds rate. Based on this evidence, we reformulate the costly state verification (CSV) contract to allow for an active financial intermediary, embed it in a New Keynesian dynamic stochastic general equilibrium (DSGE) model, and show that - consistent with our empirical findings - an expansionary monetary policy shock implies a temporary increase in bank lending relative to borrower collateral. In the model, this is accompanied by a higher default rate of borrowers.
    Keywords: Bank lending standards,Credit supply,Monetary policy,Risk channel
    JEL: E44 E52
    Date: 2014
  2. By: Thais Lærkholm Jensen; Søren Leth-Petersen; Ramana Nanda
    Abstract: We study how a mortgage reform that exogenously increased access to credit had an impact on entrepreneurship, using individual-level micro data from Denmark. The reform allows us to disentangle the role of credit access from wealth effects that typically confound analyses of the collateral channel. We find that a $30,000 increase in credit availability led to a 12 basis point increase in entrepreneurship, equivalent to a 4% increase in the number of entrepreneurs. New entrants were more likely to start businesses in sectors where they had no prior experience, and were more likely to fail than those who did not benefit from the reform. Our results provide evidence that credit constraints do affect entrepreneurship, but that the overall magnitudes are small. Moreover, the marginal individuals selecting into entrepreneurship when constraints are relaxed may well be starting businesses that are of lower quality than the average existing businesses, leading to an increase in churning entry that does not translate into a sustained increase in the overall level of entrepreneurship.
    JEL: D14 D31 G21 G28 L26
    Date: 2014–10
  3. By: Montagna, Mattia; Lux, Thomas
    Abstract: Banks have become increasingly interconnected via interbank credit and other forms of liabilities. As a consequence of the increased interconnectedness, the failure of one node in the interbank network might constitute a threat to the survival of large parts of the entire system. How important this effect of "too-big-too-fail" and "too-interconnected-too-fail" is, depends on the exact topology of the network on which the supervisory authorities have typically very incomplete knowledge. We propose a probabilistic model to combine some important known quantities (like the size of the banks) with a realistic stochastic representation of the remaining structural elements. Our approach allows us to evaluate relevant measures for the contagion after default of one unit (i.e. number of expected subsequent defaults, or their probabilities). For some quantities we are able to derive closed form solutions, others can be obtained via computational mean-field approximations.
    Keywords: contagion,interbank market,network models
    JEL: D85 G21 D83
    Date: 2014
  4. By: Jean-Bernard Chatelain (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school)
    Abstract: This paper investigates the identification, the determinacy and the stability of ad hoc, "quasi-optimal" and optimal policy rules augmented with financial stability indicators (such as asset prices deviations from their fundamental values) and minimizing the volatility of the policy interest rates, when the central bank precommits to financial stability. Firstly, ad hoc and quasi-optimal rules parameters of financial stability indicators cannot be identified. For those rules, non zero policy rule parameters of financial stability indicators are observationally equivalent to rule parameters set to zero in another rule, so that they are unable to inform monetary policy. Secondly, under controllability conditions, optimal policy rules parameters of financial stability indicators can all be identified, along with a bounded solution stabilizing an unstable economy as in Woodford (2003), with determinacy of the initial conditions of non-predetermined variables.
    Keywords: Identification; financial stability; monetary policy; optimal policy under Commitment; augmented Taylor rule
    Date: 2014–04
  5. By: Matthias Efing; Harald Hau; Patrick Kampkötter; Johannes Steinbrecher
    Abstract: We use payroll data on 1.2 million bank employee years in the Austrian, German, and Swiss banking sector to identify incentive pay in the critical banking segments of treasury/capital market management and investment banking for 66 banks. We document an economically significant correlation of incentive pay with both the level and volatility of bank trading income-particularly for the pre-crisis period 2003--7 for which incentive pay was strongest. This result is robust if we instrument the bonus share in the capital markets divisions with the strength of incentive pay in unrelated bank divisions like retail banking. Moreover, pre-crisis incentive pay appears too strong for an optimal trade-off between trading income and risk which maximizes the NPV of trading income.
    JEL: D22 G01 G20 G21 G38
    Date: 2014–09
  6. By: Lux, Thomas
    Abstract: This paper studies a simple dynamic model of interbank credit relationships. Starting from a given balance sheet structure of a banking system with a realistic distribution of bank sizes, the necessity of establishing interbank credit connections 3merges from idiosyncratic liquidity shocks. Banks initially choose potential trading partners randomly, but form preferential relationships via an elementary reinforcement learning algorithm. As it turns out, the dynamic evolution of this system displays a formation of a core-periphery structure with mainly the largest banks assuming the roles of money center banks mediating between the liquidity needs of many smaller banks. Statistical analysis shows that this evolving interbank market shares virtually all of the salient characteristics of interbank credit relationship that have been put forthin recent literature. Preferential interest rates for borrowers with strong attachment to a lender may prevent the system from becoming extortionary and guarantee the survival of the small peripherical banks.
    Keywords: liquidity,interbank market,network formation
    JEL: D85 G21 D83
    Date: 2014
  7. By: Radev, Deyan
    Abstract: We outline a procedure for consistent estimation of marginal and joint default risk in the euro area financial system. We interpret the latter risk as the intrinsic financial system fragility and derive several systemic fragility indicators for euro area banks and sovereigns, based on CDS prices. Our analysis documents that although the fragility of the euro area banking system had started to deteriorate before Lehman Brothers' file for bankruptcy, investors did not expect the crisis to affect euro area sovereigns' solvency until September 2008. Since then, and especially after November 2009, joint sovereign default risk has outpaced the rise of systemic risk within the banking system.
    Keywords: Banking Stability,Financial Distress,Tail Risk,Contagion
    JEL: C16 C61 G01 G21
    Date: 2014
  8. By: Korsgaard, Søren
    Abstract: Do consumers and merchants use the most efficient payment instruments? I examine how inter- change fees, which are fees paid from merchants' banks to consumers' banks when card transactions take place, influence the choice between cash and payment cards. I show that when consumers do not pay transaction fees to banks - a common feature in bank contracts - card use is declining in interchange fees, and surcharging does not neutralize interchange fees. According to my model, banks set interchange fees at too high a level, resulting in too few card payments. I derive an optimal interchange fee which depends only on the relative costs of producing cash and card payments and can be used by regulators to assess privately set interchange fees. When calibrated to cost data, the model implies an optimal fee that is low and may even be negative. The findings are consistent with empirical evidence of high card usage in countries with no interchange fees and have implications for the regulation of interchange fees. JEL Classification: E42, G21, G28
    Keywords: financial regulation, interchange fees, payments
    Date: 2014–06
  9. By: Bijsterbosch, Martin; Falagiarda, Matteo
    Abstract: This paper aims to shed light on the role of credit supply shocks in euro area countries during the recent pre-crisis, bust, and post-crisis periods. A time-varying parameter vector autoregression (TVP-VAR) with stochastic volatility à la Primiceri (2005) is estimated for each country, and the structural shocks are identified by imposing sign restrictions on impulse response functions based on the theoretical model by Gerali et al. (2010). The results suggest that credit supply shocks have been an important driver of business cycle fluctuations in euro area countries, and that their effects on the economy have generally increased since the recent crisis. Moreover, we report evidence that credit supply shocks contributed positively to output growth during the pre-crisis period and negatively during the downturn in economic activity in 2008-2009 in all the countries considered. In the post-crisis period, by contrast, we observe a strong rise in cross-country heterogeneity, reflecting financial fragmentation in the euro area. Although this heterogeneity across euro area countries seems to have declined since around 2012, the contribution of credit supply shocks to GDP growth and credit growth remains negative in most euro area countries, suggesting that constraints in the supply of credit continue to weaken economic activity. JEL Classification: C11, C32, E32, E51
    Keywords: credit supply shocks, euro area, sign restrictions, TVP-VAR
    Date: 2014–08
  10. By: Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
    Abstract: The European Banking Union is a major step forward in fixing major deficiencies in the institutional framework of the Euro area. The absence of effective banking supervision and resolution powers at the European level promoted excessive private risk-taking in the up-run to the Euro crisis. Effective private risk sharing once risks materialized has been hampered. A properly designed Banking Union facilitates and improves private risk sharing, and it is thus a necessary institutional complement to a monetary union. Yet, the institutional framework of the Banking Union needs further strengthening in three regards. First, the supervisory framework needs to ensure uniform supervisory standards for all banks, including those located in non-Euro area countries. Also, conflicts of interest between monetary policy and banking supervision need to be mitigated. Second, bank resolution suffers from a highly complex governance structure. Restructuring and bail-in rules allow for a high degree of discretion at the level of the resolution authority. We propose to introduce a statutory systemic risk exception, by which the exercise of discretion would be reduced, thereby strengthening the credibility of the bail-in. Third, in order to enhance the credibility of creditor involvement, fiscal backstops and ex-ante specified cross-border burden-sharing agreements are needed.
    Keywords: European Banking Union,Single Supervisory Mechanism,Single Resolution Mechanism,Risk Sharing
    JEL: E02 E42 G18
    Date: 2014
  11. By: Li, Xiaofei; Escalante, Cesar L.; Epperson, James
    Abstract: This paper is designed to identify predictors of eventual bank failure as well as factors that could enhance the survival ability of agricultural and non-agricultural banks. This study utilizes a split-population survival model that addresses two shortcomings of the basic duration model. First, this model departs from the restrictive assumption of the traditional model that all bank observations in the sample would eventually fail. Second, this model provides for a clear distinction between the determinants of the probability of failure and factors influencing the timing of the failure. The results of this study suggest that failure to allow for a split population among sample banks represents an important misspecification with serious implications in identifying the determinants of the timing of bank failure, more than just the probability of failure.
    Keywords: Financial Crisis, Survival Analysis, Bank Failure, Agricultural Banking, Agricultural Finance, Q14, C41,
    Date: 2014
  12. By: Retai Payment Systems Group, Payment and Settlement Systems Department (Bank of Japan)
    Abstract: Major economies have embarked on various innovative means for enhancing retail payment services. These include such measures as real-time settlement of bank transfers and linking remittance information with payment information for financial electronic data interchange (EDI). In Japan, meanwhile, the government released the revised Japan Revitalization Strategy in June 2014, which includes enhancement of the payment and settlement system to make financial markets more efficient. When introducing such measures, it is important to take stock of recent developments in major economies, and to improve real-time bank transfers and achieve financial EDI while considering the situation in Japan. The Bank of Japan will help financial institutions and other stakeholders steer such initiatives to enhance retail payment services, and will collaborate with the Japanese government.
    Keywords: retail payment; financial EDI; ISO20022
    Date: 2014–11–05
  13. By: Jean-Bernard Chatelain (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, UP1 - Université Paris 1, Panthéon-Sorbonne - Université Paris I - Panthéon-Sorbonne - PRES HESAM)
    Abstract: This review of the book "The Challenge of Financial Stability: A New Model and its Applications" by Goodhart C.A.E. and Tsomocos D.P. highlights the potential of the framework of strategic partial default of banks with credit chain on the interbank market for further theoretical and applied research on financial stability.
    Keywords: Financial stability, Banking, Contagion, Default, General Equilibrium
    Date: 2013–04–16
  14. By: Matteo Ghilardi; Shanaka J. Peiris
    Abstract: This paper develops an open-economy DSGE model with an optimizing banking sector to assess the role of capital flows, macro-financial linkages, and macroprudential policies in emerging Asia. The key result is that macro-prudential measures can usefully complement monetary policy. Countercyclical macroprudential polices can help reduce macroeconomic volatility and enhance welfare. The results also demonstrate the importance of capital flows and financial stability for business cycle fluctuations as well as the role of supply side financial accelerator effects in the amplification and propagation of shocks.
    Keywords: Capital flows;Asia;Emerging markets;Business cycles;Macroprudential policies and financial stability;Financial intermediation;Monetary policy;Banking sector;Open economies;General equilibrium models;Financial Frictions, Capital Regulation, Monetary Policy
    Date: 2014–08–21
  15. By: Connel Fullenkamp; Céline Rochon
    Abstract: Despite revisions to bank capital standards, fundamental shortcomings remain: the rules for setting capital requirements need to be simpler, and resolution should be an essential part of the capital requirement framework.We propose a new system of capital regulation that addresses these needs by making changes to all three pillars of bank regulation: only common equity should be recognized as capital for regulatory purposes, and risk weighting of assets should be abandoned; capital requirements should be assigned on an institution-by-institution basis according to a regulatory (s,S) approach developed in the paper; a standard for prompt, corrective action is incorporated into the (s,S) approach.
    Keywords: Bank capital;Capital regulation;Capital requirements;Bank regulations;Bank supervision;Banking systems;Regulation, Bank Capital.
    Date: 2014–09–15
  16. By: Michael Brei; Leonardo Gambacorta
    Abstract: This paper analyses how the Basel III leverage ratio (Tier 1 capital/exposure) behaves over the cycle. The analysis proposes a setup to test for the cyclical properties of bank capital ratios, taking into account structural shifts in banks' behaviour during the global financial crisis and its aftermath. Using a large data set covering international banks headquartered in 14 advanced economies for the period 1995-2012, we find that the Basel III leverage ratio is significantly more countercyclical than the riskweighted regulatory capital ratio: it is a tighter constraint for banks in booms and a looser constraint in recessions.
    Keywords: leverage, capital ratios, procyclicality, global financial crisis
    Date: 2014–10
  17. By: Wolfgang Reitgruber
    Abstract: After the release of the final accounting standards for impairment in July 2014 by the IASB, banks will face another significant methodological challenge after Basel 2. The presented work shares some first methodological thoughts and proposes ways how to approach underlying questions. It starts with a detailed discussion of the structural conservatism in the final standard. The exposure value outlined in the first exposure draft 2009 will be interpreted as a fair under amortized cost accounting and consequently provides a valid benchmark. Therefore the ED 2009 is used to quantify conservatism or hidden reserves in the actual implementation of the final standard and to separate operational side-effects from real risk impacts. The second part continues with a quantification of expected credit losses based on Impact of Risk instead of traditional cost of risk. An objective framework is suggested which allows for improved testing of forward looking credit risk estimates during credit cycles. This framework will prove useful to mitigate overly pro-cyclical provisioning and earnings volatility. Finally, an LGD monitoring and backtesting approach applicable for regulatory requirements and accounting standards is proposed. On basis of the NPL Backtest, which is part of the Impact of Risk concept, specific key risk indicators are introduced that allow for a detailed assessment of collections performance versus LGD in bucket 3.
    Date: 2014–11
  18. By: Raffaella Calabrese (Essex Business School, University of Essex); Johan A. Elkink (University College Dublin); Paolo Giudici (Department of Economics and Management, University of Pavia)
    Abstract: The recent European sovereign debt crisis clearly illustrates the importance of measuring the contagion effects of bank failures. Indeed, to better understand and monitor contagion risk, the European Central Bank is assuming the supervision of the largest banks in each of the member states. We propose a measure of contagion risk based on the spatial autocorrelation parameter of a binary spatial autoregressive model. Using different specifications of the interbank connectivity matrix and of the determinants of bank failures, we estimate the contagion parameter for banks within the Eurozone, between 1996 and 2012. We provide evidence of high levels of systemic risk due to contagion.
    Keywords: Contagion risk, spatial autoregressive models, European banks, binary data.
    Date: 2014–11
  19. By: Kühl, Michael
    Abstract: This paper compares the consequences of equity injections into banks with purchases of corporate and government bonds in a financial crisis situation using a New Keynesian model in which non-financial firms predominantly take non-market-based debt from banks instead of issuing securities. Our results show that equity injections into banks are more welfare enhancing than asset purchases following a financial shock located in the banking sector. Equity injections remove the frictions that have initiated the stress and, at the same time, relax borrowing conditions. Outright purchases also increase welfare but lower returns with negative effects on banks' profits, while the effect on asset prices to stabilize banks' balance sheets is of minor importance due to the dominance of non-market-based debt. Furthermore, we demonstrate that the origin of the financial shock matters crucially for the efficacy of measures.
    Keywords: DSGE Model,Financial Frictions,Financial Accelerator,Unconventional Policy Measures,Asset Purchase Programs,Capital Injections into Banks
    JEL: E44 E58 E61
    Date: 2014
  20. By: Akinci, Ozge (Board of Governors of the Federal Reserve System (U.S.)); Queraltó, Albert (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper proposes a macroeconomic model with financial intermediaries (banks), in which banks face occasionally binding leverage constraints and may endogenously affect the strength of their balance sheets by issuing new equity. The model can account for occasional financial crises as a result of the nonlinearity induced by the constraint. Banks' precautionary equity issuance makes financial crises infrequent events occurring along with "regular" business cycle fluctuations. We show that an episode of capital infl ows and rapid credit expansion, triggered by low country interest rates, leads banks to endogenously decrease the rate of equity issuance, contributing to an increase in the likelihood of a crisis. Macroprudential policies directed at strengthening banks' balance sheets, such as capital requirements, are shown to lower the probability of financial crises and to enhance welfare.
    Keywords: Financial intermediation; sudden stops; leverage constraints; occasionally binding constraints.
    JEL: E32 F41 F44 G15
    Date: 2014–11–07
  21. By: Michael R. Roberts
    Abstract: Using data from SEC filings, I show that the typical bank loan is renegotiated five times, or every nine months. The pricing, maturity, amount, and covenants are all significantly modified during each renegotiation, whose timing is governed by the financial health of the contracting parties and uncertainty regarding the borrowers' credit quality. The relative importance of these factors depends on the duration of the lending relationship. I interpret these results in light of financial contracting theories and emphasize that renegotiation is an important mechanism for dynamically completing contracts and for allocating control rights ex post.
    JEL: D82 G21 G23 G32 K12
    Date: 2014–09
  22. By: Ahnert, Toni
    Abstract: I study rollover risk in the wholesale funding market when intermediaries can hold liquidity ex-ante and are subject to fire sales ex-post. I demonstrate that precautionary liquidity restores multiple equilibria in a global rollover game. An intermediate liquidity level supports both the usual run equilibrium and an efficient equilibrium. I provide a uniqueness refinement to characterize the privately optimal liquidity choice. Because of fire sales, liquidity holdings are strategic substitutes. Intermediaries free-ride on the liquidity of other intermediaries, causing excessive liquidation. A macro-prudential authority internalizes the systemic nature of liquidity and restores constrained efficiency by imposing a macro-prudential liquidity buffer. JEL Classification: G01, G11, G28
    Keywords: global games, multiplicity, portfolio choice, wholesale funding
    Date: 2014–04
  23. By: Camba-Méndez, Gonzalo; Carbó-Valverde, Santiago; Rodriguez-Palenzuela, Diego
    Abstract: In this paper we study the impact that financial reputation and official market interventions have on the timing and amount of debt issuance decisions by banks. To do so, we propose an extension of the two-part modelling framework of Cragg (1971, eq. 7 and 9) to accommodate random effects. We use quarterly information on 70 major listed European banks from 2003Q1 to 2012Q1. Focusing on a wide range of financial reputation indicators, we show that credit ratings are a significant and positive determinant of the timing of uncollateralised debt issuance decisions. Empirical results do not suggest that ratings have a significant impact on the amount of debt placed by banks. Other financial reputation indicators analysed are found to be of second- order relevance on debt issuance decisions. Our results also suggest that central bank liquidity programs may have had a large impact on both the timing and the amount of collateralised debt issuance during the recent financial crisis, but had a negligible impact on uncollateralised debt issuance decisions. JEL Classification: G21, G01, G15
    Keywords: bank debt issuance, collateral, crisis, monetary policy
    Date: 2014–11
  24. By: Andrew G. Atkeson; Andrea L. Eisfeldt; Pierre-Olivier Weill
    Abstract: We develop a parsimonious model to study the equilibrium and socially optimal decisions of banks to enter, trade in, and possibly exit, an OTC market. Although we endow all banks with the same trading technology, banks' optimal entry and trading decisions endogenously lead to a realistic market structure comprised of dealers and customers with distinct trading patterns. We decompose banks' entry incentives into incentives to hedge risk and incentives to make intermediation profits. We show that dealer banks enter more than is socially optimal. In the face of large negative shocks, they may also exit more than is socially optimal when markets are not perfectly resilient.
    JEL: G0 G1 G2
    Date: 2014–08
  25. By: Eichengreen, Barry; Mehl, Arnaud; Chiţu, Livia; Richardson, Gary
    Abstract: This paper reconstructs the forgotten history of mutual assistance among Reserve Banks in the early years of the Federal Reserve System. We use data on accommodation operations by the 12 Reserve Banks between 1913 and 1960 which enabled them to mutualise their gold reserves in emergency situations. Gold reserve sharing was especially important in response to liquidity crises and bank runs. Cooperation among reserve banks was essential for the cohesion and stability of the US monetary union. But fortunes could change quickly, with emergency recipients of gold turning into providers. Because regional imbalances did not grow endlessly, instead narrowing when region-specific liquidity shocks subsided, mutual assistance created only limited tensions. These findings speak to the current debate over TARGET2 balances in Europe. JEL Classification: F30, N20
    Keywords: Federal Reserve System, gold standard, liquidity and financial crises, monetary policy, risk sharing, TARGET2 balances
    Date: 2014–07
  26. By: Maria Teresa Punzi (Department of Economics, Vienna University of Economics and Business); Katrin Rabitsch (Department of Economics, Vienna University of Economics and Business)
    Abstract: We allow for heterogeneity in investors’ ability to borrow from collateral in a Kiyotaki- Moore style macro model. We calibrate the model to match the quintiles of the distribution of leverage ratios of US non-financial firms. We show that financial amplification of the model with heterogeneous investors can be orders of magnitude higher, because of more pronounced asset price reactions.
    Keywords: Collateral Constraints, Leverage, Heterogeneity, Financial Amplification
    JEL: E32 E44
    Date: 2014–11
  27. By: Michael B. Devereux; Changhua Yu
    Abstract: International financial integration helps to diversify risk but also may increase the trans- mission of crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with endogenous portfolio choice and collateral con- straints. Collateral constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. The analysis allows for different degrees of financial integration, moving from financial autarky to bond market integration and equity market integration. Fi- nancial integration leads to a significant increase in global leverage, doubles the probability of balance sheet crises for any one country, and dramatically increases the degree of 'contagion' across countries. Outside of crises, the impact of financial integration on macro aggregates is relatively small. But the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky. Thus, a trade-off emerges between the probability of crises and the severity of crises. Financial integration can raise or lower welfare, depending on the scale of macroeconomic risk. In particular, in a low risk environment, the increased leverage resulting from financial integration can reduce welfare of investors.
    JEL: D52 F36 F44 G11 G15
    Date: 2014–09
  28. By: Bullard, James B. (Federal Reserve Bank of St. Louis)
    Abstract: Welcoming Remarks. Given at the Second Annual Community Banking in the 21st Century, The Federal Reserve System and Conference of State Bank Supervisors (CSBS), St. Louis.
    Date: 2014–09–23
  29. By: Julio J. Rotemberg
    Abstract: This paper studies the persistence and some of the consequences of the eventual abandonment by the FOMC of the principles embedded in the Federal Reserve's Tenth Annual Report of 1923. The three principles I focus on are 1) the discouraging of speculative lending by commercial banks, 2) the desire to meet the credit needs of business and 3) the preference of a focus on credit over a focus on monetary aggregates. I show that the first two principles remained important in FOMC deliberations until the mid-1960's. After this, the FOMC also spent less time discussing the composition of bank loans.
    JEL: E42 E58 N1
    Date: 2014–09

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