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on Banking |
| By: | Adrian, Tobias |
| Abstract: | This paper explores financial stability policies for the shadow banking system. I tie policy options to economic mechanisms for shadow banking that have been documented in the literature. I then illustrate the role of shadow bank policies using three examples: agency mortgage real estate investment trusts, leveraged lending, and captive reinsurance affiliates. For each example, the economic mechanisms are explained, the potential risks emanating from the activities are described, and policy options to mitigate such risks are listed. The overarching theme of the analysis is that any policy prescription for the shadow banking system is highly specific relative to the particular activity. |
| Keywords: | financial intermediation; shadow bank policies; systemic risk |
| JEL: | E44 G00 G01 G28 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10435&r=ban |
| By: | Mary M. Everett |
| Abstract: | Using novel data on individual euro area banks' balance sheets this paper shows that exposure to stressed European sovereigns manifested in a liquidity shock to their international funding through two channels: (i) a contraction in cross-border funding, and (ii) a contraction in US wholesale funding. The effectiveness of the ECB's unconventional monetary policy measures, in the form of the 3-year Long-Term Refinancing Operations (VLTROs), in mitigating effects of the European sovereign debt crisis on the supply of private sector credit is assessed. Controlling for banks' risk factors and credit demand, the first round of VLTROs in December 2011 is not found to have been successful in offsetting the decline in credit supply to Households and non-financial corporates. In contrast, the VLTROs in February 2012 are found to have mitigated the effect of the European sovereign debt crisis on credit supply. Moreover, a contraction in credit supply to non-financial corporates, but not households, is documented for euro area banks affected by the international liquidity shock and that drew on ECB liquidity under the VLTRO facilities. |
| Keywords: | European sovereign crisis, cross-border banking, sovereign debt, international transmission, non-standard measures, ECB liquidity |
| JEL: | G21 G15 H63 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:wsr:wpaper:y:2015:i:143&r=ban |
| By: | Piergiorgio Alessandri (Bank of Italy); Sergio Masciantonio (Bank of Italy); Andrea Zaghini (Bank of Italy) |
| Abstract: | We develop a methodology to identify and rank ‘systemically important financial institutions’ (SIFIs). Our approach is consistent with that followed by the Financial Stability Board but, unlike the latter, it is free of judgment and it is based entirely on publicly available data, thus filling the gap between the official views of the regulator and those that market participants form with their own information set. We apply the methodology on three samples of banks (global, EU and euro area) for the years 2007-12. |
| Keywords: | systemic risk, too big to fail |
| JEL: | G21 G01 G18 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:opques:qef_259_15&r=ban |
| By: | Bulow, Jeremy (Stanford University); Klemperer, Paul (University of Oxford) |
| Abstract: | We propose a new form of hybrid capital for banks, Equity Recourse Notes (ERNs), which ameliorate booms and bust by creating counter-cyclical incentives for banks to raise capital, and so encourage bank lending in bad times. They avoid the flaws of existing contingent convertible bonds (cocos)--in particular, they convert more credibly--so ERNs also help solve the too-big-to-fail problem: rather than forcing banks to increase equity, we should require the same or larger capital increase but permit it to be in the form of either equity or ERNs--this also gives some choice to those who claim (rightly or wrongly) that equity is more costly than debt. ERNs can be introduced within the current regulatory system, but also provide a way to reduce the existing system's heavy reliance on measures of regulatory-capital. |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3098&r=ban |
| By: | Amel-Zadeh, Amir (?); Barth, Mary E. (Stanford University); Landsman, Wayne R. (?) |
| Abstract: | We describe analytically commercial bank behavior focusing on actions banks take in response to economic gains and losses on their assets to meet regulatory leverage requirements. Our analysis shows that absent differences in regulatory risk weights across assets, leverage cannot be procyclical. We test the analytical description's predictions using a sample of US commercial banks, during economic upturns and downturns, including the recent financial crisis. Although we find a significantly positive relation between change in leverage and change in assets, this procyclical relation evaporates when change in each bank's weighted average regulatory risk weight is included in the estimating equation. We also find that all changes in equity, including those arising from fair value accounting, are significantly negatively related to change in leverage, which is inconsistent with fair value accounting contributing to procyclical leverage. In addition, we find no evidence of a relation between change in leverage and the interaction between change in assets arising from fair value accounting and other changes in assets. Taken together, the empirical evidence indicates that fair value accounting is not a source of procyclical leverage. The key conclusion we draw is that bank regulatory requirements, particularly regulatory leverage determined using regulatory risk-weighted assets, explain why banks' leverage can be procyclical, and that fair value accounting does not. |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3073&r=ban |
| By: | Schmeiser, Maximilian D. (Board of Governors of the Federal Reserve System (U.S.)); Gross, Matthew B. (University of Michigan) |
| Abstract: | We examine the evolution of mortgage modification terms obtained by distressed subprime borrowers during the recent housing crisis, and the effect of the various types of modifications on the subsequent loan performance. Using the CoreLogic LoanPerformance dataset that contains detailed loan level information on mortgages, modification terms, second liens, and home values, we estimate a discrete time proportional hazard model with competing risks to examine the determinants of post-modification mortgage outcomes. We find that principal reductions are particularly effective at improving loan outcomes, as high loan-to-value ratios are the single greatest contributor to re-default and foreclosure. However, any modification that reduces total payment and interest (P&I) reduces the likelihood of subsequent re-default and foreclosure. Modifications that involve increasing the loan principal--primarily through capitalized interest and fees--are more likely to fail, even controlling for change in P&I. |
| Keywords: | Mortgage Modification; Subprime; Mortgage Default; Foreclosure; HAMP |
| JEL: | D12 G21 R20 R28 |
| Date: | 2014–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2015-06&r=ban |
| By: | Vanasco, Victoria (Stanford University) |
| Abstract: | This paper presents a model of securitization that highlights the link between information acquisition at the loan screening stage and liquidity in markets where securities backed by loan cashflows are sold. While information is beneficial ex-ante when used to screen loans, it becomes detrimental ex-post because it introduces a problem of adverse selection. The model matches key features of the securitization practice, such as the tranching of loan cashflows, and it predicts that when gains from securitization are 'sufficiently' large, loan screening is inefficiently low. There are two channels that drive this inefficiency. First, when gains from trade are large, a loan issuer is tempted ex-post to sell a large portion of its cashflows, and lower retention reduces incentives to screen loans. Second, the presence of adverse selection in secondary markets creates informational rents for issuers holding low quality loans, reducing the value of loan screening. This suggests that incentives for loan screening not only depend on the portion of loans retained by issuers, but also on how the market prices different securities. Turning to financial regulation, I characterize the optimal mechanism and show that it can be implemented with a simple tax scheme. This paper, therefore, contributes to the recent debate on how to regulate securitization. |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3248&r=ban |
| By: | Iancu, Dan Andrei (Stanford University); Trichakis, Nikolaos (?); Tsoukalas, Gerry (?) |
| Abstract: | We study the interplay between financial covenants and the operational decisions of a retailer that obtains financing through a secured, inventory-based lending contract. We characterize how leverage affects dynamic inventory decisions, and find that it can lead to surprising non-threshold policies, and perverse incentives such as sales under-reporting. We show that, under perfectly competitive lending, financial covenants are necessary and sufficient to restore channel optimality, and emerge as critical contract parameters. We characterize the optimal covenant terms in equilibrium, and perform comparative statics with respect to important operational details. Surprisingly, we find that retailers operating under higher demands, lower inventory depreciation rates or higher profit margins face more stringent covenants. Furthermore, we show that covenants are not substitutable by other contractual terms, such as interest rates and loan limits, even under a monopolistic lending market. We study the effect of additional operational flexibility, and show that it can impact covenant effectiveness in a surprising, non-monotonic way. Our results are well aligned with empirical findings in the finance and accounting literature, and also yield new insights that could be tested empirically. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3246&r=ban |
| By: | Koudijs, Peter (Stanford University); Voth, Hans-Joachim (University of Zurich) |
| Abstract: | What determines risk-bearing capacity and the amount of leverage in financial markets? Using unique archival data on collateralized lending, we show that personal experience can affect individual risk-taking and aggregate leverage. When an investor syndicate speculating in Amsterdam in 1772 went bankrupt, many lenders were exposed. In the end, none of them actually lost money. Nonetheless, only those at risk of losing money changed their behavior markedly--they lent with much higher haircuts. The rest continued as before. The differential change is remarkable since the distress was public knowledge. Overall leverage in the Amsterdam stock market declined as a result. |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3103&r=ban |
| By: | Admati, Anat R. (Stanford University) |
| Abstract: | Excessive leverage (indebtedness) in banking endangers the public and distorts the economy. Yet current and proposed regulations only tweak previous regulations that failed to provide financial stability. This paper discusses the forces that have led to this situation, some of which appear to be misunderstood. The benefits to society of requiring that financial institutions use significantly more equity funding than the status quo are large, while any costs are entirely private and due to banks' ability to shift some of their costs to others when they use debt. Without quantitative analysis, I outline improved regulations and how they can be implemented. |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3030&r=ban |
| By: | Gornall, Will (Stanford University); Strebulaev, Ilya A. (Stanford University) |
| Abstract: | We develop a model of the joint capital structure decisions of banks and their borrowers. Strikingly high bank leverage emerges naturally from the interplay between two sets of forces. First, seniority and diversification reduce bank asset volatility by an order of magnitude relative to that of their borrowers. Second, previously unstudied supply chain effects mean that highly levered financial intermediaries can offer the lowest interest rates. Low asset volatility enables banks to take on high leverage safely; supply chain effects compel them to do so. Firms with low leverage also arise naturally, as borrowers internalize the systematic risk costs they impose on their lenders. Because risk assessment techniques from the Basel framework underlie our model, we can quantify the impact capital regulation and other government interventions have on leverage and fragility. Deposit insurance and the expectation of government bailouts increase not only bank risk taking, but also borrower risk taking. Capital regulation lowers bank leverage but can lead to compensating increases in the leverage of borrowers, which can paradoxically lead to riskier banks. Doubling current capital requirements would reduce the default risk of banks exposed to high moral hazard by up to 90%, with only a small increase in bank interest rates. |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3102&r=ban |
| By: | Vanasco, Victoria (Stanford University); Asriyan, Vladimir (?) |
| Abstract: | We construct a dynamic model of financial intermediation in which changes in the information held by financial intermediaries generate asymmetric credit cycles as the ones documented by Reinhart and Reinhart (2010). We model financial intermediaries as "expert" agents who have a unique ability to acquire information about firm fundamentals. While the level of "expertize" in the economy grows in tandem with information that the "experts" possess, the gains from intermediation are hindered by informational asymmetries. We find the optimal financial contracts and show that the economy inherits not only the dynamic nature of information flow, but also the interaction of information with the contractual setting. We introduce a cyclical component to information by supposing that the fundamentals about which experts acquire information are stochastic. While persistence of fundamentals is essential for information to be valuable, their randomness acts as an opposing force and diminishes the value of expert learning. Our setting then features economic fluctuations due to waves of "confidence" in the intermediaries' ability to allocate funds profitably. |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3235&r=ban |
| By: | Kowalik, Michal |
| Keywords: | Banking; Liquidity; Interbank markets; Secondary markets |
| JEL: | G21 G28 |
| Date: | 2014–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp14-18&r=ban |
| By: | DeMarzo, Peter M. (Stanford University); Livdan, Dmitry (University of CA, Berkeley); Tchistyi, Alexei (University of CA, Berkeley) |
| Abstract: | We consider optimal incentive contracts when managers can, in addition to shirking or diverting funds, increase short term profits by putting the firm at risk of a low probability "disaster." To avoid such risk-taking, investors must cede additional rents to the manager. In a dynamic context, however, because managerial rents must be reduced following poor performance to prevent shirking, poorly performing managers will take on disaster risk even under an optimal contract. This risk taking can be mitigated if disaster states can be identified ex-post by paying the manager a large bonus if the firm survives. But even in this case, if performance is sufficiently weak the manager will forfeit eligibility for a bonus, and again take on disaster risk. When effort costs are convex, reductions in effort incentives are used to limit risk taking, with a jump to high powered incentives in the gambling region. Our model can explain why suboptimal risk taking can emerge even when investors are fully rational and managers are compensated optimally. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3149&r=ban |
| By: | Chan, Sewin (Federal Reserve Bank of New York); Haughwout, Andrew F. (Federal Reserve Bank of New York); Tracy, Joseph (Federal Reserve Bank of New York) |
| Abstract: | This chapter considers the structure of mortgage finance in the U.S., and its role in shaping patterns of homeownership, the nature of the housing stock, and the organization of residential activity. We start by providing some background on the design features of mortgage contracts that distinguish them from other loans, and that have important implications for issues presented in the rest of the chapter. We then explain how mortgage finance interacts with public policy, particularly tax policy, to influence a household’s decision to own or rent, and how shifts in the demand for owner-occupied housing are translated into housing prices and quantities, given the unusual nature of housing supply. We consider the distribution of mortgage credit in terms of access and price, by race, ethnicity, income, and over the lifecycle, with particular attention to the role of recent innovations such as non-prime mortgage securitization and reverse mortgages. The extent of negative equity has been unprecedented in the past decade, and we discuss its impact on strategic default, housing turnover, and housing investment. We describe spatial patterns in foreclosure and summarize the evidence for foreclosure spillovers in urban neighborhoods. Finally, we offer some thoughts on future innovations in mortgage finance. |
| Keywords: | mortgage; cities |
| JEL: | G21 R21 R31 |
| Date: | 2015–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:713&r=ban |
| By: | Massa, Massimo; Schmidt, Daniel |
| Abstract: | We investigate the pricing implications of the parallel trading of loans and bonds of the same firm. We show that loan, by making lenders share sensitive information about the borrower with the loan market participants, lower the information advantage of the asset managers affiliated to the lender who respond by reducing their stake in the bonds of the firm whose loans are sold, independently of considerations about the future firm value. This reduces information asymmetry in the bond market and improves its liquidity. This provides the first evidence of a direct informational link between the loan and bond secondary markets. |
| Keywords: | Corporate Bonds; Information Asymmetry; Loan Trading |
| JEL: | G14 G21 G22 G23 G24 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10446&r=ban |
| By: | Zachary Feinstein; Birgit Rudloff; Stefan Weber |
| Abstract: | Systemic risk refers to the risk that the financial system is susceptible to failures due to the characteristics of the system itself. The tremendous cost of this type of risk requires the design and implementation of tools for the efficient macroprudential regulation of financial institutions. The current paper proposes a novel approach to measuring systemic risk. Key to our construction is a rigorous derivation of systemic risk measures from the structure of the underlying system and the objectives of a financial regulator. The suggested systemic risk measures express systemic risk in terms of capital endowments of the financial firms. Their definition requires two ingredients: first, a cash flow or value model that assigns to the capital allocations of the entities in the system a relevant stochastic outcome. The second ingredient is an acceptability criterion, i.e. a set of random variables that identifies those outcomes that are acceptable from the point of view of a regulatory authority. Systemic risk is measured by the set of allocations of additional capital that lead to acceptable outcomes. The resulting systemic risk measures are set-valued and can be studied using methods from set-valued convex analysis. At the same time, they can easily be applied to the regulation of financial institutions in practice. We explain the conceptual framework and the definition of systemic risk measures, provide an algorithm for their computation, and illustrate their application in numerical case studies. We apply our methodology to systemic risk aggregation as described in Chen, Iyengar & Moallemi (2013) and to network models as suggested in the seminal paper of Eisenberg & Noe (2001), see also Cifuentes, Shin & Ferrucci (2005), Rogers & Veraart (2013), and Awiszus & Weber (2015). |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1502.07961&r=ban |
| By: | Barth, Mary E. (Stanford University); Gomez-Biscarri, Javier (Universitat Pompeu Fabra and Barcelona GSE); Kasznik, Ron (Stanford University); Lopez-Espinosa, German (Universidad Navarra) |
| Abstract: | We address banks' use of available-for-sale (AFS) securities to manage earnings and regulatory capital. Although prior research investigates banks' use of realized securities gains and losses to smooth earnings and regulatory capital, results are mixed. Creation of AFS securities and enhanced disclosures permit more powerful tests and new insights. We find banks realize gains and losses on AFS securities to smooth earnings and regulatory capital, and banks with more accumulated unrealized gains and losses do so to a greater extent. Banks with negative earnings realize losses to take a big bath, unless they have accumulated unrealized gains that offset the negative earnings. If so, they smooth earnings. Our inferences apply to non-listed and listed banks, which suggests the incentives do not derive solely from public capital market pressures. Our findings reveal the discretion afforded by historical cost-based accounting for AFS securities gains and losses enables banks to manage earnings and regulatory capital. |
| JEL: | G12 M41 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3047&r=ban |
| By: | Francisco Blasques; Falk Bräuning; Iman van Lelyveld |
| Abstract: | We introduce a structural dynamic network model of the formation of lending relationships in the unsecured interbank market. Banks are subject to random liquidity shocks and can form links with potential trading partners to bilaterally Nash bargain about loan conditions. To reduce credit risk uncertainty, banks can engage in costly peer monitoring of counterparties. We estimate the structural model parameters by indirect inference using network statistics of the Dutch interbank market from 2008 to 2011. The estimated model accurately explains the high sparsity and stability of the lending network. In particular, peer monitoring and credit risk uncertainty are key factors in the formation of stable interbank lending relationships that are associated with improved credit conditions. Moreover, the estimated degree distribution of the lending network is highly skewed with a few very interconnected core banks and many peripheral banks that trade mainly with core banks. Shocks to credit risk uncertainty can lead to extended periods of low market activity, amplified by a reduction in peer monitoring. Finally, our monetary policy analysis shows that a wider interest rate corridor leads to a more active market through a direct effect on the outside options and an indirect multiplier effect by increasing banks' monitoring and search efforts. |
| Keywords: | Interbank liquidity; financial networks; credit risk uncertainty; peer monitoring; monetary policy; trading relationships; indirect parameter estimation |
| JEL: | C33 C51 E52 G01 G21 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:460&r=ban |
| By: | Peia, Oana (ESSEC Business School); Vranceanu, Radu (ESSEC Business School) |
| Abstract: | This paper analyzes how banks' funding constraints impact the access and cost of capital of small firms. Banks raise external finance from a large number of small investors who face co-ordination problems and invest in small, risky businesses. When investors observe noisy signals about the true implementation cost of real sector projects, the model can be solved for a threshold equilibrium in the classical global games approach. We show that a "socially optimal" interest rate that maximizes the probability of success of the small firm is higher than the risk-free rate, because higher interest rates relax the bank's funding constraint. However, banks will generally set an interest rate higher than this socially optimal one. This gives rise to a built-in inefficiency of banking intermediation activity that can be corrected by various policy measures. |
| Keywords: | Bank finance; Small business; Global games; Optimal return; Strategic uncertainty |
| JEL: | C72 D82 G21 G32 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:essewp:dr-15001&r=ban |
| By: | Francesco, Aiello; Graziella, Bonanno |
| Abstract: | Italy has experienced a restructuring and consolidation process in the banking industry since the 1990s’ that is expected to foster efficiency and competition. Despite the reforms, a peculiarity of the industry is the persistence of small mutual-cooperative banks (BCCs) active in narrowed markets. The scope of this paper is to evaluate the level and the dynamics of BCC efficiency compared with other bank-types and to analyze its main determinants over the period 2006-2011. Efficiency is firstly estimated with stochastic frontiers and then used as dependent variable in fixed and random effects models that have been run to regress BCC efficiency against individual and environmental factors. The latter are meant to gauge the structure of the provincial banking market, that is to say the reference market of BCCs. Results show that BCCs perform better than other banks, even though efficiency has decreased over time, owing to the effect of the current crisis. Furthermore, BCC efficiency increases with market concentration and demand density and decreases as bank branches increase in local markets. This holds whatever the frontier (cost or profit). Finally, local development negatively affects (only) cost efficiency, while BCCs gain in generating profits when systemic credit risk increases. |
| Keywords: | Mutual-cooperative banks; local markets; stochastic frontiers; efficiency determinants |
| JEL: | C13 D21 D22 G21 O16 P13 |
| Date: | 2015–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:62486&r=ban |
| By: | Ben Lockwood (University of Warwick); Erez Yerushalmi (University of Warwick) |
| Abstract: | This paper considers the optimal taxation of transactions services in a dynamic general equilibrium setting, where households use both cash and costly transactions services provided by banks to purchase consumption goods. With a full set of all tax instruments, the optimal tax structure is indeterminate. However, all optimal tax structures distort the relative costs of payment media, by raising the relative cost of deposits to cash. In the simplest optimal tax structure, the Friedman rule holds i.e. cash should be untaxed, and the rate of tax on transactions services can be higher or lower than the consumption tax. When parameters are calibrated to US data, simulations suggest that the transactions services tax should be considerably lower. This is because a transactions tax has a "double distortion": it distorts the choice between payment media, and indirectly taxes consumption. This contrasts with the special case of the cashless economy, when the first distortion is absent: in this case, it is optimal to tax transactions services at the same rate as consumption. |
| Keywords: | financial intermediation services, tax design, banks, monitoring,payment services |
| JEL: | G21 H21 H25 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:btx:wpaper:1423&r=ban |
| By: | Danisewicz, Piotr (Lancaster University); Reinhardt, Dennis (Bank of England); Sowerbutts, Rhiannon (Bank of England) |
| Abstract: | This paper examines whether cross-border spillovers of macroprudential regulation depend on the organisational structure of banks’ foreign affiliates. Our analysis compares the response of foreign banks’ branches versus subsidiaries in the United Kingdom to changes in macroprudential regulations in foreign banks’ home countries. By focusing on branches and subsidiaries of the same banking group, we are able to control for all the factors affecting parent banks’ decisions regarding the lending of their foreign affiliates. We document that there are important differences between the type of regulation and the type of lending. Following a tightening of capital regulation, branches of multinational banks reduce interbank lending growth by 6 percentage points more relative to subsidiaries of the same banking group. Lending to non-banks does not exhibit such differences. A tightening in lending standards or reserve requirements at home does not have differential effects on both interbank and non-bank lending in the United Kingdom. |
| Keywords: | Macro prudential regulation; cross-border lending; credit supply; foreign banks organisational structure |
| JEL: | E51 E58 G21 G28 |
| Date: | 2015–02–20 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0524&r=ban |
| By: | Sandra Lizarazo (Universidad Carlos III de Madrid); Horacio Sapriza (Federal Reserve Board); Javier Bianchi (University of Wisconsin) |
| Abstract: | This paper studies the link between banking crises, sovereign default and govern- ment guarantees. A banking crisis can lead to a domestic credit crunch, which can be mitigated by government guarantees. However, the provision of bailout guaran- tees exposes the government to potentially severe losses from a banking sector failure and a sharp rise in public debt, causing sovereign default risk, and thus sovereign spreads, to increase substantially. As a result, the value of government guarantees deteriorates, deepening the crisis in the financial sector. The recent bailout in Ireland clearly illustrates the relevance of such risk transmission mechanism. An additional important contribution of our paper is to determine under which circumstances it is desirable for the government to provide bailout guarantees to the financial sector of the economy. A calibrated version of our model can mimic some of the interaction dynamics between financial sector risks and sovereign risks observed in Ireland during the crisis. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:1297&r=ban |
| By: | Patrick Bolton; Neng Wang; Jinqiang Yang |
| Abstract: | We formulate a dynamic financial contracting problem with risky inalienable human capital. We show that the inalienability of the entrepreneur’s risky human capital not only gives rise to endogenous liquidity limits but also calls for dynamic liquidity and risk management policies via standard securities that firms routinely pursue in practice, such as retained earnings, possible line of credit draw-downs, and hedging via futures and insurance contracts. |
| JEL: | G3 G32 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20979&r=ban |
| By: | Aggey Semenov (University of Ottawa); Hector Perez Saiz (Bank of Canada) |
| Abstract: | We use a unique detailed database with individual state campaign contributions made by banks in U.S. from 1998 to 2010 to understand how these contributions influence the regulation of the banking industry in that state, and in particular the approval of bank mergers by the state banking regulatory authority. We find that banks tend to contribute more to candidates that play a key role in appointing the head of the state banking regulator. In addition, we find that, after controlling for size or other key bank level variables, banks that are involved in a merger in the near future are more likely to contribute to elected senators and the governor, who play key roles in appointing the head of the state bank regulator that approves mergers which involve state banks. Our results help to understand better the role that campaign contributions have in the shaping of bank regulation in U.S. and the bank market structure in the last two decades. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:1265&r=ban |
| By: | Jensen, Henrik; Ravn, Søren Hove; Santoro, Emiliano |
| Abstract: | In the last decades, capital markets across the industrialized world have undergone massive deregulation, involving increases in the loan-to-value (LTV) ratios of households and firms. We study the business-cycle implications of this phenomenon in a dynamic general equilibrium model with multiple credit-constrained agents. Starting from low LTV ratios, a progressive relaxation of credit constraints leads to both higher macroeconomic volatility and stronger comovement between debt and real variables. This pattern reverses at LTV ratios not far from those currently observed in many advanced economies, since credit constraints become non-binding more often. As expansionary shocks may make credit constraints non-binding, while contractionary shocks cannot, recessions become deeper than expansions. The non-monotonic relationship between credit market conditions and macroeconomic fluctuations poses a serious challenge for regulatory and macroprudential policies. |
| Keywords: | business cycles; capital-market liberalization; capital-market regulation; occasionally non-binding contract constraints |
| JEL: | E32 E44 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10462&r=ban |
| By: | Luigi Bocola (University of Pennsylvania) |
| Abstract: | This paper examines the aggregate implications of sovereign credit risk in a business cycle model in which banks are exposed to risky government debt. An increase in the probability of a future sovereign default leads to a reduction in credit to firms because of two channels. First, it lowers the value of government debt on the balance sheet of banks, tightening their funding constraints and leaving them with fewer resources to lend to firms. Second, it raises the required premia demanded by banks for lending to firms because this activity has become riskier: if the sovereign default occurs, the economy falls in a major recession and claims to the productive sector pay out little. I estimate the nonlinear model with Italian data using Bayesian techniques. I find that sovereign credit risk led to a rise in the financing premia of firms that peaked 100 basis points, and cumulative output losses of 4.75% by the end of 2011. Both channels were quantitatively important drivers of the propagation of sovereign credit risk to the real economy. I then use the model to evaluate the effects of subsidized long term loans to banks, calibrated to the ECB's Longer Term Refinancing Operations. The presence of a significant risk channel at the policy enactment explains the limited stimulative effects of these interventions. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:1286&r=ban |
| By: | Haroon Mumtaz (Queen Mary University of London); Gabor Pinter (Bank of England); Konstantinos Theodoridis (Bank of England) |
| Abstract: | This paper evaluates the performance of a variety of structural VAR models in estimating the impact of credit supply shocks. Using a Monte-Carlo experiment, we show that identification based on sign and quantity restrictions and via external instruments is effective in recovering the underlying shock. In contrast, identification based on recursive schemes and heteroscedasticity suffer from a number of biases. When applied to US data, the estimates from the best performing VAR models indicate, on average, that credit supply shocks that raise spreads by 10 basis points reduce GDP growth and inflation by 1% after one year. These shocks were important during the Great Recession, accounting for about half the decline in GDP growth. |
| Keywords: | Credit supply shocks, Proxy SVAR, Sign restrictions, Identification via heteroscedasticity, DSGE models |
| JEL: | C15 C32 E32 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp739&r=ban |
| By: | Fernando Alvarez (University of Chicago and NBER); Francesco Lippi (University of Sassari and EIEF) |
| Abstract: | We present a model that characterizes the relationship between optimal dynamic cash management and the choice of the means of payment. The novel feature of the model is the sequential nature of the payments choice. In each instant the agent can choose to pay with either cash or credit. This framework predicts that the current level of the stock of cash determines whether the agent uses cash or credit. Cash is used whenever the agent has enough of it, credit is used when cash holdings are low, a pattern recently documented by households data from several countries. The average level of cash and the average share of expenditures paid in cash depend on the opportunity cost of cash relative to the cost of credit. The model produces a rich set of over-identifying restrictions for consumers’ cash-management and payment choices which can be tested using recent households survey and diary data. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:eie:wpaper:1502&r=ban |