nep-ban New Economics Papers
on Banking
Issue of 2015‒11‒01
fourteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Lending-of-last-resort is as lending-of-last-resort does: Central bank liquidity provision and interbank market functioning in the euro area By Garcia de Andoain, Carlos; Heider, Florian; Hoerova, Marie; Manganelli, Simone
  2. Optimal Capital Requirements over the Business and Financial Cycles By Frederic Malherbe
  3. Assessing the macroeconomic impact of bank intermediation shocks: a structural approach By Chen, kaiji; Zha, Tao
  4. "Bank Leverage Ratios and Financial Stability: A Micro- and Macroprudential Perspective" By Emilios Avgouleas
  5. "What Should Be Done with Greek Banks to Help the Country Return to a Path of Growth?" By Emilios Avgouleas; Dimitri B. Papadimitriou
  6. Saving and loan associations vs. commercial banks in Estonia: Responses to the financial crisis By Egle Tafenau
  7. Did Foreign Banks “Cut and Run” or Stay Committed to Emerging Europe During the Crises? By John Bonin; Dana Louie
  8. Implementing Loan-To-Value and Debt-To-Income ratios: Learning from country experiences. The case of Poland By Beata Bierut,; Tomasz Chmielewski; Adam Głogowski,; Sławomir Zajączkowski; Andrzej Stopczyński
  9. Inequality Indebtedness and Financial Crises By Antonio Scognamillo
  10. Alternative measures of credit extension for countercyclical buffer decisions in South Africa By Raputsoane, Leroi
  11. Optimal Liquidity Regulation With Shadow Banking By Grochulski, Borys; Zhang, Yuzhe
  12. Modern Monetary Circuit Theory, Stability of Interconnected Banking Network, and Balance Sheet Optimization for Individual Banks By Alexander Lipton
  13. Depositor discipline and bank failures in local markets during the financial crisis By Lamers, Martien
  14. Capital Controls as an Instrument of Monetary Policy By Ignacio Presno; Scott Davis

  1. By: Garcia de Andoain, Carlos; Heider, Florian; Hoerova, Marie; Manganelli, Simone
    Abstract: This paper investigates the impact of ample liquidity provision by the European Central Bank on the functioning of the overnight unsecured interbank market from 2008 to 2014. We use novel data on interbank transactions derived from TARGET2, the main euro area payment system. To identify exogenous shocks to central bank liquidity, we exploit the timing of ECB liquidity operations and use a simple structural vector auto-regression framework. We argue that the ECB acted as a de-facto lender-of-last-resort to the euro area banking system and identify two main effects of central bank liquidity provision on interbank markets. First, central bank liquidity replaces the demand for liquidity in the interbank market, especially during the financial crisis (2008-2010). Second, it increases the supply of liquidity in the interbank market in stressed countries (Greece, Italy and Spain) during the sovereign debt crisis (2011-2013).
    Keywords: central bank policy; financial crisis; interbank markets; lender-of-last-resort; sovereign debt crisis
    JEL: E58 F36 G01 G21
    Date: 2015–10
  2. By: Frederic Malherbe (London Business School)
    Abstract: I propose a simple theory of intertwined business and financial cycles, where financial regulation both optimally responds to and influences the cycles. In this model, banks do not internalize the effect of their credit expansion on other banks' expected bankruptcy costs, which leads to excessive aggregate lending. In response, the regulator sets a capital requirement to trade off expected output against financial stability. The capital requirement that ensures investment efficiency depends on the state of the economy and, because of a general equilibrium effect, its stringency increases with aggregate banking capital. A regulation that fails to take this effect into account would exacerbate economic fluctuations and result in excessive aggregate lending during a boom. It would also allow for an excessive build-up of risk in the financial sector, which implies that, at the peak of a boom, even a small adverse shock could trigger a banking sector collapse, followed by an excessively severe credit crunch.
    Date: 2015
  3. By: Chen, kaiji (Emory University); Zha, Tao (Federal Reserve Bank of Atlanta)
    Abstract: We take a structural approach to assessing the empirical importance of shocks to the supply of bank-intermediated credit in affecting macroeconomic fluctuations. First, we develop a theoretical model to show how credit supply shocks can be transmitted into disruptions in the production economy. Second, we use the unique micro-banking data to identify and support the model's key mechanism. Third, we find that the output effect of credit supply shocks is not only economically and statistically significant but also consistent with the vector autogression evidence. Our mode estimation indicates that a negative one-standard-deviation shock to credit supply generates a loss of output by 1 percent.
    Keywords: intermediation cost; credit supply channel; micro bank-level data; call report; senior loan officers; identification; supply and demand; intermediation costs; endogenous monitoring activities
    JEL: C51 C81 C82 E32 E44 G21
    Date: 2015–08–01
  4. By: Emilios Avgouleas
    Abstract: Bank leverage ratios have made an impressive and largely unopposed return; they are mostly used alongside risk-weighted capital requirements. The reasons for this return are manifold, and they are not limited to the fact that bank equity levels in the wake of the global financial crisis (GFC) were exceptionally thin, necessitating a string of costly bailouts. A number of other factors have been equally important; these include, among others, the world's revulsion with debt following the GFC and the eurozone crisis, and the universal acceptance of Hyman Minsky's insights into the nature of the financial system and its role in the real economy. The best examples of the causal link between excessive debt, asset bubbles, and financial instability are the Spanish and Irish banking crises, which resulted from nothing more sophisticated than straightforward real estate loans. Bank leverage ratios are primarily seen as a microprudential measure that intends to increase bank resilience. Yet in today's environment of excessive liquidity due to very low interest rates and quantitative easing, bank leverage ratios should also be viewed as a key part of the macroprudential framework. In this context, this paper discusses the role of leverage ratios as both microprudential and macroprudential measures. As such, it explains the role of the leverage cycle in causing financial instability and sheds light on the impact of leverage restraints on good bank governance and allocative efficiency.
    Keywords: Leverage; Banks; Financial Instability; Macroprudential Regulation; Leverage Cycle; Bubbles; Debt Overhang
    JEL: G21 G28 K22
    Date: 2015–10
  5. By: Emilios Avgouleas; Dimitri B. Papadimitriou
    Abstract: The recapitalization of Greek banks is perhaps the most critical problem for the Greek state today. Despite direct cash infusions to Greek banks that have so far exceeded 45 billion euros, with corresponding guarantees of around 130 billion euros, credit expansion has failed to pick up. There are two obvious reasons for this failure: first, the massive exodus of deposits since 2010; and second, the continuous recession--mainly the product of strongly deflationary policies dictated by international lenders. Following the 2012-13 recapitalization, creditors allowed the old, now minority, shareholders and incumbent management (regardless of culpability) to retain effective control of the banks--a decision that did not conform to accepted international practices. Sitting on a ticking time bomb of nonperforming loans (NPLs), Greek banks, rather than adopting the measures necessary to restructure their portfolios, cut back sharply on lending, while the country's economy continued to shrink. The obvious way to rehabilitate Greek banking following the new round of recapitalization scheduled for later this year is the establishment of a "bad bank" that can assume responsibility for the NPL workouts, manage the loans, and in some cases hold them to maturity and turn them around. This would allow Greek banks to make new and carefully underwritten loans, resulting in a much-needed expansion of the credit supply. Sound bank recapitalization with concurrent avoidance of any creditor bail-in could help the Greek banking sector return to financial health—and would be an effective first step in returning the country to the path of growth.
    Date: 2015–10
  6. By: Egle Tafenau
    Abstract: The aim of the paper is to analyze the development of the Estonian credit and saving market, especially considering the sector of households and non-financial corporations, in order to reveal the potential of saving and loan association (SLA) to enhance the economic and social development outside of the main economic centers of Estonia. We show that the SLAs and commercial banks have developed differently during the latest years, with cut-backs in the amount of issued loans by the commercial banks, while the SLAs have increased their corresponding activity. The period of analysis is 2004-2014, as the data for the SLAs is only available since 2004. Moreover, the period covers the pre-crisis period of loan boom triggered by the commercial banks, as well as the crisis itself. We rely on the data of the Bank of Estonia. Unfortunately, only consolidated data is available, such that it is not possible to analyze the regional distribution of the issued loans. The developments in the loans issued by the financial institutions as well as deposits with them are discussed in the context of changed legal environment and general economic situation. Though the share of loans issued by the SLAs is still tiny in Estonia, it cannot be concluded that their total contribution to the economic development of rural areas is significant. However, in light of the recent fast growth in the deposits and loans by the SLAs, their relevance is expected to increase in the future. This is especially the case if they manage to take over the niche left by the commercial banks that have closed down their offices in small towns.
    Keywords: Saving and loan associations; transition economies; financial crisis
    JEL: G21 R10
    Date: 2015–10
  7. By: John Bonin (Department of Economics, Wesleyan University); Dana Louie
    Abstract: Our objective is to examine empirically the behavior of foreign banks regarding real loan growth during a financial crisis for a set of countries in which these banks dominate the banking sectors due primarily to having taken over large existing former state-owned banks. The eight countries are among the most developed in Emerging Europe, their banking sectors having been modernized by the beginning of the time period. We consider a data period that includes an initial credit boom (2004 – 2007) followed by the global financial crisis (2008 & 2009) and the onset of the Eurozone crisis (2010). Our main innovations with respect to the existing literature on banking during the financial crisis are to include explicit consideration of exchange rate dynamics and to separate foreign banks into two categories, namely, subsidiaries of the Big 6 European MNBs and all other foreign-controlled banks. Our results show that bank lending was impacted adversely by the crisis but that the two types of foreign banks behaved differently. The Big 6 banks remained committed to the region in that their lending behavior was not different from that of domestic banks corroborating the notion that these countries are a “second home market” for these banks. Contrariwise, the other foreign banks were primarily responsible for fueling the credit boom prior to the crisis but then “cut and ran” by decreasing their lending appreciably during the crisis. Our results also indicate different bank behavior in countries with flexible exchange rate regimes from those in the Eurozone. Hence, we conclude that both innovations matter in empirical work on bank behavior during a crisis in the region and may, by extension, be relevant to other small countries in which banking sectors are dominated by foreign financial institutions.
    JEL: P34 G01 G15
    Date: 2015–10
  8. By: Beata Bierut,; Tomasz Chmielewski; Adam Głogowski,; Sławomir Zajączkowski; Andrzej Stopczyński
    Abstract: Starting from the mid-2000s, Poland experienced a period of rapid growth in mortgage lending, with banks offering foreign-currency, high-LTV housing loans, which exposed the sector to rising credit risk and funding challenges. Later, a surge in consumer lending led to a threat of rising credit risk in this segment. These supervisory challenges were addressed through three main instruments: guidelines related to the assessment of a borrower’s creditworthiness as well as LTV and DTI limits. The regulation has been successful from both microprudential and financial stability perspectives, as it has contributed to better risk management by banks and to the reduction of FX mortgage lending.
    Keywords: financial stability, macroprudential policy, loan-to-value ratios, debt-service-to -income ratios, house prices, credit growth.
    JEL: E44 E58 G21 G28
    Date: 2015
  9. By: Antonio Scognamillo (Dipartimento di Scienze per l'Economia e l'Impresa)
    Abstract: This work is an empirical contribution that investigates the presence of a relationship among income inequality, household indebtedness and the erup- tion of systemic banking crises (namely the I-I-C nexus). We test this hy- pothesis on a panel of 31 countries over the period 1980-2012 within four different scenarios. We find strong evidence of a statistically significant asso- ciation between income inequality and systemic banking crises via household indebtedness (the I-I-C nexus) regardless of the specification and the estima- tion technique chosen. However, we find no evidence of a feedback effect of a systemic banking crisis on income inequality, at least in the short run. We also find that economies characterized by highly liberalized financial mar- kets are more prone to experience such a nexus. These results suggest that reforming the architecture of financial regulation and supervision is still an important issues. However, it is a necessary but not sufficient condition in order to ensure financial stability.
    Keywords: Inequality Indebtedness Financial crisis Financial Regulation
    JEL: D30
    Date: 2015
  10. By: Raputsoane, Leroi
    Abstract: This paper analyses the behaviour of alternative measures of credit extension for countercyclical buffer decisions in South Africa. The cyclical properties of alternative measures of credit extension are examined over the economic and the financial cycles. The results show that the deviation of the ratio of private sector credit extension to gross domestic product from its long term trend is countercyclical with the economic cycle. The results also show that the deviation of the logarithm of private sector credit extension from its long term trend is procyclical with both the economic and the financial cycle. The annual percent change in private sector credit extension generally performs poorly in cyclical terms with both the economic and the financial cycle. Consequently, of the three alternative measures of private sector credit extension considered, the deviation of the logarithm of private sector credit extension from its long term trend could be used as a common reference guide for implementing the countercyclical capital buffers for financial institutions in South Africa.
    Keywords: Credit extension, Countercyclical capital buffers
    JEL: C32 E44 E51 G21
    Date: 2015–10–27
  11. By: Grochulski, Borys (Federal Reserve Bank of Richmond); Zhang, Yuzhe (Texas A&M University)
    Abstract: We study the impact of shadow banking on optimal liquidity regulations in a Diamond-Dybvig maturity mismatch environment. A pecuniary externality arising out of the banks' access to private retrade renders competitive equilibrium inefficient. Shadow banking provides an outside option for banks, which adds a new constraint in the mechanism design problem that determines the optimal allocation. A tax on illiquid assets and a subsidy to the liquid asset similar to the payment of interest on reserves (IOR) constitute an optimal liquidity regulation policy in this economy. During expansions, i.e., when the return on illiquid assets is high, the threat of investors flocking out to shadow banking pins down optimal policy rates. These rates do not respond to business cycle fluctuations as long as the economy stays out of recession. In recessions, when the return on illiquid assets is low, optimal liquidity regulation policy becomes sensitive to the business cycle: both policy rates are reduced, with deeper discounts given in deeper recessions. In addition, when high aggregate demand for liquidity is anticipated, the IOR rate is reduced and, unless the shadow banking constraint binds, the tax rate on illiquid assets is increased.
    Date: 2015–10–23
  12. By: Alexander Lipton
    Abstract: A modern version of Monetary Circuit Theory with a particular emphasis on stochastic underpinning mechanisms is developed. It is explained how money is created by the banking system as a whole and by individual banks. The role of central banks as system stabilizers and liquidity providers is elucidated. It is shown how in the process of money creation banks become naturally interconnected. A novel Extended Structural Default Model describing the stability of the Interconnected Banking Network is proposed. The purpose of banks' capital and liquidity is explained. Multi-period constrained optimization problem for banks's balance sheet is formulated and solved in a simple case. Both theoretical and practical aspects are covered.
    Date: 2015–10
  13. By: Lamers, Martien (Groningen University)
    Date: 2015
  14. By: Ignacio Presno (Universidad de Montevideo); Scott Davis (Federal Reserve Bank of Dallas)
    Abstract: Large swings in capital flows into and out of emerging markets can potentially lead to excessive volatility in asset prices and credit supply. In order to lessen the impact of capital flows on financial instability, a number of researchers and policy makers have recently proposed the use of capital controls. This paper considers the benefit of adding capital controls as a potential instrument of monetary policy in a small open economy. In a DSGE framework, we find that when domestic agents are subject to collateral constraints and the value of collateral is subject to fluctuations driven by foreign capital inflows and outflows, the adoption of temporary capital controls can lead to a significant welfare improvement. The benefits of capital controls are present even when monetary policy is determined optimally, implying that there may be a role for capital controls to exist side-by-side with conventional monetary tools as an instrument of monetary policy.
    Date: 2015

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