nep-ban New Economics Papers
on Banking
Issue of 2015‒11‒21
sixteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Credit Conditions and Consumption, House Prices and Debt: What Makes Canada Different? By John Muellbauer; Pierre St-Amant; David Williams
  2. The credit quality channel: Modeling contagion in the interbank market By Fink, Kilian; Krüger, Ulrich; Meller, Barbara; Wong, Lui-Hsian
  3. How does macroprudential regulation change bank credit supply? By Dimitrios Tsomocos; Alexandros Vardoulakis; Anil Kashyap
  4. The Impact of Interest Rate Risk on Bank Lending By Toni Beutler; Robert Bichsel; Adrian Bruhin; Jayson Danton
  5. Deposit Competition and Financial Fragility: Evidence from the US Banking Sector By Gregor Matvos; Ali Hortacsu; Mark Egan
  6. The role of investment banking in systemic risk profiles. Evidence from a panel of EU banking sectors By Renata Karkowska
  7. Monetary Policy and Financial Stability: Cross-Country Evidence By Christian Friedrich; Kristina Hess; Rose Cunningham
  8. SMEs and access to bank credit: Evidence on the regional propagation of the financial crisis in the UK By Degryse, Hans; Matthews, Kent; Zhao, Tianshu
  9. When is macroprudential policy effective? By Chris McDonald
  10. Credit policies before and during the financial crisis By Palle Sørensen
  11. Maintaining Central-Bank Financial Stability under New-Style Central Banking By Robert E. Hall; Ricardo Reis
  12. Bank profitability and its determinants in Pakistan: A panel data analysis after financial crisis By Ali, Muhammad
  13. Deleveraging, short sale constraints and market crash By Liang Wu; Lei Zhang; Zhiming Fu
  14. Do regulations and supervision shape the capital crunch effect of large banks in the EU? By Malgorzata Olszak; Mateusz Pipien; Iwona Kowalska; Sylwia Roszkowska
  15. The Role of Credit in Predicting US Recessions By Harri Pönkä
  16. Modelling the time-variation in euro area lending spreads By Boris Blagov; Michael Funke; Richhild Moessner

  1. By: John Muellbauer; Pierre St-Amant; David Williams
    Abstract: There is widespread agreement that, in the United States, higher house prices raise consumption via collateral or possibly wealth effects. The presence of similar channels in Canada would have important implications for monetary policy transmission. We trace the impact of shifts in non-price household credit conditions through joint estimation of a system of error-correction equations for Canadian aggregate consumption, house prices and mortgage debt. We find strong evidence that, after controlling for income and household portfolios, easier credit conditions raise house prices, debt and consumption. However, unlike in the United States, housing collateral effects on consumption are absent. Given credit conditions, rising house prices increase the mortgage down-payment requirement and reduce consumption, although there is evidence for some attenuation of this effect over the 2000s. We also find that high and rising levels of both house prices and debt since the late-1990s can be mostly explained by movements in incomes, housing supply, mortgage interest rates and credit conditions, suggesting that the outlook for house prices and debt could depend mainly on the future paths of these variables.
    Keywords: Credit and credit aggregates, Domestic demand and components, Economic models, Financial Institutions, Financial stability, Financial system regulation and policies, Housing, Transmission of monetary policy
    JEL: E02 E21 E44 G21 R21 R31
    Date: 2015
  2. By: Fink, Kilian; Krüger, Ulrich; Meller, Barbara; Wong, Lui-Hsian
    Abstract: We propose an algorithm to model contagion in the interbank market via what we term the credit quality channel. In existing models on contagion via interbank credit, external shocks to banks often spread to other banks only in case of a default. In contrast, shocks are transmitted via asset devaluations and deteriorations in the credit quality in our algorithm: First, the probability of default (PD) of those banks directly affected by some shock increases. This increases the expected loss of the credit portfolios of the initially affected banks' counterparties, thereby reducing the counterparties' regulatory capital ratio. From a logistic regression, we estimate the increase in the counterparties' PD due to a reduced capital ratio. Their increased PDs in turn affect the counterparties' counterparties, and so on. This coherent and flexible framework is applied to bilateral interbank credit exposure of the entire German banking system in order to examine policy questions. For that purpose, we propose to measure the potential cost of contagion of a given shock scenario by the aggregated regulatory capital loss computed in our algorithm.
    Keywords: contagion,systemic risk,macroprudential policy,policy evaluation,interconnectedness
    JEL: C63 G01 G17 G21 G28
    Date: 2015
  3. By: Dimitrios Tsomocos (to be added); Alexandros Vardoulakis (Board of Governors of the Federal Reserve System); Anil Kashyap (University of Chicago)
    Abstract: We analyze a variant of the Diamond-Dybvig (1983) model of banking in which savers can use a bank to invest in a risky project operated by an entrepreneur. The savers can buy equity in the bank and save via deposits. The bank chooses to invest in a safe asset or to fund the entrepreneur. The bank and the entrepreneur face limited liability and there is a probability of a run which is governed by the bank's leverage and its mix of safe and risky assets. The possibility of the run reduces the incentive to lend and take risk, while limited liability pushes for excessive lending and risk-taking. We explore how capital regulation, liquidity regulation, deposit insurance, loan to value limits, and dividend taxes interact to offset these frictions. We compare agents welfare in the decentralized equilibrium absent regulation with welfare in equilibria that prevail with various regulations that are optimally chosen. In general, regulation can lead to Pareto improvements but fully correcting both distortions requires more than one regulation.
    Date: 2015
  4. By: Toni Beutler (Swiss National Bank); Robert Bichsel (Swiss National Bank); Adrian Bruhin (University of Lausanne); Jayson Danton (University of Lausanne)
    Abstract: In this paper, we empirically analyze the transmission of realized interest rate risk – the gain or loss in bank economic capital due to movements in interest rates – to bank lending. We exploit a unique panel data set that contains supervisory information on the repricing maturity profiles of Swiss banks and provides us with an individual measure of interest rate risk exposure net of hedging. Our analysis yields three main results. First, our estimates indicate that a year after a permanent 1 percentage point upward shock in nominal interest rates, the average bank of 2013Q3 would ceteris paribus reduce its cumulative loan growth by approximately 170 basis points. An estimated 28% of this reduction would be the result of realized interest rate risk exposure weakening the bank’s economic capital. Second, due to the banks’ heterogeneity in interest rate risk exposure, the effect of the shock would differ across institutions and could be redistributive across regions. Finally, bank lending seems to be mainly driven by capital rather than liquidity, suggesting that a higher capitalized banking system can better shield its creditors from shocks in interest rates.
    Date: 2015–11
  5. By: Gregor Matvos (University of Chicago Booth School of Bu); Ali Hortacsu (University of Chicago); Mark Egan (University of Chicago)
    Abstract: We develop and estimate an empirical model of the U.S. banking sector using data covering the largest U.S. banks over the period 2002-2013. Our model incorporates insured depositors and run-prone uninsured depositors who choose between differentiated banks. Banks compete for deposits and can endogenously default. We estimate demand for uninsured deposits and find that it declines with banks' financial distress, which is not the case for insured deposits demand. We calibrate the supply side of the model and find that the deposit elasticity to bank default is large enough to introduce the possibility of multiple equilibria, suggesting that banks can be very fragile. Last, we use our model to analyze the proposed bank regulatory changes. For example, our results suggest that the capital requirement below 17% can lead to significant instability in the banking system, and that a requirement of 31% maximizes the welfare of the worst equilibrium.
    Date: 2015
  6. By: Renata Karkowska (University of Warsaw, Faculty of Management)
    Abstract: The goal of this study is to identify empirically how non-traditional activities affect directly the risk profiles and profitability of the banking sector. Through a dataset that covers 2678 European banks spanning the period 1996–2011 and the methodology of panel regression, the empirical findings document that investment banks have a negative effect on systemic risk in the banking sector. To show the heterogeneity of systemic risk determinants, the study sample was divided according to the economic development of a country into two groups: advanced and developing countries. We examine the implications of banks’ activity and risk-taking that manifest themselves as spreading and growing instability in the banking system. Then we explore the implications of the interaction between banking risk and structural, macroeconomic and financial market determinants. The findings have implications for both bank risk management and regulators. This paper advances the agenda of making macroprudential policy operational.
    Keywords: systemic risk, investment banking, emerging markets, credit risk, liquidity, bank solvency, instability
    JEL: F36 G21 G32 G33
    Date: 2015–05
  7. By: Christian Friedrich; Kristina Hess; Rose Cunningham
    Abstract: Central banks may face challenges in achieving their price stability goals when financial stability risks are present. There is, however, considerable heterogeneity among central banks with respect to how they manage these potential trade-offs. In this paper, we review the institutional and operational policy frameworks of ten central banks in major advanced economies and then assess the effect of financial stability risks on their monetary policy decisions according to these frameworks. To do so, we construct a time-varying financial stability orientation (FSO) index that quantifies a central bank’s policy orientation with respect to financial stability that spans the major viewpoints of the literature: “leaning against the wind” versus “cleaning up after the crash.” The index encompasses three dimensions: (i) the nature of the statutory frameworks, (ii) the extent of the regulatory tool kit, and (iii) the prominence of financial stability references in central bank monetary policy statements. We then include our FSO index in a modified Taylor rule, which is estimated using a cross-country panel of up to ten central banks for the period from 2000Q1 to 2014Q4. We find that in episodes of high financial stability risks, measured by a strongly positive credit to GDP gap, “leaning-type” central banks, i.e., those with a high FSO index value, appear to account for financial stability considerations in their monetary policy rate decisions. For “cleaning-type” central banks, we do not find this to be the case. Our baseline specification suggests that a representative leaning-type central bank’s policy rate is about 0.3 percentage points higher when financial stability risks are present than the policy rate of a representative cleaning-type central bank. We also find that the strength of this response increases in the additional presence of a house price boom but not so for the simultaneous occurrence of an equity price boom.
    Keywords: Financial stability, International topics, Monetary policy framework
    JEL: E5 E4 G01
    Date: 2015
  8. By: Degryse, Hans; Matthews, Kent (Cardiff Business School); Zhao, Tianshu
    Abstract: We study the sensitivity of banks’ credit supply to small and medium size enterprises (SMEs) in the UK to banks’ financial condition before and during the financial crisis. Employing unique data on the geographical location of all bank branches in the UK, we connect firms’ access to bank credit to the financial condition (i.e., bank health and the use of core deposits) of all bank branches in the vicinity of the firm over the period 2004-2011. Before the crisis, banks’ local financial conditions did not influence credit availability irrespective of the functional distance (i.e., the distance between bank branch and bank headquarters). However, during the crisis, we find that SMEs with in their vicinity banks that have stronger financial condition face greater credit availability when the functional distance is low. Our results point to a “flight to headquarters” effect during the financial crisis.
    Keywords: financial crisis; credit supply; flight to headquarters; flight to quality; bank organization
    JEL: G21 G29 L14
    Date: 2015–08
  9. By: Chris McDonald (Reserve Bank of New Zealand)
    Abstract: Previous studies have shown that limits on loan-to- value (LTV) and debt-to-income (DTI) ratios can stabilise the housing market, and that tightening these limits tends to be more effective than loosening them. This paper examines whether the relative effectiveness of tightening vs. loosening macroprudential measures depends on where in the housing cycle they are implemented. I find that tightening measures have greater effects when credit is expanding quickly and when house prices are high relative to income. Loosening measures seem to have smaller effects than tightening, but the difference is negligible in downturns. Loosening being found to have small effects is consistent with where it occurs in the cycle. macroprudential policies.
    Date: 2015–11
  10. By: Palle Sørensen (Aarhus University and CREATES)
    Abstract: This paper empirically distinguishes between the two main contending explanations for credit cycles. Namely, the bank lending channel and the balance sheet channel. This is done by using unique Danish survey, register, rating, and bank data. The results indicate that the bank lending channel explains most of the changes in credit policy by Danish banks towards small and medium (SME) sized firms. However, the results show that both channels are operational, but the balance sheet channel is surprisingly weak partly because discouragement during the crisis kept struggling firms from applying for credit. The analysis also reveals that the credit supply was weaker in banks that were struggling during the crisis and indirectly that firms could not off-set this effect by changing banks. Furthermore, the evidence suggests that the financial crisis also affected the liquidity of non-financial firms, as credit demand rose immediately following the crisis.
    Keywords: Business Fluctuations, Financial Markets and the Macroeconomy, Banks, and Credit Policies.
    JEL: E32 E44 G21 G32
    Date: 2015–11–10
  11. By: Robert E. Hall (Hoover Institution); Ricardo Reis
    Abstract: Since 2008, the central banks of advanced countries have borrowed trillions of dollars from their commercial banks in the form of interest-paying reserves and invested the proceeds in portfolios of risky assets. We investigate how this new style of central banking affects central banks’ solvency. A central bank is insolvent if its requirement to pay dividends to its government exceeds its income by enough to cause an unending upward drift in its debts to commercial banks. We consider three sources of risk to central banks: interest-rate risk (the Federal Reserve), default risk (the European Central Bank), and exchange-rate risk (central banks of small open economies). We find that a central bank that pays dividends equal to a standard concept of net income will always be solvent—its reserve obligations will not explode. In some circumstances, the dividend will be negative, meaning that the government is making a payment to the bank. If the charter does not provide for payments in that direction, then reserves will tend to grow more in crises than they shrink in normal times. To prevent this buildup, the charter needs to provide for makeup reductions in payments from the bank to the government. We compute measures of the financial strength of central banks, and discuss how different institutions interact with quantitative easing policies to put these banks in less or more danger of instability. We conclude that the risks to financial stability are real in theory, but remote in practice today.
    JEL: E42 E58
    Date: 2015–07
  12. By: Ali, Muhammad
    Abstract: This study seeks to investigate the internal and external determinants of the Pakistan banking sector, specifically after the recent financial crisis of 2008. The sample data comprises of total 26 banks, which include 17 conventional, 5 Islamic and 4 public banks. The selected sample covers the period of five years from 2009 to 2013. A balanced panel data regression model has been used and considered return on assets (ROA) and return on equity (ROE) as an alternative of bank's profitability. The results of the study suggest that bank’s profitability is significantly affected by its internal determinants while external determinants are insignificant. We find operating efficiency, liquidity, non-performing loans to total assets and real GDP has negative impact, whereas financial risk, gearing ratio, asset management, bank size, deposits, loans to total assets and inflation show positive impact on the assets side. On the other side, operating efficiency, gearing ratio, asset management, liquidity, deposits and real GDP have a positive impact while financial risk, bank size, asset quality and inflation exert negative impact on the equity side. During the study period, findings suggest that the Pakistan banking industry has managed well to avoid significant impact of external factors like inflation and GDP over profitability while efficient management is required to improve internal factors to be more profitable.
    Keywords: Banks, Assets, Operating costs, Profits, Assets size, Bank-specific determinants, Profitability.
    JEL: E0 E2 E4
    Date: 2015–04–01
  13. By: Liang Wu; Lei Zhang; Zhiming Fu
    Abstract: In this paper, we develop a theory of market crashes resulting from a deleveraging shock. We consider two representative investors in a market holding different opinions about the public available information. The deleveraging shock forces the high confidence investors to liquidate their risky assets to pay back their margin loans. When short sales are constrained, the deleveraging shock creates a liquidity vacuum in which no trades can occur between the two representative investors until the price drop to a threshold below which low confidence investors take over the reduced demands. There are two roles short sellers could play to stabilize the market. First, short sellers provide extra supply in a bullish market so that the price of the asset is settled lower than otherwise. Second, short sellers catch the falling price earlier in the deleveraging process if they are previously allowed to hold a larger short position. We apply our model to explain the recent deleveraging crisis of the Chinese market with great success.
    Date: 2015–11
  14. By: Malgorzata Olszak (Department of Banking and Money Markets, Faculty of Management, University of Warsaw, Poland); Mateusz Pipien (Department of Econometrics and Operations Research, Cracow University of Economics, Poland); Iwona Kowalska (Department of Mathematics and Statistical Methods, Faculty of Management, University of Warsaw, Poland); Sylwia Roszkowska (University of Warsaw, Faculty of Management)
    Abstract: This paper extends the literature on the capital crunch effect by examining the role of public policy for the link between lending and capital in a sample of large banks operating in the European Union. Applying Blundell and Bond (1998) two-step robust GMM estimator we show that restrictions on bank activities and more stringent capital standards weaken the capital crunch effect, consistent with reduced risk taking and boosted bank charter values. Official supervision also reduces the impact of capital ratio on lending in downturns. Private oversight seems to be related to thin capital buffers in expansions, and therefore the capital crunch effect is enhanced in countries with increased market discipline. We thus provide evidence that neither regulations nor supervision at the microprudential level is neutral from a financial stability perspective. Weak regulations and supervision seem to increase the pro-cyclical effect of capital on bank lending.
    Keywords: capital ratio, lending, capital crunch, regulations, supervision, procyclicality
    JEL: E32 G21 G28 G32
    Date: 2015–10
  15. By: Harri Pönkä (University of Helsinki and CREATES)
    Abstract: We study the role of credit in forecasting US recession periods with probit models. We employ both classical recession predictors and common factors based on a large panel of financial and macroeconomic variables as control variables. Our findings suggest that a number of credit variables are useful predictors of US recessions over and above the control variables both in and out of sample. Especially the excess bond premium, capturing the cyclical changes in the relationship between default risk and credit spreads, is found to be a powerful predictor. Overall, models that combine credit variables, common factors, and classic recession predictors, are found to have the best forecasting performance.
    Keywords: Business cycle, Credit Spread, Factor models, Forecasting, Probit models
    JEL: C22 C25 E32 E37
    Date: 2015–11–08
  16. By: Boris Blagov; Michael Funke; Richhild Moessner
    Abstract: Using a Markov-switching VAR with endogenous transition probabilities, we analyse what has triggered the interest rate pass-through impairment for Italy, Ireland, Spain and Portugal. We find that global risk factors have contributed to higher lending rates in Italy and Spain, problems in the banking sector help to explain the impairment in Spain, and fiscal problems and contagion effects have contributed in Italy and Ireland. We also find that the ECB's unconventional monetary policy announcements have had temporary positive effects in Italy. Due to the zero lower bound these findings are amplified if EONIA is used as a measure of the policy rate. We did not detect changes in the monetary policy transmission for Portugal.
    Keywords: Lending rates, interest rate pass-through
    Date: 2015–11

This nep-ban issue is ©2015 by Christian Calmès. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.