nep-ban New Economics Papers
on Banking
Issue of 2016‒04‒09
six papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Structural reforms in banking: The role of trading By Krahnen, Jan Pieter; Noth, Felix; Schüwer, Ulrich
  2. Key Determinants of Demand, Credit Underwriting, and Performance on Government-Insured Mortgage Loans in Russia By Lozinskaia Agata; Ozhegov Evgeniy
  3. Can a bank run be stopped? Government guarantees and the run on Continental Illinois By Mark A Carlson; Jonathan Rose
  4. Inequality and Financial Fragility By Yuliyan Mitkov
  5. Adapting to changing input prices in response to the crisis: The case of US commercial banks By Laura Spierdijk; Sherrill Shaffer; Tim Considine
  6. Limited Liability, Asset Price Bubbles and the Credit Cycle: The Role of Monetary Policy By Jakub Mateju; Michal Kejak

  1. By: Krahnen, Jan Pieter; Noth, Felix; Schüwer, Ulrich
    Abstract: In the wake of the recent financial crisis, significant regulatory actions have been taken aimed at limiting risks emanating from trading in bank business models. Prominent reform proposals are the Volcker Rule in the U.S., the Vickers Report in the UK, and, based on the Liikanen proposal, the Barnier proposal in the EU. A major element of these reforms is to separate "classical" commercial banking activities from securities trading activities, notably from proprietary trading. While the reforms are at different stages of implementation, there is a strong ongoing discussion on what possible economic consequences are to be expected. The goal of this paper is to look at the alternative approaches of these reform proposals and to assess their likely consequences for bank business models, risk-taking and financial stability. Our conclusions can be summarized as follows: First, the focus on a prohibition of only proprietary trading, as envisaged in the current EU proposal, is inadequate. It does not necessarily reduce risk-taking and it likely crowds out desired trading activities, thereby negatively affecting financial stability. Second, there is potentially a better solution to limit excessive trading risk at banks in terms of potential welfare consequences: Trading separation into legally distinct or ring-fenced entities within the existing banking organizations. This kind of separation limits cross-subsidies between banking and proprietary trading and diminishes contagion risk, while still allowing for synergies across banking, non-proprietary trading and proprietary trading.
    Keywords: banking,structural reforms,prohibition of proprietary trading,banking separation
    JEL: G21 G28
    Date: 2016
  2. By: Lozinskaia Agata; Ozhegov Evgeniy
    Abstract: This research analyses the process of lending from Russian state-owned mortgage provider. Two-level lending and insurance of mortgage system lead to substantially higher default rates for insured loans. This means that underwriting incentives for regional operators of government mortgage loans perform poorly. We use loan-level data of issued mortgage by one regional government mortgage provided in order to understand the interdependence between underwriting, choice of contract terms including loan insurance by borrower and loan performance. We found an evidence of a difference in credit risk measures for insured and uninsured loans and interest income.
    JEL: C36 D12 R20
    Date: 2016–03–24
  3. By: Mark A Carlson; Jonathan Rose
    Abstract: This paper analyzes the run on Continental Illinois in 1984. We find that the run slowed but did not stop following an extraordinary government intervention, which included the guarantee of all liabilities of the bank and a commitment to provide ongoing liquidity support. Continental's outflows were driven by a broad set of US and foreign financial institutions. These were large, sophisticated creditors with holdings far in excess of the insurance limit. During the initial run, creditors with relatively liquid balance sheets nevertheless withdrew more than other creditors, likely reflecting low tolerance to hold illiquid assets. In addition, smaller and moredistant creditors were more likely to withdraw. In the second and more drawn out phase of the run, institutions with relative large exposures to Continental were more likely to withdraw, reflecting a general unwillingness to have an outsized exposure to a troubled institution even in the absence of credit risk. Finally, we show that the concentration of holdings of Continental's liabilities was a key dynamic in the run and was importantly linked to Continental's systemic importance.
    Keywords: bank runs, deposit insurance, deposit guarantee, financial crisis
    Date: 2016–03
  4. By: Yuliyan Mitkov (Rutgers University)
    Abstract: I study how the distribution of wealth influences the government’s response to a banking crisis and the fragility of the financial system. When the wealth distribution is unequal, the government’s bailout policy during a systemic crisis will be shaped in part by distributional concerns. In particular, government guarantees of deposits will tend to be credible for relatively poor investors, but may not be credible for wealthier investors. As a result, wealthier investors will have a stronger incentive to panic and, in equilibrium, the institutions in which they invest are more likely to experience a run and receive a bailout. Thus, without political frictions and under a government that is both benevolent and utilitarian, bailouts will tend to benefit wealthy investors at the expense of the general public. Rising inequality can strengthen this pattern. In some cases, more progressive taxation reduces financial fragility and can even raise equilibrium welfare for all agents.
    Keywords: Bailouts, Inequality, Financial stability, Limited commitment
    JEL: E61 G21 G28
    Date: 2016–03–24
  5. By: Laura Spierdijk; Sherrill Shaffer; Tim Considine
    Abstract: Substitution elasticities quantify the extent to which the demand for inputs responds to changes in input prices. They are considered particularly relevant from the perspective of cost management. Because the crisis has drastically altered the economic environment in which banks operate, we expect to find changes in banks' substitution patterns over time. This study uses a dynamic demand system to analyze U.S. commercial banks' substitution elasticities and adjustment time to input price changes during the 2000 - 2013 period. After the onset of the crisis, banks' response to input price changes became more sluggish and the substitutability of most input factors decreased significantly. Yet the substitutability of labor for physical capital rose remarkably, which we attribute to the continuing adoption of online banking technologies. Our results confirm that, with only few exceptions, the crisis has significantly reduced the substitutability of banks' input factors and thereby the possibilities for cost management. Nevertheless, we find that even after the onset of the crisis banks continued to control their costs by substituting labor for purchased funds and - to a lesser extent - labor for physical capital and core deposits for purchased funds. The results are consistent across banks of different sizes.
    Keywords: financial crisis, substitution elasticities, US commercial banks
    JEL: G21 D24 C30
    Date: 2016–04
  6. By: Jakub Mateju; Michal Kejak
    Abstract: This paper suggests that the dynamics of the non-fundamental component of asset prices are one of the drivers of the credit cycle. The presented model builds on the financial accelerator literature by including a stock market where investors with limited liability trade stocks of productive firms with stochastic productivities. Investors borrow funds from the banking sector and can go bankrupt. Their limited liability induces a moral hazard problem which shifts demand for risk and drives prices of risky assets above their fundamental value. Embedding the contracting problem in a New Keynesian general equilibrium framework, the model shows that expansionary monetary policy induces loose credit conditions and leads to a rise in both the fundamental and non-fundamental components of stock prices. A positive shock to the non-fundamental component triggers a credit cycle: collateral value rises, and lending and default rates decrease. These effects reverse after several quarters, inducing a credit crunch. The credit boom lasts only while stock market growth maintains sufficient momentum. However, monetary policy does not reduce the volatility of inflation and the output gap by reacting to asset prices.
    Keywords: Credit cycle, limited liability, monetary policy, non-fundamental asset pricing
    JEL: E32 E44 E52 G10
    Date: 2015–12

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