nep-ban New Economics Papers
on Banking
Issue of 2016‒07‒30
thirteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Aggregate Bank Capital and Credit Dynamics By Nataliya Klimenko; Sebastian Pfeil; Jean-Charles Rochet; Gianni De Nicolo
  2. Collateralization, Leverage, and Stressed Expected Loss By Eric JONDEAU; Amir KHALILZADEH
  3. Liquidity Risk, Bank Networks, and the Value of Joining the Federal Reserve System By Calomiris, Charles W.; Jaremski, Matthew; Park, Haelim; Richardson, Gary
  4. Comment on Peek and Rosengren (2005) “Unnatural Selection: Perverse Incentives and the Allocation of Credit in Japan” By Inoue, Hitoshi; Nakashima, Kiyotaka; Takahashi, Koji
  5. A False Sense of Security: Why U.S. Banks Diversify and Does it Help? By Priyank Gandhi; Patrick Christian Kiefer; Alberto Plazzi
  6. Equity is Cheap for Large Financial Institutions: The International Evidence By Priyank Gandhi; Hanno N. Lustig; Alberto Plazzi
  7. The Shadow Cost of Repos and Bank Liability Structure By Nataliya KLIMENKO; Santiago MORENO-BROMBERG
  8. Bank Financial world crisis: Inefficiencies and Responsibilities By Elisa Fusco; Bernardo Maggi
  9. The Impact of Treasury Supply on Financial Sector Lending and Stability By Arvind KRISHNAMURTHY; Annette VISSING-JORGENSEN
  10. Empty Creditors and Strong Shareholders: The Real Effects of Credit Risk Trading By Stefano Colonnello; Matthias Efing; Francesca Zucchi
  11. Household Leverage and the Recession By Midrigan, Virgiliu; Philippon, Thomas
  12. Which Swiss Gnomes Attract Money? Efficiency and Reputation as Performance Drivers of Wealth Management Banks By Urs Birchler; René Hegglin; Michael R. Reichenecker; Alexander F. Wagner
  13. When Do Laws and Institutions Affect Recovery Rates on Collateral? By Degryse, Hans; Ioannidou, Vasso; Liberti, Jose Maria; Sturgess, Jason

  1. By: Nataliya Klimenko (University of Zurich); Sebastian Pfeil (University of Bonn); Jean-Charles Rochet (University of Zurich, University of Toulouse I and Swiss Finance Institute); Gianni De Nicolo (International Monetary Fund and CESifo)
    Abstract: We develop a novel dynamic model of banking showing that aggregate bank capital is an important determinant of bank lending. In our model commercial banks finance their loans with deposits and equity, while facing equity issuance costs. Because of this financial friction, banks build equity buffers to absorb negative shocks. Aggregate bank capital determines the dynamics of lending. Notably, the equilibrium loan rate is a decreasing function of aggregate capitalization. The competitive equilibrium is constrained inefficient, because banks do not internalize the consequences of individual lending decisions for the future loss-absorbing capacity of the banking sector. In particular, we find that unregulated banks lend too much. Imposing a minimum capital ratio helps tame excessive lending, which enhances stability of the banking system.
    Keywords: macro-model with a banking sector, aggregate bank capital, pecuniary externality, capital requirements
    JEL: E21 E32 F44 G21 G28
  2. By: Eric JONDEAU (University of Lausanne and Swiss Finance Institute); Amir KHALILZADEH (University of Lausanne)
    Abstract: We describe a general equilibrium model with a banking system in which the deposit bank collects deposits from households and the merchant bank provides funds to firms. Merchant banks borrow collateralized short-term funds from deposit banks. In a financial downturn, as the value of collateral decreases, the merchant bank must sell assets on short notice, reinforcing the crisis, and default if their cash buffer is insufficient. The deposit bank suffers from loss because of the depreciated assets. If the value of the deposit bank’s assets is insufficient to cover deposits, it also defaults. Deposits are insured by the government. The premium paid by the deposit bank is its expected loss on the deposits. We define the bank’s capital shortfall in the crisis as the expected loss on deposits under stress. We calibrate the model on the U.S. economy and show how this measure of stressed expected loss behaves. In the absence of regulation, a 40% decline of the securities market would induce a loss of 17.8% in the ex-ante value of the assets or 80.7% of the ex-ante value of the equity.
    Keywords: Real business cycle model, Capital shortfall, Systemic risk, Collateral, Leverage
    JEL: D5 E2 E32 E44 G2
  3. By: Calomiris, Charles W. (Columbia University); Jaremski, Matthew (Colgate University); Park, Haelim (Office of Financial Research, Department of Treasury); Richardson, Gary (Federal Reserve Bank of Richmond)
    Abstract: Reducing systemic liquidity risk related to seasonal swings in loan demand was one reason for the founding of the Federal Reserve System. Existing evidence on the post-Federal Reserve increase in the seasonal volatility of aggregate lending and the decrease in seasonal interest rate swings suggests that it succeeded in that mission. Nevertheless, less than 8 percent of state-chartered banks joined the Federal Reserve in its first decade. Some have speculated that nonmembers could avoid higher costs of the Federal Reserve’s reserve requirements while still obtaining access indirectly to the Federal Reserve discount window through contacts with Federal Reserve members. We find that individual bank attributes related to the extent of banks’ ability to mitigate seasonal loan demand variation predict banks’ decisions to join the Federal Reserve. Consistent with the notion that banks could obtain indirect access to the discount window through interbank transfers, we find that a bank’s position within the interbank network (as a user or provider of liquidity) predicts the timing of its entry into the Federal Reserve System and the effect of Federal Reserve membership on its lending behavior. We also find that indirect access to the Federal Reserve was not as good as direct access. Federal Reserve member banks saw a greater increase in lending than nonmember banks.
    JEL: G21 G28 N22
    Date: 2016–07–06
  4. By: Inoue, Hitoshi; Nakashima, Kiyotaka; Takahashi, Koji
    Abstract: Peek and Rosengren (2005) suggested the mechanism of “unnatural selection,” where Japanese banks with impaired capital increase credit to low-quality firms because of their motivation to pursue balance sheet cosmetics. In this study, we reexamine this mechanism in terms of the interaction effect in a nonlinear specification of bank lending, using data from 1994 to 1999. We rigorously demonstrate that their estimation results imply that Japanese banks allocated lending from viable firms to unviable ones regardless of the degree of bank capitalization.
    Keywords: interaction effect, nonlinear specification, probit model, forbearance lending
    JEL: G01 G21 G28
    Date: 2016–07–25
  5. By: Priyank Gandhi (University of Notre Dame); Patrick Christian Kiefer (UCLA Anderson School of Management); Alberto Plazzi (USI-Lugano and Swiss Finance Institute)
    Abstract: Modern U.S. banks engage into activities traditionally considered as non-core for the banking sector. Consistent with extant models of financial intermediation, which suggest banks diversify to lower risk and improve profitability, we document that banks with higher probability of financial distress and deadweight financial costs diversify more aggressively. Diversified banks appear to benefit from "coinsurance", are more profitable, less financially constrained, and supply more credit. However, diversification does not lead to real reductions in risk as its benefits are limited to "good" times. Diversified banks are more exposed to systematic risk and their lending is more sensitive to macroeconomic conditions. They are also more prone to correlation risk, the risk that diversification benefits provided by non-core activities may unexpectedly change especially when they are most needed. Our study contributes to the current debate on the optimal scope of bank activities, and highlights novel channels through which diversification impacts banks' credit supply and therefore the real economy.
    Keywords: Bank diversification, Non-interest income, Systemic risk, Financial crisis
    JEL: G01 G21 G28
  6. By: Priyank Gandhi (Mendoza College of Business, University of Notre Dame); Hanno N. Lustig (Stanford Graduate School of Business; National Bureau of Economic Research (NBER)); Alberto Plazzi (USI-Lugano; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute)
    Abstract: Equity is a cheap source of funding for a country's largest financial institutions. In a large panel of 31 countries, we find that the stocks of a country's largest financial companies earn returns that are significantly lower than stocks of non-financials with the same risk exposures. In developed countries, only the largest banks' stock earns negative risk-adjusted returns, but, in emerging market countries, other large non-bank financial firms do. Even though large banks have high betas, these risk-adjusted return spreads cannot be attributed to the risk anomaly. Instead, we find that the large-minus-small, financial-minus-nonfinancial, risk-adjusted spread varies across countries and over time in ways that are consistent with stock investors pricing in the implicit government guarantees that protect shareholders of the largest banks. The spread is significantly larger for the largest banks in countries with deposit insurance, backed by fiscally strong governments, and in common law countries that offer shareholders better protection from expropriation. Finally, the spread also predicts large crashes in that country's stock market and output.
    Keywords: Banking crisis, Banking, Government bailouts
    JEL: G01 G21 G12
  7. By: Nataliya KLIMENKO (University of Zurich); Santiago MORENO-BROMBERG (University of Zurich)
    Abstract: Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank’s financing structure. In our model the bank’s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long–term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that their use adds to the cost of long–term debt financing, which limits the bank’s appetite for unstable repo funding. This effect is, however, weakened under poor returns on assets, abundant deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank’s financing choices and show that all these tools are able to curb the bank’s reliance on repos.
    Keywords: Bank financing structure; repos; liquid reserves; rollover risk; regulation
    JEL: G21 G28 G32 G35
  8. By: Elisa Fusco ("Sapienza" University of Rome); Bernardo Maggi ("Sapienza" University of Rome)
    Abstract: In light of the recent financial world crisis, is crucial to investigate into the responsibilities of the main actors in the credit sectors, i.e. banks and local governments. In this framework, we propose a methodology able to analyze the quality of the problem loans adopted by banks, their level of efficiency in the risk management strategies and the governments policy action in the supervision of the local banking system. Our approach is based on the introduction of the “Non performing Loans” variable as an undesirable output in an output distance function (as stochastic frontier) in order to estimate the efficiency of the bank and calculate the shadow price of the NPLs (not normally observable) per each year, bank and country. Then we compare the management of the NPLs and their price across geographic areas and bank dimension over time in order to map the responsibilities and to draw some policy implications. From an econometric point of view, we -to our knowledge- for first adopt the semi-nonparametric Fourier specification which, among the functional-flexibleform alternatives, is capable to guarantee the convergence of the estimated parameters and the related X-efficiency to the true ones.
    Keywords: Commercial bank, Financial world crisis, Non performing loans, Efficiency, Flexible forms, Distance function.
    JEL: G21 D24 C33 C51 L23
    Date: 2016–07
  9. By: Arvind KRISHNAMURTHY (Stanford University and National Bureau of Economic Research); Annette VISSING-JORGENSEN (National Bureau of Economic Research, University of California, Berkeley, and Center for Economic Policy Research)
    Abstract: We present a theory in which the key driver of short-term debt issued by the financial sector is the portfolio demand for safe and liquid assets by the nonfinancial sector. This demand drives a premium on safe and liquid assets that the financial sector exploits by owning risky and illiquid assets and writing safe and liquid claims against them. The central prediction of the theory is that safe and liquid government debt should crowd out financial sector lending financed by short-term debt. We verify this prediction with US data from 1875 to 2014. We take a series of approaches to rule out standard crowding out via real interest rates and to address potential endogeneity concerns.
    Keywords: Treasury Supply, Monetary Economics, Financial stability, Banking
    JEL: G12 G2 E4
  10. By: Stefano Colonnello (Otto-von-Guericke Universität Magdeburg; Halle Institute for Economic Research); Matthias Efing (Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute; University of Geneva - Geneva Finance Research Institute; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)); Francesca Zucchi (Federal Reserve Board)
    Abstract: Credit derivatives give creditors the possibility to transfer debt cash flow rights to other market participants while retaining control rights. We use the market for credit default swaps (CDSs) as a laboratory to show that the real effects of such debt unbundling crucially hinge on shareholder bargaining power. We find that creditors buy more CDS protection when facing strong shareholders to secure themselves a valuable outside option in distressed renegotiations. After the start of CDS trading, the distance-to-default, investment, and market value of firms with powerful shareholders drop by 7.9%, 7%, and 8.8% compared to other firms.
    Keywords: Debt Decoupling, Empty Creditors, Credit Default Swaps, Shareholder Bargaining Power, Real Effects
    JEL: G32 G33 G34
  11. By: Midrigan, Virgiliu; Philippon, Thomas
    Abstract: A salient feature of the Great Recession is that regions that experienced larger declines in household debt also experienced larger declines in employment. We study a model in which liquidity constraints amplify the response of employment to changes in debt. We estimate the model using panel data on consumption, employment, wages and debt for U.S. states. Though successful in matching the cross-sectional evidence, the model predicts that deleveraging cannot, by itself, account for the large drop in aggregate employment in the U.S. The 25% decline in household debt observed in the data leads to a modest 1.5% drop in the natural rate of interest, and is easily offset by monetary policy. Household deleveraging is more potent, however, in the presence of other shocks that trigger the zero lower bound on interest rates. In the presence of such shocks household deleveraging accounts for about half of the decline in U.S. employment.
    Keywords: great recession; Household Debt; Regional Evidence; zero lower bound
    JEL: E2 E4 E5 G0 G01
    Date: 2016–07
  12. By: Urs Birchler (University of Zurich - Faculty of Economics, Business Administration and Information Technology); René Hegglin (University of Zurich - Department of Banking and Finance); Michael R. Reichenecker (UBS AG); Alexander F. Wagner (University of Zurich - Department of Banking and Finance; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI))
    Abstract: Wealth management constitutes an important aspect of today's banking world, but very little is known about what explains the differences among banks in their ability to attract new assets under management. Using a unique panel database of Swiss private banks, we test the hypothesis that the performance of a bank in attracting new money depends on two input factors: skill and reputation. We first estimate the unobservable skill of a bank as a deviation of observed cost efficiency from expected efficiency. In a second step, we find that relatively skilled banks -- that is, banks that are more cost-efficient than predicted by their input factors -- also perform better in attracting net new money. We also find that negative media coverage (such as in the context of fraudulent business practices related to tax evasion) strongly diminishes the future ability to attract assets under management, especially at small banks. Thus, adding to the explicit fines that many Swiss banks had to pay in the course of the U.S. Department of Justice's investigations, there are substantial implicit and reputational costs to banks. Consistent with the notion that trust plays an important role, banks with a higher service intensity (number of employees per assets under management) attract more future funds; by contrast, investment performance for clients seems not to explain future net new money growth.
    Keywords: Wealth management, Reputation risk, Net new money, Cost-income ratio
    JEL: G21
  13. By: Degryse, Hans; Ioannidou, Vasso; Liberti, Jose Maria; Sturgess, Jason
    Abstract: We examine how law and institutions affect banks' expected recovery rates on collateral using a novel dataset of secured loans made by a single bank across 16 countries, which includes a detailed description of the underlying assets pledged as collateral and the bank's ex-ante appraised liquidation value. On average, expected recovery rates are higher where laws and institutions grant creditors stronger enforcement rights and bargaining power in the event of default. Using within-borrower estimation to compare recovery rates on different assets for the same borrower, we find that movable collateral that is less redeployable, more susceptible to agency problems, or faster to depreciate exhibits recovery rates that are lower and more vulnerable to laws and institutions. Further, the bank compensates for lower recovery rates in economies with weak performance by charging higher interest rates. The results shed light on one of the underlying economic channels through which weak laws and institutions undermine countries' financial and economic development.
    Date: 2016–07

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