nep-ban New Economics Papers
on Banking
Issue of 2016‒08‒28
sixteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. The limits of model-based regulation By Behn, Markus; Haselmann, Rainer; Vig, Vikrant
  2. Relationship lending in the interbank market and the price of liquidity By Brauning, Falk; Fecht, Falko
  3. Assessing the costs and benefits of capital-based macroprudential policy By Behn, Markus; Gross, Marco; Peltonen, Tuomas
  4. Geographic Diversification and Banks’ Funding Costs By Ross Levine; Chen Lin; Wensi Xie
  5. Political Foundations of the Lender of Last Resort: A Global Historical Narrative By Calomiris, Charles; Flandreau, Marc; Laeven, Luc
  6. Credit market competition and liquidity crises By Carletti, Elena; Leonello, Agnese
  7. Risk Adjustment of the Credit-Card Augmented Divisia Monetary Aggregates By William Barnett; Liting Su
  8. The Role of Capital Requirements and Credit Composition in the Transmission of Macroeconomic and Financial Shocks By Oscar Valencia; Daniel Osorio; Pablo Garay
  9. Data Sources for the Credit-Card Augmented Divisia Monetary Aggregates By Barnett, William; Su, Liting
  10. Financial Stability and Optimal Interest-Rate Policy By Ajello, Andrea; Laubach, Thomas; Lopez-Salido, J. David; Nakata, Taisuke
  11. Provider Payment Methods and Incentives By Randall P. Ellis; Bruno Martins; Michelle McKinnon Miller
  12. The I Theory of Money By Markus K. Brunnermeier; Yuliy Sannikov
  13. The credit card debt puzzle: the role of preferences, credit risk, and financial literacy By Gorbachev, Olga; Luengo-Prado, Maria Jose
  14. The Global Financial Cycle, Monetary Policies and Macroprudential Regulations in Small, Open Economies By Gregory Bauer; Gurnain Pasricha; Rodrigo Sekkel; Yaz Terajima
  15. Determinants of business loan default in Ghana By Ellis Kofi, Akwaa-Sekyi; Portia, Bosompra
  16. Nominal Rigidities in Debt and Product Markets By Carlos Garriga; Finn E. Kydland; Roman Šustek

  1. By: Behn, Markus; Haselmann, Rainer; Vig, Vikrant
    Abstract: In this paper, we investigate how the introduction of sophisticated, model-based capital regulation affected the measurement of credit risk by financial institutions. Model-based regulation was meant to enhance the stability of the financial sector by making capital charges more sensitive to risk. Exploiting the introduction of the model-based approach in Germany and the richness of our loan-level data set, we show that (1) internal risk estimates employed for regulatory purposes systematically underpredict actual default rates by 0.5 to 1 percentage points; (2) both default rates and loss rates are higher for loans that were originated under the model-based approach, while corresponding risk-weights are significantly lower; and (3) interest rates are higher for loans originated under the model-based approach, suggesting that banks were aware of the higher risk associated with these loans and priced them accordingly. Counter to the stated objective of the reform, financial institutions have lower capital charges and at the same time experience higher loan losses. Further, we document that large banks benefited from the reform as they experienced a reduction in capital charges and consequently expanded their lending at the expense of smaller banks that did not introduce the model-based approach. Overall, our results highlight that if the challenges that accompanies complex regulation are too high simpler rules may increase the efficacy of financial regulation. JEL Classification: G01, G21, G28
    Keywords: Basel regulation, capital regulation, complexity of regulation, internal ratings
    Date: 2016–07
  2. By: Brauning, Falk (Federal Reserve Bank of Boston); Fecht, Falko (Frankfurt School of Finance & Management)
    Abstract: We empirically investigate the effect that relationship lending has on the availability and pricing of interbank liquidity. Our analysis is based on a daily panel of unsecured overnight loans between 1,079 distinct German bank pairs from March 2006 to November 2007, a period that includes the 2007 liquidity crisis that marked the beginning of the 2007/08 global financial crisis. We find that (i) relationship lenders are more likely to provide liquidity to their closest borrowers, (ii) particularly opaque borrowers obtain liquidity at lower rates when borrowing from their relationship lenders, and (iii) during the crisis, relationship lenders provided cheaper loans to their closest borrowers. Our results hold after controlling for search frictions as well as a large set of (time-varying) bank and bank-pair control variables and fixed effects. While we find some indication that lending relationships help banks reduce search frictions in the over-the-counter interbank market, our results establish that bank-pair relationships have a significant impact on interbank credit availability and pricing due to mitigating uncertainty about counterparty credit quality.
    Keywords: interbank market; relationship lending; financial crisis; central counterparty; financial contagion
    JEL: D61 E44 G10 G21
    Date: 2016–07–14
  3. By: Behn, Markus; Gross, Marco; Peltonen, Tuomas
    Abstract: We develop an integrated Early Warning Global Vector Autoregressive (EW-GVAR) model to quantify the costs and benefits of capital-based macroprudential policy measures. Our findings illustrate that capital-based measures are transmitted both via their impact on the banking system's resilience and via indirect macro-financial feedback effects. The feedback effects relate to dampened credit and asset price growth and, depending on how banks move to higher capital ratios, can account for up to a half of the overall effectiveness of capital- based measures. Moreover, we document significant cross-country spillover effects, especially for measures implemented in larger countries. Overall, our model helps to understand how and through which channels changes in capitalization affect bank lending and the wider economy and can inform policy makers on the optimal calibration and timing of capital-based macroprudential instruments. JEL Classification: G01, G21, G28
    Keywords: cost-benefit analysis, early-warning system, GVAR, macroprudential policy
    Date: 2016–07
  4. By: Ross Levine; Chen Lin; Wensi Xie
    Abstract: We assess the impact of the geographic expansion of bank assets on the cost of banks’ interest-bearing liabilities. Existing research suggests that expansion can both intensify agency problems that increase funding costs and facilitate risk diversification that decreases funding costs. Using a newly developed identification strategy, we discover that the geographic expansion of banks across U.S. states lowered their funding costs, especially when banks are headquartered in states with lower macroeconomic covariance with the overall U.S. economy. The results are consistent with the view that geographic expansion offers large risk diversification opportunities that reduce funding costs.
    JEL: G21 G28 G32
    Date: 2016–08
  5. By: Calomiris, Charles; Flandreau, Marc; Laeven, Luc
    Abstract: This paper offers a historical perspective on the evolution of central banks as lenders of last resort (LOLR). Countries differ in the statutory powers of the LOLR, which is the outcome of a political bargain. Collateralized LOLR lending as envisioned by Bagehot (1873) requires five key legal and institutional preconditions, all of which required political agreement. LOLR mechanisms evolved to include more than collateralized lending. LOLRs established prior to World War II, with few exceptions, followed policies that can be broadly characterized as implementing "Bagehot's Principles" : seeking to preserve systemic financial stability rather than preventing the failure of particular banks, and limiting the amount of risk absorbed by the LOLR as much as possible when providing financial assistance. After World War II, and especially after the 1970s, generous deposit insurance and ad hoc bank bailouts became the norm. The focus of bank safety net policy changed from targeting systemic stability to preventing depositor loss and the failure of banks. Statutory powers of central banks do not change much over time, or correlate with country characteristics, instead reflecting idiosyncratic political histories.
    Keywords: bank runs; central banks; economic history; Financial crises; lender of last resort
    Date: 2016–08
  6. By: Carletti, Elena; Leonello, Agnese
    Abstract: We develop a model where banks invest in reserves and loans, and trade loans on the interbank market to deal with liquidity shocks. Two types of equilibria emerge, depending on the degree of credit market competition and the level of aggregate liquidity risk. In one equilibrium, all banks keep enough reserves and remain solvent. In the other, some banks default with positive probability. The latter equilibrium exists when competition is not too intense and high liquidity shocks are not too likely. The model delivers several implications concerning the severity of crises and credit availability along the business cycle. JEL Classification: G01, G20, G21
    Keywords: cash-in-the-market pricing, interbank market, price volatility, systemic crises
    Date: 2016–07
  7. By: William Barnett (Department of Economics, The University of Kansas; Center for Financial Stability, New York City; IC2 Institute, University of Texas at Austin); Liting Su (Department of Economics, The University of Kansas;)
    Abstract: While credit cards provide transactions services, as do currency and demand deposits, credit cards have never been included in measures of the money supply. The reason is accounting conventions, which do not permit adding liabilities, such as credit card balances, to assets, such as money. However, economic aggregation theory and index number theory measure service flows and are based on microeconomic theory, not accounting. Barnett, Chauvet, Leiva-Leon, and Su (2016) derived the aggregation and index number theory needed to measure the joint services of credit cards and money. They derived and applied the theory under the assumption of risk neutrality. But since credit card interest rates are high and volatile, risk aversion may not be negligible. We extend the theory by removing the assumption of risk neutrality to permit risk aversion in the decision of the representative consumer.
    Keywords: Credit Cards, Money, Credit, Aggregation, Monetary Aggregation, Index Number Theory, Divisia Index, Risk, Euler Equations, Asset Pricing
    JEL: C43 C53 C58 E01 E3 E40 E41 E51 E52 E58 G17
    Date: 2016–08
  8. By: Oscar Valencia (Banco de la República de Colombia); Daniel Osorio (Banco de la República de Colombia); Pablo Garay
    Abstract: This paper builds a general equilibrium model that incorporates banks, financial frictions, default and a capital requirements. Ex-ante heterogeneous households decide how much to save or borrow for the sake of consumption (consumer credit) or the provision of housing services(mortgages). These choices are subject to borrowing limits, which depend on the value of real estate assets (for mortgages) or labour income (for consumer loans). The model includes final goods producers who must borrow in order to finance working capital/labour requirements (business credit borrowing) and intermediate good producers subject to nominal rigidities. Saving and borrowing are intermediated by a bank facing different capital requirements for each credit category. Any shock that has an impact on bank capital (for instance, a default shock) directly affects the bank’s income, the cost of external finance and, eventually, interest rates on loans. Changes in interest rates have second-round effects on labour and consumption through the borrowing limits. Simulations of the model suggest that the business cycle properties of credit and credit quality for each credit category are consistent with what is observed in the data. Classification JEL: E5, G21, G28
    Keywords: DSGE Models; Financial Frictions; Macroprudential Policy
    Date: 2016–08
  9. By: Barnett, William; Su, Liting
    Abstract: In 2013, the Center for Financial Stability (CFS) initiated its Divisia monetary aggregates database, maintained within the CFS program called Advances in Monetary and Financial Measurement (AMFM), in accordance with Barnett (1980, 2012). The CFS is now making available Divisia monetary aggregates extended to include the transactions services of credit cards. The extended aggregates are called the augmented Divisia monetary aggregates and are available to the public in monthly releases. The new aggregates are also available to Bloomberg terminal users. The theory on which the new aggregates is based is provided in Barnett and Su (2014). In this paper, we provide detailed information on the data sources used in producing the new augmented Divisia monetary aggregates.
    Keywords: monetary aggregates; credit cards; aggregation theory; index number theory; data; Divisia index.
    JEL: C8 E4 G1
    Date: 2016–04–30
  10. By: Ajello, Andrea; Laubach, Thomas; Lopez-Salido, J. David; Nakata, Taisuke
    Abstract: We study optimal interest-rate policy in a New Keynesian model in which the economy can experience financial crises and the probability of a crisis depends on credit conditions. The optimal adjustment to interest rates in response to credit conditions is (very) small in the model calibrated to match the historical relationship between credit conditions, output, inflation, and likelihood of financial crises. Given the imprecise estimates of key parameters, we also study optimal policy under parameter uncertainty. We find that Bayesian and robust central banks will respond more aggressively to financial instability when the probability and severity of financial crises are uncertain.
    Keywords: Financial crises ; Financial stability and risk ; Leverage ; Monetary policy ; Optimal policy
    JEL: E43 E52 E58 G01
    Date: 2016–08
  11. By: Randall P. Ellis (Boston University); Bruno Martins (Boston University); Michelle McKinnon Miller (Loyola Marymount University)
    Abstract: Diverse provider payment systems create incentives that affect the quantity and quality of health care services provided. Payments can be based on provider characteristics, which tend to minimize incentives for quality and quantity. Or payments can be based on quantities of services provided and patient characteristics, which provide stronger incentives for quality and quantity. Payments methods using both broader bundles of services and larger numbers of payment categories are growing in prevalence. The recent innovation of performance-based payment attempts to target payments on key patient attributes so as to improve incentives, better manage patients, and control costs.
    Keywords: Provider payment, fees schedules, Diagnosis Related Groups (DRG), moral hazard, selection, capitation, incentives, risk adjustment
    Date: 2015–08–12
  12. By: Markus K. Brunnermeier; Yuliy Sannikov
    Abstract: A theory of money needs a proper place for financial intermediaries. Intermediaries diversify risks and create inside money. In downturns, micro-prudent intermediaries shrink their lending activity, fire-sell assets and supply less inside money, exactly when money demand rises. The resulting Fisher disinflation hurts intermediaries and other borrowers. Shocks are amplified, volatility spikes and risk premia rise. Monetary policy is redistributive. Accommodative monetary policy that boosts assets held by balance sheet-impaired sectors, recapitalizes them and mitigates the adverse liquidity and disinflationary spirals. Since monetary policy cannot provide insurance and control risk-taking separately, adding macroprudential policy that limits leverage attains higher welfare.
    JEL: E32 E41 E44 E51 E52 E58 G01 G11 G21
    Date: 2016–08
  13. By: Gorbachev, Olga (University of Delaware); Luengo-Prado, Maria Jose (Federal Reserve Bank of Boston)
    Abstract: We use the 1979 National Longitudinal Survey of Youth to revisit what is termed the credit card debt puzzle: why consumers simultaneously co-hold high-interest credit card debt and low-interest assets that could be used to pay down this debt. This dataset contains unique information on intelligence, financial literacy, and preferences, while also providing a complete picture of households’ balance sheets. Relative to individuals with no credit card debt but positive liquid assets, individuals in the puzzle group have higher discount rates, slightly lower financial literacy scores, and very different perceptions on future credit risk: many individuals are using credit cards for precautionary motives.
    Keywords: household finance; risk aversion; time preferences; precautionary motives; bankruptcy; foreclosure
    JEL: D14 D91 E21 G02
    Date: 2016–07–07
  14. By: Gregory Bauer; Gurnain Pasricha; Rodrigo Sekkel; Yaz Terajima
    Abstract: This paper analyzes the implications of the global financial cycle for conventional and unconventional monetary policies and macroprudential policy in small, open economies such as Canada. The paper starts by summarizing recent work on financial cycles and their growing correlation across borders. The resulting global financial cycle may be followed by a financial crisis that is quite costly. The cycle causes time variation in global risk premia in fixed income, equity and foreign exchange markets. In turn, time-varying global risk premia affect the transmission mechanisms of both conventional and unconventional monetary policies in small, open economies. While there are large costs associated with financial crises, the paper summarizes new work showing that the central banks’ leaning against the effects of the global financial cycle would typically be too costly. The paper concludes with some suggestions for the formation of macroprudential policies that are designed to offset the financial imbalances that grow during the boom phase of the cycle.
    Keywords: International financial markets; Financial stability; Housing; Monetary policy framework
    JEL: E42 E43 E44 E52 F41
    Date: 2016
  15. By: Ellis Kofi, Akwaa-Sekyi; Portia, Bosompra
    Abstract: The initiation, funding, servicing and monitoring of loans by financial intermediaries has been done without regard to some critical factors which could have averted the likelihood of default. The study aimed at measuring the extent that owner-specific, borrower-specific, loan and lender-specific characteristics could determine the probability of loan default. The study used logistic regression for 224 business customers of a bank in Ghana from its nation-wide branches. The study found that owner’s extra income (ownership characteristics), multiple borrowing, diversion of loan purpose (borrower characteristics), loan price, loan purpose, loan age, repayment plan (loan characteristics) and underfunding (lender characteristics) significantly determined the probability of business loan default. The overall model predicted up to 78.5% of variations in the likelihood of default. The hierarchy of strong determinants given by their odd ratios were loan purpose (47.9 times), underfunding (19.2 times), diversion of loan purpose (11.7 times) multiple borrowing (9.4 times) and owner’s extra income (8.2 times). The study can conclude that financial intermediaries should be wary of the credit granting process taking cognisance of ownership, borrower, loan and lender characteristics especially the significant predictors. Combining quantitative and qualitative variables as determinants of default could be considered in future.
    Keywords: borrower-specific characteristics, default, financial intermediaries, lender characteristics, loan characteristics, ownership characteristics
    JEL: G21 G32
    Date: 2015–11
  16. By: Carlos Garriga (Federal Reserve Bank of St. Louis); Finn E. Kydland (University of California-Santa Barbara and NBER); Roman Šustek (Queen Mary University of London, Centre for Macroeconomics, and CERGE-EI)
    Abstract: Standard models used for monetary policy analysis rely on sticky prices. Recently, the literature started to explore also nominal debt contracts. Focusing on mortgages, this paper compares the two channels of transmission within a common framework. The sticky price channel is dominant when shocks to the policy interest rate are temporary, the mortgage channel is important when the shocks are persistent. The first channel has significant aggregate effects but small redistributive effects. The opposite holds for the second channel. Using yield curve data decomposed into temporary and persistent components, the redistributive and aggregate consequences are found to be quantitatively comparable.
    Keywords: Mortgage contracts, Sticky prices, Monetary policy, Yield curve, Redistributive vs. aggregate effects.
    JEL: E32 E52 G21 R21
    Date: 2016–08

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