nep-ban New Economics Papers
on Banking
Issue of 2016‒09‒11
25 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Liquidity Runs By Matta, Rafael; Perotti, Enrico C
  2. Loan Borrowing of Non-Financial Sector of the Russian Economy By Berezinskaya, Olga; Schelokova, D.V.
  3. Network, Market, and Book-Based Systemic Risk Rankings By Michiel C.W. van de Leur; Andre Lucas
  4. The Determinants of Non-performing Loans: Dynamic Panel Evidence from South Asian Countries By Md. Shahidul Islam; Shin-Ichi Nishiyama
  5. Credit Defaults, Bank Lending and the Real Economy By Sebastiaan Pool
  6. Merger and Acquisitions in South African Banking: A Network DEA Model By Peter Wanke; Andrew Maredza; Rangan Gupta
  7. A Study of Financial Services provided by Foreign Financial Institutions (FFIs) Operating in India consistently during the period 2003-04 to 2012-13 with reference to India’s Foreign Trade. By Edurkar, Ashok; Chougule, Dr.Dattatrya G.
  8. Measuring Concentration Risk - A Partial Portfolio Approach By Pierpaolo Grippa; Lucyna Gornicka
  9. Peer-to-Peer Lending – A (Financial Stability) Risk Perspective By Benjamin Käfer
  10. Default, Mortgage Standards, and Housing Liquidity By Hongfei Sun; Chenggang Zhou; Allen Head
  11. Market Frictions, Interbank Linkages and Excessive Interconnections By Pragyan Deb
  12. Banking Competition and Firm-Level Financial Constraints in Latin America By Roberto Álvarez; Mauricio Jara
  13. Learning from crisis: Relational capital in lending relationships: Evidence from European family firms By Marco Cucculelli; Valentina Peruzzi; Alberto Zazzaro
  14. Deferred compensation and risk-taking incentives By Roman Inderst; Marcus Opp; Florian Hoffmann
  15. Bank Exposures and Sovereign Stress Transmission By Carlo Altavilla; Marco Pagano; Saverio Simonelli
  16. Quantitative Easing and Liquidity in the Japanese Government Bond Market By Kentaro Iwatsubo; Tomoki Taishi
  17. Sovereign Risk and Deposit Dynamics; Evidence from Europe By David A. Grigorian; Vlad Manole
  18. Banking Union and the ECB as Lender of Last Resort By Karl Whelan
  19. Observations on financial stability concerns for monetary policymakers: remarks at the Shanghai Advanced Institute of Science, Beijing, China, August 31, 2016 By Rosengren, Eric S.
  20. Profitability and Balance Sheet Repair of Italian Banks By Andreas Jobst; Anke Weber
  21. Application of Factor and Cluster Analysis for an evaluation of Business Practices Models of Foreign Banks. By Edurkar, Ashok; Chougule, Dr.Dattatrya G.
  22. Negative Interest Rate Policy (NIRP); Implications for Monetary Transmission and Bank Profitability in the Euro Area By Andreas Jobst; Huidan Lin
  23. Can Foreign Banks Reignite India’s Manufacturing, Domestic & Foreign Trade Growth with Application of Competitive Business Practices Models? By Edurkar, Ashok; Chougule, Dr.Dattatrya G.
  24. Germany; Financial Sector Assessment Program-Systemic Liquidity and Bank Funding-Technical Notes By International Monetary Fund. Monetary and Capital Markets Department
  25. Sovereign Risk and Bank Risk-Taking By Anil Ari

  1. By: Matta, Rafael; Perotti, Enrico C
    Abstract: Can the risk of losses upon premature liquidation produce bank runs? We show how a unique run equilibrium driven by asset liquidity risk arises even under minimal fundamental risk. To study the role of illiquidity we introduce realistic norms on bank default, such that mandatory stay is triggered before all illiquid assets are sold. Since illiquid assets are not available in a run, asset liquidity risk has a concave effect on run incentives, quite unlike fundamental risk. Runs are rare when asset liquidity is abundant, become more frequent as it falls and decrease again under very low asset liquidity. The socially optimal demandable debt contract limits inessential runs by targeting a high rollover yield. However, the private choice minimizes funding costs, tolerating more frequent runs when illiquid states are sufficiently rare.
    Keywords: bank runs; demandable debt; global games; liquidity risk; mandatory stay.
    JEL: G21
    Date: 2016–08
  2. By: Berezinskaya, Olga (Russian Presidential Academy of National Economy and Public Administration (RANEPA)); Schelokova, D.V. (Russian Presidential Academy of National Economy and Public Administration (RANEPA))
    Abstract: The work is devoted to analysis of credit borrowing of non-financial sector of the economy. The relevance of the work is determined by the importance of non-financial sector credit for the implementation of their potential "window of opportunity", reduced availability of financial resources and high credit risk of a number of industries. The work contains a comprehensive analysis of lending and non-financial sector of the economy is based on the data of the statistical reporting of enterprises, reporting of credit institutions and the Central Bank estimates. The paper identified the dynamics and current debt load sectors non-financial sector and the role of the Russian banking system in lending to industry, formulated imbalances and risks of expansion of bank lending to non-financial sector. The results obtained are productive for the understanding of the prospects and limitations of lending sectors non-financial sector of the Russian economy, the risks and the potential growth of its credit borrowing.
    Keywords: loan, credit, window of opportunity
    Date: 2016–05–16
  3. By: Michiel C.W. van de Leur (VU University Amsterdam, the Netherlands); Andre Lucas (VU University Amsterdam, the Netherlands)
    Abstract: We investigate the information content of stock correlation based network measures for systemic risk rankings, such as SIFIRank (based on Google's PageRank). Using European banking data, we first show that SIFIRank is empirically equivalent to a ranking based on average pairwise stock correlations. Next, we find that correlation based network measures still appear to complement currently available systemic risk ranking methods based on book or market values. A further analytical investigation, however, shows that the value-added appears to be mainly attributable to pairwise cross-sectional heterogeneity rather than to more subtle network relations and feedback loops.
    Keywords: Systemically Important Financial Institutions (SIFI); European banking sector; systemic risk rankings; network based risk measures
    JEL: G01 G21
    Date: 2016–09–08
  4. By: Md. Shahidul Islam; Shin-Ichi Nishiyama
    Abstract: Using the GMM estimator, this paper empirically studies the bank-specific, industry specific and macroeconomics specific determinants of non-performing loans of banks in the South Asian countries (Bangladesh, India, Nepal and Pakistan) for the period of 1997-2012. We found that moral hazard problems between the bank management and the depositors in addition to that between the bank management and the shareholders; and the adverse selection of borrowers by the bank significantly affect the bank credit risk. We also found evidence that bad management, cost inefficiency, income diversification, bank size, industry concentration ratio, inflation and GDP growth rate all significantly explain the levels of bank NPLs. Empirical results show a moderate degree of persistence of NPLs and a late-hit of the global financial crisis in the banking sector of the region.
    Date: 2016–09
  5. By: Sebastiaan Pool
    Abstract: This paper examines how the materialization of credit defaults affects the real economy. I estimate a DSGE model including banks, firms and financial frictions using euro area data. The estimation results show that a positive credit default shock, which is identified as an unanticipated increase in credit default losses, complicates monetary policy because output falls while inflation goes up. The monetary authority must choose between stabilizing output and inflation and is therefore less effective. Inflation increases slightly because firms experience besides a demand contraction also a cost-push effect when banks increase the lending rate. Countercyclical capital buffers can in this case complement conventional monetary policy but there is a trade-off: they effectively attenuate macroeconomic fluctuations, but increase the persistence of the slump as banks rebuild their capital more slowly. A bank recapitalization overcomes this trade-off and significantly reduces macroeconomic fluctuations.
    Keywords: Banking; Credit risk; Credit defaults; Countercyclical Capital Buffer; Bayesian Estimation
    JEL: E44 E51 E52
    Date: 2016–08
  6. By: Peter Wanke (COPPEAD Graduate Business School, Federal University of Rio de Janeiro, Rio de Janeiro); Andrew Maredza (School of Economics and Decision Science, North West University, South Africa); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria)
    Abstract: Banking in South Africa is known for its small number of companies that operate as an oligopoly. This paper presents a strategic fit assessment of mergers and acquisitions (M&A) in South African banks. A network DEA (Data Envelopment Analysis) approach is adopted to compute the impact of contextual variables on several types of efficiency scores of the resulting virtual merged banks: global (merger), technical (learning), harmony (scope), and scale (size) efficiencies. The impact of contextual variables related to the origin of the bank and its type is tested by means of a set of several robust regressions to handle dependent variables bounded in 0 and 1: Tobit, Simplex, and Beta. The results reveal that bank type and origin impact virtual efficiency levels. However, the findings also show that harmony and scale effects are negligible due to the oligopolistic structure of banking in South Africa
    Keywords: Banks, South Africa, Merger and Acquisitions, Network, DEA, Robust Regression Analysis
    JEL: C6 G21
    Date: 2016–09
  7. By: Edurkar, Ashok; Chougule, Dr.Dattatrya G.
    Abstract: Both domestic and foreign trade needs financial services at each and every step of the business cycle. This role is carried out by both domestic as well as Foreign Financial Institutions (FFIs). This paper aims to take a review of financial services provided by FFIs operating in India based on four major hypothesis. For this research study, 24 FFIs operating in India consistently as per “Profile of Banks” published by RBI, out of the universe consisting of 43 FFIs and 43 representative offices of FFIs in India between 2003-04 and 2012-13(ten years observation period), are considered. This paper broadly covers foreign financial institutions having legal entity and financial roots primarily in home country and entered in India for tapping Indian financial market for providing financial services in the form of term loans, cash credit, bridge loans, investments and funding for business activities(business financing operations) .
    Keywords: Financial Service, Foreign Financial Institutions, Foreign Banks, Finance, Foreign Trade
    JEL: G2 G21 O1
    Date: 2016–06–15
  8. By: Pierpaolo Grippa; Lucyna Gornicka
    Abstract: Concentration risk is an important feature of many banking sectors, especially in emerging and small economies. Under the Basel Framework, Pillar 1 capital requirements for credit risk do not cover concentration risk, and those calculated under the Internal Ratings Based (IRB) approach explicitly exclude it. Banks are expected to compensate for this by autonomously estimating and setting aside appropriate capital buffers, which supervisors are required to assess and possibly challenge within the Pillar 2 process. Inadequate reflection of this risk can lead to insufficient capital levels even when the capital ratios seem high. We propose a flexible technique, based on a combination of “full†credit portfolio modeling and asymptotic results, to calculate capital requirements for name and sector concentration risk in banks’ portfolios. The proposed approach lends itself to be used in bilateral surveillance, as a potential area for technical assistance on banking supervision, and as a policy tool to gauge the degree of concentration risk in different banking systems.
    Keywords: Banking sector;Loan concentration;Credit risk;Capital requirements;Bank regulations;Bank supervision;concentration risk, Basel capital requirements, Pillar 2, Credit VaR.
    Date: 2016–08–02
  9. By: Benjamin Käfer (University of Kassel)
    Abstract: The aim of this paper is to discuss P2P lending, a subcategory of crowdfunding, from a (financial stability) risk perspective. The discussion focuses on a number of dimensions such as the role of soft information, herding, platform default risk, liquidity risk, and the institutionalization of P2P markets. Overall, we conclude that P2P lending is more risky than traditional banking. However, it is important to recognize that a constant conclusion would be misleading. P2P platforms have evolved and changed their appearance markedly over time, which implies that although our final conclusion of increased riskiness through P2P markets remains valid over time, it is based on different arguments at different points in time. In addition, we discuss that acting on P2P online platforms satisfies most possible definitions of shadow banking and shows significant similarities with many observed aspects of shadow banking. We thus infer that P2P lending can be considered part of the shadow banking sector.
    Keywords: Peer-to-peer lending, crowdfunding, financial development, financial stability risk, shadow banking
    JEL: F34 G21 G23
    Date: 2016
  10. By: Hongfei Sun (Queen's University); Chenggang Zhou (Queen's University); Allen Head (Queen's University)
    Abstract: The influence of households' indebtedness on their house-selling decisions is studied in a tractable dynamic general equilibrium model with housing market search and defaultable long-term mortgages. In equilibrium, sellers' behavior varies significantly with their indebtedness. Specifically, both asking prices and time-to-sell increase with the relative size of sellers' outstanding mortgages. In turn, the liquidity of the housing market associated with equilibrium time-to-sell determines the mortgage standards offered by competitive banks. When calibrated to the U.S. economy the model generates, as observed, negative correlations over time between both house prices and time-to-sell with down-payment ratios.
    Date: 2016
  11. By: Pragyan Deb
    Abstract: This paper studies banks' decision to form financial interconnections using a model of financial contagion that explicitly takes into account the crisis state of the world. This allows us to model the network formation decision as optimising behaviour of competitive banks, where they balance the benefits of forming interbank linkages against the cost of contagion. We use this framework to study various market frictions that can result in excessive interconnectedness that was seen during the crisis. In this paper, we focus on two channels that arise from regulatory intervention—deposit insurance and the too big to fail problem.
    Keywords: Banks;Interconnectedness;Financial contagion;Financial crises;Deposit insurance;Systemically important financial institutions;Too-big-to-fail;Econometric models;Contagion, network formation, financial crises, deposit insurance, too-big-to-fail.
    Date: 2016–08–26
  12. By: Roberto Álvarez; Mauricio Jara
    Abstract: Prior literature argues that, given the existence of information asymmetries and agency costs, higher competition may increase financial constraints by reducing banks’ incentives to build lending relationships. Using a sample of listed firms for six Latin American countries, we analyze the relation between banking competition and financial constraints. We find evidence in line with prior research that banking competition increases financial constraints. This result is robust and heterogeneous. We include other country-specific variables and check the robustness of our findings; the main results hold. Our results show that the effect of competition differs across firms and industries. Specifically, consistent with the information hypothesis, the negative impact of competition is higher for small quoted firms and for lowassets tangibility industries. Also, as expected, we find evidence that firms are more affected by financial constraints during the last crisis. This negative effect is larger for firms in more competitive banking industries.
    Date: 2016–08
  13. By: Marco Cucculelli (Università Politecnica delle Marche, Dipartimento di Scienze economiche e sociali); Valentina Peruzzi (Università Politecnica delle Marche, Dipartimento di Scienze economiche e sociali); Alberto Zazzaro (Università Politecnica delle Marche, Dipartimento di Scienze Economiche e Sociali, MoFiR - Ancona, Italy, CSEF, Naples, Italy)
    Abstract: In this paper we empirically investigate the effects of active family involvement in the company.s management on bank-firm lending relationships and access to credit. Based on the trade-off between relational and management human capital, we explore whether the relational capital embodied in the family leadership of the company influences the lending relationships with the main bank in terms of information sensitivity and duration. Then, we test whether family firms with family CEOs are more likely to experience a credit restriction from banks than family firms appointing professional CEOs external to the family. Results indicate that family businesses appointing family managers are significantly more likely to maintain soft-information-based and longer-lasting lending relationships. However, having family executives does not have a negative impact on firm.s access to credit, while the creation of soft-information-based and long-lasting lending relationships significantly reduces the likelihood of experiencing credit restrictions. In view of these findings, family relational capital seems to have a univocal beneficial impact on bank-firm relationship in our sample.
    Keywords: Family firm, family CEO, soft-information, relational capital, relationship lending, credit rationing
    JEL: D22 G21 G22
    Date: 2016–09
  14. By: Roman Inderst (Univ. Frankfurt and Imperial College Lon); Marcus Opp (UC Berkeley, Haas School of Business); Florian Hoffmann (University of Bonn)
    Abstract: Our paper develops a simple principal-agent framework to analyze the equilibrium relationship between risk-taking and the timing of pay. In our setup, the agent's one-time action has persistent effects through affecting the arrival time distribution of a disaster event. While the principal receives informative signals about the agent's action over time, it is costly to rely on this information for incentive pay since the agent is relatively impatient. Optimal compensation contracts resolve the tension between impatience and information with at most two payout dates. Our framework lends itself to analyze recent regulatory interventions mandating minimum deferral periods and clawback provisions in the financial sector. It shows how such regulatory interference in the timing dimension causes the principal to adjust other dimensions of the compensation contract, which may then lead to higher risk-taking. Mandatory deferral requirements are more likely to be effective in reducing risk-taking when competition for agents is high.
    Date: 2016
  15. By: Carlo Altavilla (European Central Bank); Marco Pagano (University of Naples Federico II, CSEF, EIEF, CEPR, and ECGI); Saverio Simonelli (University of Naples Federico II)
    Abstract: Using novel monthly data for 226 euro-area banks from 2007 to 2015, we investigate the causes and effects of banks’ sovereign exposures during and after the euro crisis. First, in the vulnerable countries, the publicly owned, recently bailed out and less strongly capitalized banks reacted to sovereign stress by increasing their domestic sovereign holdings more than other banks, suggesting that their choices were affected both by moral suasion and by yield-seeking. Second, their exposures significantly amplified the transmission of risk from the sovereign and its impact on lending. This amplification of the impact on lending cannot be ascribed to spurious correlation or reverse causality.
    Date: 2016
  16. By: Kentaro Iwatsubo (Graduate School of Economics, Kobe University); Tomoki Taishi (Graduate School of Economics, Kobe University)
    Abstract: The gQuantitative and Qualitative Monetary Easing (QQE) h enacted immediately after the inauguration of the Bank of Japan Governor Kuroda brought violent fluctuations in the prices of government bonds and deteriorated market liquidity. Does a central bank fs government bond purchasing policy generally reduce market liquidity? Do conditions exist that can prevent the decrease? This paper analyzes how the Bank of Japan fs purchasing policy changes influenced market liquidity. The results revealed that three specific policy changes contributed significantly to improving market liquidity: 1) increased purchasing frequency; 2) a decrease in the purchase amount per transaction; and 3) a reduced variability in the purchase amounts. These policy changes facilitated investors f purchase schedule expectations and helped reduce market uncertainty. The evidence supports the theory that the effect of government bond purchasing policy on market liquidity depends on the market fs informational environment.
    Date: 2016–09
  17. By: David A. Grigorian; Vlad Manole
    Abstract: The unprecedented expansion of sovereign balance sheets since the global financial crisis has given a new meaning to the term sovereign risk. Developments in Europe since early 2010 presented new challenges for the functioning of private banks in an environment of heightened sovereign risk. This paper uses an innovative way of measuring the perception of sovereign risk and its impact on deposit dynamics during 2006–11. Using an extension of a common market discipline framework, it shows that exposure to sovereign risk may have limited the ability of banks in Europe to attract deposits. The results are robust to inclusion of conventional measures of bank performance and the sector-wide holdings of foreign sovereign debt.
    Keywords: Sovereign risk;Europe;Financial crisis;Banks;Bank deposits;Econometric models;Time series;overeign risk, market discipline, bank deposits, European crisis
    Date: 2016–07–22
  18. By: Karl Whelan
    Abstract: This paper focuses on how the lender of last resort function works in the euro area. It argues that the Eurosystem does not provide a clear and transparent lender of last resort facility and discusses how this has promoted financial instability and has critically undermined free movement of capital in the euro area. Until this weakness in the euro area’s policy infrastructure is fixed, it will be difficult to have a truly successful banking union.
    Keywords: European Central Bank; Lender of last resort; Banking union
    JEL: E58 G21
    Date: 2016–08
  19. By: Rosengren, Eric S. (Federal Reserve Bank of Boston)
    Abstract: Speaking at a conference in Beijing, Boston Fed President Eric Rosengren said it has been appropriate to be patient about normalizing interest rates, given that growth “has continued to underwhelm.” But the Fed’s mandated goals – stable prices and maximum sustainable employment – are likely to be achieved relatively soon, and “keeping interest rates low for a long time is not without risks.”
    Date: 2016–08–31
  20. By: Andreas Jobst; Anke Weber
    Abstract: The profitability of Italian banks depends, among other factors, on the strength of the ongoing economic recovery, the stance of monetary policy, and the beneficial effects of current and past reforms, notably to address structural obstacles to resolving nonperforming loans (NPLs) and to foster banking sector consolidation. Improved profitability would enable banks to raise capital buffers and accelerate the cleanup of their balance sheets. This paper investigates quantitatively the current and prospective earnings capacity of Italian banks. A bottom-up analysis of the 15 largest Italian banks suggests that the system is on the whole profitable, but that there is significant heterogeneity across banks. Many banks should become more profitable as the economy recovers, but their capacity to lend depends on the size of their capital buffers. However, a number of smaller banks face profitability pressures, even under favorable assumptions. There is thus a need to push ahead decisively on cleaning up balance sheets, including through cost cutting and efficiency gains.
    Keywords: Banks;Italy;Profits;Non-performing loans;Credit expansion;Bank capital;Balance sheets;banks, nonperforming loans, bank profitability.
    Date: 2016–08–19
  21. By: Edurkar, Ashok; Chougule, Dr.Dattatrya G.
    Abstract: This paper attempts to assess business practices models of twenty four foreign banks. During the period 2003 to 2013, these foreign banks were operating in India. Data and information related to these foreign banks were obtained through the use of publicly available information. Business practices models of these foreign banks, are evaluated by the application of factor analysis followed by cluster analysis. Twenty three variables related to working of foreign banks supported with five variables related to India’s foreign trade are reduced into eight factors by using factor analysis. Using these eight factors, cluster analysis was carried out to group twenty four foreign banks into three clusters leading to three distinct business practices models. The dataset for analysis was for the period for financial years 2003-04 to 2012-13 and the focus is on post RBI Road Map-2005. The foreign banks’ sample consists of consistently operating twenty four foreign banks out of the universe consisting of forty three foreign banks operating in India between 2003-04 and 2012-13(ten years observation period).This study broadly covers foreign banks having legal entity and financial roots primarily in home country and entered in India for tapping Indian financial market in the form of term loans, cash credit, bridge loans, investments and funding for business activities (business financing operations) .
    Keywords: Foreign Banks, Finance, Models, Foreign Trade, Financing
    JEL: G2 G21 P0
    Date: 2016–07–14
  22. By: Andreas Jobst; Huidan Lin
    Abstract: More than two years ago the European Central Bank (ECB) adopted a negative interest rate policy (NIRP) to achieve its price stability objective. Negative interest rates have so far supported easier financial conditions and contributed to a modest expansion in credit, demonstrating that the zero lower bound is less binding than previously thought. However, interest rate cuts also weigh on bank profitability. Substantial rate cuts may at some point outweigh the benefits from higher asset values and stronger aggregate demand. Further monetary accommodation may need to rely more on credit easing and an expansion of the ECB’s balance sheet rather than substantial additional reductions in the policy rate.
    Keywords: Negative interest rates;Euro Area;Interest rate policy;Banks;Profits;Monetary transmission mechanism;Unconventional monetary policy instruments;European Central Bank;negative rates, NIRP, unconventional monetary policy, monetary transmission
    Date: 2016–08–10
  23. By: Edurkar, Ashok; Chougule, Dr.Dattatrya G.
    Abstract: This research paper attempts to find out foreign banks (FBs) potential to reignite India’s manufacturing, domestic & foreign trade growth with application of competitive business practices models. This task is accomplished with the evaluation of competitive business practices models covering twenty four foreign banks (FBs) operating in India post Reserve Bank of India (RBI) Road Map 2005 and during the period 2003 to 2013 through the use of publicly available information. Competitive business practices models have been evaluated by the application of factor analysis followed by cluster analysis. Twenty three variables related to working of foreign banks supported with five variables related to India’s foreign trade were reduced into four factors by using factor analysis. Using these four factors cluster analysis was carried out to group twenty four foreign banks into three clusters leading to three distinct competitive business practices models. The dataset for analysis was for the period for financial years 2003-04 to 2012-13 and the focus is on post RBI Road Map-2005 for foreign banks. The foreign banks’ sample consists of consistently operating twenty four foreign banks (FBs) out of the universe consisting of forty three foreign banks operating in India between 2003-04 and 2012-13. This study broadly covers foreign banks (FBs) having legal entity and financial roots primarily in home country and entered in India for tapping Indian financial market in the form of term loans, cash credit, bridge loans, investments and funding for business activities (business financing operations)
    Keywords: Foreign Banks, Finance, Models, Foreign Trade, Financing
    JEL: G2 G21 O1 O10
    Date: 2016–07–19
  24. By: International Monetary Fund. Monetary and Capital Markets Department
    Abstract: This paper focuses on the current state of the principal markets for nondeposit based funding for German financial institutions. A key finding is that although the current level of liquidity of the banking system is abundant, underpinned by active central bank support, the resilience of liquidity in some bank funding markets appears weaker than in the past. The financial system is dominated by banks and is generally sound and robust to shocks. The German banking system consists of a large number of banks in three main pillars: private commercial banks, public sector banks, and cooperative banks (accounting for 39 percent, 27 percent, and 14 percent, respectively of total banking system assets).
    Keywords: Financial Sector Assessment Program;Banking sector;Liquidity;Financial stability;Financial institutions;Asset management;Germany;
    Date: 2016–06–29
  25. By: Anil Ari (University of Cambridge)
    Abstract: In European countries recently hit by a sovereign debt crisis, the share of domestic sovereign debt held by the national banking system has sharply increased, raising issues in their economic and financial resilience, as well as in policy design. This paper examines these issues by analyzing the banking equilibrium in a model with optimizing banks and depositors. To the extent that sovereign default causes bank losses also independently of their holding of domestic government bonds, undercapitalized banks have an incentive to gamble on these bonds. The optimal reaction by depositors to insolvency risk imposes discipline, but also leaves the economy susceptible to self-fulfilling shifts in sentiments, where sovereign default also causes a banking crisis. Policy interventions face a trade-off between alleviating funding constraints and strengthening incentives to gamble. Subsidized loans to banks, similar to the ECB's non-targeted longer-term refinancing operations (LTRO), may eliminate the good equilibrium when the banking sector is undercapitalized. Targeted interventions have the capacity to eliminate adverse equilibria.
    Date: 2016

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