nep-ban New Economics Papers
on Banking
Issue of 2016‒12‒18
twelve papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Market Discipline Working for and Against Financial Stability: The Two Faces of Equity Capital in U.S. Commercial Banking By Joseph P. Hughes; Loretta J. Mester; Choon-Geol Moon
  2. "The Credit Card Debt Puzzle: The Role of Preferences, Credit Risk, and Financial Literacy" By Olga Gorbachev; María José Luengo-Prado
  3. Liquidity and Risk Management: Coordinating Investment and Compensation Policies By Patrick Bolton; Neng Wang; Jinqiang Yang
  4. The Effects of Creditor Rights and Bank Information Sharing on Borrower Behavior: Theory and Evidence By Boyd, John H.; Hakenes, Hendrik; Heitz, Amanda Rae
  5. Bank response to higher capital requirements: Evidence from a quasi-natural experiment By Gropp, Reint; Mosk, Thomas; Ongena, Steven; Wix, Carlo
  6. Nonlinearities of mortgage spreads over the business cycles By Cheng, Chak Hung Jack; Chiu, Ching-Wai (Jeremy)
  7. The determinants of loan loss provisions: an analysis of the Greek banking system in light of the sovereign debt crisis By Platon Monokroussos,; Dimitrios Thomakos; Thomas A. Alexopoulos
  8. Financial Fragility in Monetary Economies By Fernando Martin; Aleksander Berentsen; David Andolfatto
  9. Credit, Money, Interest, and Prices By Yuliy Sannikov; Saki Bigio
  10. Antecedents of corporate social responsibility in the banks of Central-Eastern Europe and in the countries of the former Soviet union By Khurshid Djalilov; Jens Hoelscher
  11. Relative Performance, Banker Compensation, and Systemic Risk By Albuquerque, Rui; Cabral, Luis; Guedes, Jose
  12. Optimal Debt Maturity and Firm Investment By Joachim Jungherr; Immo Shott

  1. By: Joseph P. Hughes (Rutgers University); Loretta J. Mester (Federal Reserve Bank of Cleveland and the Wharton School, University of Pennsylvania); Choon-Geol Moon (Hanyang University)
    Abstract: The second Basel Capital Accord points to market discipline as a tool to reinforce capital standards and supervision in promoting bank safety and soundness. The Bank for International Settlements contends that market discipline imposes strong incentives on banks to operate in a safe and efficient manner – in particular, to maintain an adequate capital base to absorb potential losses from their risk exposures. Using 2007 and 2013 data on top-tier, publicly traded U.S. bank holding companies, we find that market discipline rewards risk-taking at some of the largest U.S. financial institutions. In particular, we find evidence of two faces of equity investment – dichotomous capital strategies for maximizing value. At banks with higher-valued investment opportunities, a marginal increase in their equity capital ratio is associated with better financial performance, while at banks with lower-valued investment opportunities, a marginal decrease in their equity capital ratio is associated with better financial performance. Because the largest U.S. financial institutions tend to have lower-valued investment opportunities, our results suggest that they may have a market-based incentive to reduce their capital ratio. To the extent that market discipline rewards reducing the capital ratio among the largest banks, it would tend to undermine financial stability. Our results support the need for regulatory capital requirements.
    Keywords: banking, efficiency, capital structure, charter value
    JEL: C58 G21 G28
    Date: 2016–12–14
  2. By: Olga Gorbachev (Department of Economics, University of Delaware); María José Luengo-Prado (Boston Federal Reserve)
    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. Relative to individuals with no credit card debt but positive liquid assets (savers), borrower-savers 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. Moreover, changing perceptions about credit risk are essential for predicting transitions among the two groups. Respondents whose credit risk increases over time are more likely to transition from being savers to being borrower-savers, and vice versa. Preferences and the composition of financial portfolios also play a role in these transitions. Importantly, we find that financial literacy may help mitigate the effect of preferences.
    Keywords: household finance, risk aversion, time preferences, precautionary motives, bankruptcy, foreclosure
    Date: 2016
  3. By: Patrick Bolton (Columbia University); Neng Wang (Columbia Business School); Jinqiang Yang (School of Finance, Shanghai University of Finance and Economics)
    Abstract: We formulate a dynamic financial contracting problem with risky inalienable human capital. We show that the inalienability of the entrepreneur’s risky human capital not only gives rise to endogenous liquidity limits but also calls for dynamic liquidity and risk management policies via standard securities that firms routinely pursue in practice, such as retained earnings, possible line of credit draw-downs, and hedging via futures and insurance contracts.
    Date: 2016
  4. By: Boyd, John H.; Hakenes, Hendrik; Heitz, Amanda Rae
    Abstract: This paper provides a comprehensive theoretical and empirical analysis of "creditor rights" and "information sharing" throughout over 1.8 million public and private firms in Europe. We show that many of the outcomes associated with greater levels of creditor rights can be obtained with higher information sharing between banks. Both theory and empirics show that creditor rights and information sharing are associated with greater firm leverage, lower profitability, as well as greater distance to default. Moreover, both theory and empirics find that creditor rights and information sharing are robust substitutes. Our analysis suggests that poor creditor rights, which tend to be sticky over time, can be substituted by improved information sharing.
    Keywords: Creditor rights; information sharing.
    JEL: G21 G28 L15
    Date: 2016–12
  5. By: Gropp, Reint; Mosk, Thomas; Ongena, Steven; Wix, Carlo
    Abstract: We study the impact of higher capital requirements on banks' balance sheets and its transmission to the real economy. The 2011 EBA capital exercise provides an almost ideal quasi-natural experiment, which allows us to identify the effect of higher capital requirements using a difference-in-differences matching estimator. We find that treated banks increase their capital ratios not by raising their levels of equity, but by reducing their credit supply. We also show that this reduction in credit supply results in lower firm-, investment-, and sales growth for firms which obtain a larger share of their bank credit from the treated banks.
    Keywords: banking,regulation,real effects of finance
    JEL: E22 E44 G21
    Date: 2016
  6. By: Cheng, Chak Hung Jack (George Dean Johnson, Jr. College of Business and Economics, University of South Carolina Upstate); Chiu, Ching-Wai (Jeremy) (Bank of England)
    Abstract: This paper provides robust evidence for the non-linear effects of mortgage spread shocks during recessions and expansions in the United States. Estimating a smooth-transition VAR model, we show that mortgage spread shocks hitting in recessionary regimes create significantly deeper and more protracted decrease in industrial production and prices, as well as a persistent fall in house prices. Evidence also suggests that shock propagation is amplified through the interaction of stock prices. Our empirical results complement the theoretical literature which emphasizes the role of occasionally binding collateral constraints and asset prices in explaining macroeconomic asymmetries.
    Keywords: Mortgage spread shocks; smooth transition vector autoregressions; nonlinearities; financial frictions
    JEL: C32 E32 E44 E52
    Date: 2016–12–09
  7. By: Platon Monokroussos,; Dimitrios Thomakos; Thomas A. Alexopoulos
    Abstract: We utilize a new set of macroeconomic and regulatory data to analyze the evolution of loan loss provisioning practices in the Greek banking system over the period 2005-2015. We explore the determinants of the aggregate loan loss reserves to total loans ratio, which reflects the accumulation of provisions net of write-offs, and constitutes an important metric of the credit quality of loan portfolios. Our results suggest that domestic credit institutions respond relatively quickly to macroeconomic shocks, though the latter’s effects on the provisioning behavior of the domestic banking system show significant persistence. Furthermore, the impact of macroeconomic shocks on the loan loss reserves ratio has become stronger (both in terms of magnitude and statistical significance) following the outbreak of the Greek sovereign debt crisis. From a macro policy perspective, this result indicates that a sustainable stabilization of macroeconomic conditions is a key precondition for safeguarding domestic financial stability. For a regulatory standpoint, it suggests that the possibility of macroeconomic regime-related effects on banks’ provisioning policies should be taken into account when macro prudential stress tests of the banking system are designed and implemented.
    JEL: F3 G3
    Date: 2016–11
  8. By: Fernando Martin (Federal Reserve Bank of St. Louis); Aleksander Berentsen (University of Basel); David Andolfatto (Federal Reserve Bank of St. Louis)
    Abstract: We integrate the Diamond and Dybvig (1983) theory of financial fragility with the Lagos and Wright (2005) model of monetary exchange. Non-bank monetary economies with well-functioning secondary markets for capital can allocate risk reasonably well, but are never efficient. When secondary markets are subject to ``market freeze'' events, risk-sharing deteriorates accordingly. A fractional-reserve bank can dominate a monetary economy because: (i) it provides superior risk-sharing even when market freeze events are absent; and (ii) it bypasses the need for a secondary capital market to begin with. Indeed, fractional reserve banks can implement the optimal allocation when monetary policy follows the Friedman rule. However, the desirability of fractional reserve banking is diminished if the structure is subject to ``bank runs''. In the event of a run, an open secondary market allows banks to liquidate capital at a price that permits honoring all deposit obligations. If bank runs are expected to occur with a sufficiently high probability, then a narrow banking structure may be preferred. Narrow banks are more stable, but offer less risk-sharing. We find that high inflation economies penalize narrow banking systems relatively more than fractional reserve systems. Special interests are not generally aligned over the choice of bank regime.
    Date: 2016
  9. By: Yuliy Sannikov (Princeton University); Saki Bigio (UCLA)
    Abstract: We develop a monetary theory where monetary policy operates exclusively through the bank-lending channel. Credit demand and deposit creation are dynamically linked. Policy tools affect lending through the provision of reserves and their influence on interbank market rates. A credit crunch causes debt-deflation episode that sends agents to their borrowing constraints. Unemployment increases because firms reduce utilization to avoid the risk of violating borrowing limits. Standard monetary policy has power only if credit is extended. We study the cross-section and aggregate dynamics of credit, monetary aggregates, nominal interest, and prices after several policy experiments.
    Date: 2016
  10. By: Khurshid Djalilov (Bournemouth University, Executive Business Centre); Jens Hoelscher (Bournemouth University, Executive Business Centre)
    Abstract: This article explores the determinants of corporate social responsibilities (CSR) in the banking sector of the transition countries of Central and Eastern Europe (CEE), as well as those of the former Soviet Union (FSU). Our panel fixed-logit results for 237 banks, covering the period 2000–2012, show that while financial performance is not associated with CSR, larger banks are more likely to engage in CSR. Additionally, a government’s effectiveness and its regulatory quality increase the likelihood that the banks will engage in social activities. A range of possible approaches that governments can take to encourage social activities in the banking sector of transition countries are provided. Overall, our results are consistent with the theory that the necessary conditions must be in place to support CSR, which seem to be absent in the countries under investigation.
    Keywords: Banks; corporate social responsibility; performance; transition economies
    JEL: P20 M14 G21
    Date: 2016–12
  11. By: Albuquerque, Rui; Cabral, Luis; Guedes, Jose
    Abstract: This paper shows that in the presence of correlated investment opportunities across banks, risk sharing between bank shareholders and bank managers leads to compensation contracts that include relative performance evaluation and to investment decisions that are biased toward such correlated opportunities, thus creating systemic risk. We analyze various policy recommendations regarding bank managerial pay and show that shareholders optimally undo the intended risk-reducing effects of the policies, demonstrating their ineffectiveness in curbing systemic risk.
    Date: 2016–12
  12. By: Joachim Jungherr; Immo Shott
    Abstract: This paper introduces a maturity choice to the standard model of firm financing and investment. Long-term debt renders the optimal firm policy time-inconsistent. Lack of commitment gives rise to debt dilution. This problem becomes more severe during downturns. We show that cyclical debt dilution generates the observed counter-cyclical behavior of default, bond spreads, leverage, and debt maturity. It also generates the pro-cyclical term structure of corporate bond spreads. Debt dilution renders the equilibrium outcome constrained-inefficient: credit spreads are too high and investment is too low. In two policy experiments we find the following: (1) an outright ban of long-term debt improves welfare in our model economy, and (2.) debt dilution accounts for 84% of the credit spread and 25% of the welfare gap with respect to the first best allocation.
    Keywords: firm financing; investment; debt maturity; credit spreads; debt dilution
    JEL: E22 E32 E44 G32
    Date: 2016–11

This nep-ban issue is ©2016 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.