nep-ban New Economics Papers
on Banking
Issue of 2017‒04‒16
twenty-one papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Shadow banking out of the shadows: non-bank intermediation and the Italian regulatory framework By Carlo Gola; Marco Burroni; Francesco Columba; Antonio Ilari; Giorgio Nuzzo; Onofrio Panzarino
  2. Rating Trajectories and Credit Risk Migration: Evidence for SMEs By Camilla Ferretti; Giampaolo Gabbi; Piero Ganugi; Pietro Vozzella
  3. Bank Capital Redux: Solvency, Liquidity, and Crisis By Jordà, Òscar; Richter, Björn; Schularick, Moritz; Taylor, Alan M.
  4. Does revenue diversification still matter in banking? Evidence from some European countries By Mariarosa Borroni; Simone Rossi
  5. Global Banking: Risk Taking and Competition By Faia, Ester; Ottaviano, Gianmarco
  6. SRISK: a conditional capital shortfall measure of systemic risk By Christian Brownlees; Robert Engle
  7. The Effect of Central Bank Liquidity Injections on Bank Credit Supply By Luisa Carpinelli; Matteo Crosignani
  8. Real-time determination of credit cycle phases in emerging markets By Elena Deryugina; Alexey Ponomarenko
  9. Product Network Connectivity and Information for Loan Pricing By Jiangtao FU; OGURA Yoshiaki
  10. International Expansion and Riskiness of Banks By Faia, Ester; Ottaviano, Gianmarco; Sanchez Arjona, Irene
  11. Lending-based crowdfunding: opportunities and risks By Marcello Bofondi
  12. Fracking and Mortgage Default By Cunningham, Chris; Gerardi, Kristopher S.; Shen, Yannan
  13. Non-performing loans and the supply of bank credit: evidence from Italy By Matteo Accornero; Piergiorgio Alessandri; Luisa Carpinelli; Alberto Maria Sorrentino
  14. Estimating Liquidity Created by Banks in Pakistan By Sabahat
  15. Sentiment Volatility and Bank Lending Behavior By Mustafa Caglayan; Mustafa Caglayan; Bing Xu
  16. The income distribution and the Irish mortgage market By Lydon, Reamonn; McCann, Fergal
  17. Illiquidity Component of Credit Risk By Stephen Morris; Hyun Song Shin
  18. How does monetary policy pass-through affect mortgage default? Evidence from the Irish mortgage market By Byrne, David; Kelly, Robert; O'Toole, Conor
  19. Can Italy grow out of its NPL overhang? A panel threshold analysis By Kamiar Mohaddes; Mehdi Raissi; Anke Weber
  20. Harry Potter and the Goblin Bank of Gringotts By Zachary Feinstein
  21. Understanding the fundamental dynamics of interbank networks By Teruyoshi Kobayashi; Taro Takaguchi

  1. By: Carlo Gola (Bank of Italy); Marco Burroni (Bank of Italy); Francesco Columba (Bank of Italy); Antonio Ilari (Bank of Italy); Giorgio Nuzzo (Bank of Italy); Onofrio Panzarino (Bank of Italy)
    Abstract: Shadow banking is the creation or transfer – by banks and non-bank intermediaries – of bank-like risks outside the banking system. In Italy the shadow banking system is fully regulated, mostly following the principle of same business-same rules or ‘bank-equivalent regulation’. After an overview of the topic, we describe the Italian shadow banking system and the related regulatory and supervisory framework in place before the financial crisis and the subsequent enhancements. A quantitative representation of Italian shadow banking is also provided. The paper argues that through a wide and consistent regulatory perimeter, based on the principle of ‘bank-equivalent regulation’, it is possible to setup a well-balanced prudential framework, where both bank and non-bank regulation contribute to reducing systemic risks and regulatory arbitrage.
    Keywords: shadow banking system, financial stability, macro-prudential regulation, non-bank financial intermediaries, market-based finance
    JEL: E44 E58 G00 G01 G21 G23 G28
    Date: 2017–02
  2. By: Camilla Ferretti (DISCE, Università Cattolica); Giampaolo Gabbi (DISAG, Università di Siena); Piero Ganugi (DIA, Università di Parma); Pietro Vozzella (DISAG, Università di Siena)
    Abstract: The misestimation of rating transition probabilities may lead banks to lend money incoherently with borrowers’ default trajectory, causing both a deterioration in asset quality and higher system distress. Applying a Mover-Stayer model to determine the migration risk of small and medium enterprises, we find that banks are overestimating their credit risk resulting in excessive regulatory capital. This has important macroeconomic implications due to the fact that holding a large capital buffer is costly for banks and this in turn influences their ability to lend in the wider economy. This conclusion is particularly true during economic downturns with the consequence of exacerbating the cyclicality in risk capital that therefore acts to aggravate economic conditions further. We also explain part of the misevaluation of borrowers and the actual relevant weight of nonperforming loans within banking portfolios: prudential prescriptions cannot be considered as effective as expected by regulators who have designed the “new” regulation in response to the most recent crisis.The Mover-Stayers approach helps to reduce calculation inaccuracy when analyzing the historical movements of borrowers’ ratings and, consequently improves the efficacy of the resource allocation process and banking industry stability.
    Keywords: credit risk; Markov chains; absorbing state; rating migration
    Date: 2016–07
  3. By: Jordà, Òscar; Richter, Björn; Schularick, Moritz; Taylor, Alan M.
    Abstract: Higher capital ratios are unlikely to prevent a financial crisis. This is empirically true both for the entire history of advanced economies between 1870 and 2013 and for the post-WW2 period, and holds both within and between countries. We reach this startling conclusion using newly collected data on the liability side of banks' balance sheets in 17 countries. A solvency indicator, the capital ratio has no value as a crisis predictor; but we find that liquidity indicators such as the loan-to-deposit ratio and the share of non-deposit funding do signal financial fragility, although they add little predictive power relative to that of credit growth on the asset side of the balance sheet. However, higher capital buffers have social benefits in terms of macro-stability: recoveries from financial crisis recessions are much quicker with higher bank capital.
    Keywords: bank liabilities; capital ratio; crisis prediction; Financial crises; local projections
    JEL: E44 G01 G21 N20
    Date: 2017–03
  4. By: Mariarosa Borroni (DISCE, Università Cattolica); Simone Rossi (DISCE, Università Cattolica)
    Abstract: Following a common wisdom in banking, revenue diversification is likely to produce a "portfolio-effect" in bank income statement, enhancing the creation of greater and more stable profits. We test this hypothesis on a sample of 110 large commercial, saving and cooperative banks headquartered in 8 EMU countries for the period 2005-2013. Results indicate that diversification strategies have had a role in determining banks profitability only for selected subsamples (and in particular for commercial and saving banks); on the contrary, efficiency and credit portfolio quality have been the main drivers of profits in the period under examination. We contribute to previous literature using a cross-country balanced dataset that covers both the pre-crisis and the following economically troubled periods. Topics underlying this work - and empirical results - have relevant policy implications from a managerial and regulatory point of view.
    Keywords: Bank performance, Revenue diversification
    JEL: G21 L25
    Date: 2017–03
  5. By: Faia, Ester; Ottaviano, Gianmarco
    Abstract: Direct involvement of global banks in local retail activities can reduce risk-taking by promoting local competition. We develop this argument through a model in which multinational banks operate simultaneously in different countries with direct involvement in imperfectly competitive local deposit and loan markets. The model generates predictions that are consistent with the foregoing argument as long as the expansionary impact of competition on multinational banks'aggregate profits through larger scale is strong enough to o¤set its parallel contractionary impact through lower loan-deposit return margin (a result valid with both perfectly and imperfectly correlated loans'risk). When this is the case, banking globalization also moderates the credit crunch following a deterioration in the investment climate. Compared with multinational banking, the beneficial effect of cross-border lending on risk-taking is weaker.
    Keywords: appetite for leverage; endogenous risk taking; expectation of rents extraction; global bank; oligopoly; oligopsony
    JEL: G21 G32 L13
    Date: 2017–03
  6. By: Christian Brownlees; Robert Engle
    Abstract: We introduce SRISK to measure the systemic risk contribution of a financial firm. SRISK measures the capital shortfall of a firm conditional on a severe market decline, and is a function of its size, leverage and risk. We use the measure to study top US financial institutions in the recent financial crisis. SRISK delivers useful rankings of systemic institutions at various stages of the crisis and identifies Fannie Mae, Freddie Mac, Morgan Stanley, Bear Stearns and Lehman Brothers as top contributors as early as 2005-Q1. Moreover, aggregate SRISK provides early warning signals of distress in indicators of real activity. JEL Classification: C22, C23, C53, G01, G20Keywords: Systemic Risk Measurement, Great Financial Crisis, GARCH, DCC
    Date: 2017–03
  7. By: Luisa Carpinelli; Matteo Crosignani
    Abstract: We study the effectiveness of central bank liquidity injections in restoring bank credit supply following a wholesale funding dry-up. We combine borrower-level data from the Italian credit registry with bank security-level holdings and analyze the transmission of the European Central Bank three-year Long Term Refinancing Operation. Exploiting a regulatory change that expands eligible collateral, we show that banks more affected by the dry-up use this facility to restore their credit supply, while less affected banks use it to increase their holdings of high-yield government bonds. Unable to switch from affected banks during the dry-up, firms benefit from the intervention.
    Keywords: Bank Credit Supply ; Bank Wholesale Funding ; Lender of Last Resort ; Unconventional Monetary Policy
    JEL: E50 E58 G21 H63
    Date: 2017–03
  8. By: Elena Deryugina (Bank of Russia, Russian Federation); Alexey Ponomarenko (Bank of Russia, Russian Federation)
    Abstract: We test the ability of early warning indicators that appear in the literature to predict credit cycle peaks in a cross-section of emerging markets. Our results confirm that the standard credit gap indicator performs satisfactorily. The robustness of real-time credit cycle determination may potentially (and with a risk of overfitting the data) be improved by simultane-ously monitoring GDP growth, banks’ non-core liabilities, the financial sector’s value added and (to a lesser extent) the change in the debt service ratio.
    Keywords: credit cycle, countercyclical capital buffers, early warning indicators, emerging markets.
    JEL: E37 E44 E51
    Date: 2017–01
  9. By: Jiangtao FU; OGURA Yoshiaki
    Abstract: A theory predicts that loan pricing is less sensitive to public information, such as a credit score provided by a credit information vendor, if the lender obtains more accurate private information about the credit quality of borrowers. We find that loan pricing is less sensitive to public information when a borrower is more connected with other borrowers of the lender through a supply network by using a unique database of inter-firm relationships and bank-firm relationships. This effect is significant statistically and economically after controlling for the bank-firm or inter-firm relationship characteristics and other firm characteristics. This finding provides evidence that banks make use of private information observed from their borrowers' network in their loan pricing.
    Date: 2017–03
  10. By: Faia, Ester; Ottaviano, Gianmarco; Sanchez Arjona, Irene
    Abstract: We exploit an original dataset on 15 European banks classified as G-SIBs by the BIS to assess whether expansion in foreign markets increases their riskiness, and through which channels that eventually happens. We find that there is a strong negative correlation between bank risk (proxied with CDS price or loan loss provisions) and foreign expansion. The same is true when using systemic risk metrics (marginal expected shortfalls or CoVaR). On the one hand, banks that expand abroad more have lower riskiness so that, given individual bank riskiness, their expansion reduces the (weighted) average riskiness of the banks' pool. On the other hand, foreign expansion of any given bank makes the bank and thus the banks' pool less risky. In terms of the channels, diversification, competition and regulation are all important. Expansion in destination countries with different business cycle co-movement and with stricter regulations than the origin country decreases a bank's riskiness. As for competition, expansion decreases riskiness only when competition in the origin country is less intense than in the destination countries.
    Keywords: banks’ risk; Competition; Diversification; global expansion; regulation.; systemic risk
    Date: 2017–04
  11. By: Marcello Bofondi (Banca d'Italia)
    Abstract: Lending-based crowdfunding (LBC) is an alternative funding channel to that represented by credit intermediaries. LBC allows households and small businesses to be financed directly by a multitude of investors. Supply meets demand online platforms. This paper first describes how LBC platforms operate, identifying the potential risks and benefits of their operations and then attempts to indicate if and how LBC will contribute to the evolution of the financial system. Although it is unlikely that LBC will pose a significant threat to the banking system and its profitability, it has nevertheless the potential to stimulate traditional intermediaries to review their business models and to create an alternative source of financing for households and small and medium-sized enterprises. The risks to financial stability posed by LBC can be mitigated by establishing rules that limit the expansion of credit to riskier borrowers and by ensuring investors’ capacity to absorb any losses.
    Keywords: FinTech, lending-based crowdfunding, financial innovation
    JEL: G21 G23 G28
    Date: 2017–03
  12. By: Cunningham, Chris (Federal Reserve Bank of Atlanta); Gerardi, Kristopher S. (Federal Reserve Bank of Atlanta); Shen, Yannan (Clemson University)
    Abstract: This paper finds that increased hydraulic fracturing, or "fracking," along the Marcellus Formation in Pennsylvania had a significant, negative effect on mortgage credit risk. Controlling for potential endogeneity bias by utilizing the underlying geologic properties of the land as instrumental variables for fracking activity, we find that mortgages originated before the 2007 boom in shale gas, were, post-boom, significantly less likely to default in areas with greater drilling activity. The weight of evidence suggests that the greatest benefit from fracking came from strengthening the labor market, consistent with the double trigger hypothesis of mortgage default. The results also suggest that increased fracking activity raised house prices at the county level.
    Keywords: mortgage default; hydraulic fracking; house prices; shale gas
    JEL: G21 Q51 R11
    Date: 2017–03–01
  13. By: Matteo Accornero (Bank of Italy); Piergiorgio Alessandri (Bank of Italy); Luisa Carpinelli (Bank of Italy); Alberto Maria Sorrentino (Bank of Italy)
    Abstract: We use an extensive loan-level dataset to study the influence of non-performing loans (NPLs) on the supply of bank credit to nonfinancial firms in Italy between 2008 and 2015. We use time-varying firm fixed effects to control for shifts in demand and changes in borrower characteristics, and we also resort to the supervisory interventions associated to the 2014 Asset Quality Review to identify exogenous variations in the banks’ NPL ratios. We find that banks’ lending behavior is not causally affected by the level of NPL ratios: the negative correlation between NPL ratios and credit growth in our data is mostly generated by changes in firms’ conditions and a contraction in their demand for credit. However, the exogenous emergence of NPLs and the associated increase in provisions can cause a negative adjustment in credit supply.
    Keywords: credit register, credit risk, credit supply, non-performing loans
    JEL: E51 E58 G00 G21
    Date: 2017–03
  14. By: Sabahat (State Bank of Pakistan)
    Abstract: The saving-investment facilitation, the core function of the banking system results in liquidity creation. The on-balance sheet and off-balance sheet activities of banks play a vital role in liquidity provision: banks create liquidity while actively managing their portfolios of assets and liabilities of different maturities. This study attempts to measure the liquidity created by Pakistan’s banking system using methods employed by Berger and Bouwman (2009). Four measures LIC-C1, LIC-C2, LIC-T1 and LIC-T2 have been constructed for banks. We also group banks according to their size. Analyses of these measures indicate that, compared to other measures, the LIC-C1 measure records the highest amount of liquidity created during Sep07-Jun16. In absolute terms, liquidity of Rs 2.55 trillion was created at the end of Jun 2016, equal to 16.5 percent of the total assets of the banking industry. Further, a disaggregated analysis shows that most of the participation has come from large banks; medium sized banks’ ability remained subdued, whereas the group of small banks performed well in liquidity provision.
    Keywords: Liquidity Creation, Banking System, Balance Sheet
    JEL: G10 G21 E50 E58
    Date: 2017–03
  15. By: Mustafa Caglayan; Mustafa Caglayan; Bing Xu
    Abstract: Using a panel of commercial, co-operative and savings banks from G7 countries, we investigate whether change in sentiment and its volatility affect banks' lending behavior. Sentiment indicators, which gauge the state of the economy from the perspective of the economic agents, are widely considered as a critical component by academics, policy makers and media in the transmission of shocks into the economic activity. We also know that leading indicators usually change before the economic activities change as a whole and provide useful information on the state of the economy. Surprisingly, earlier studies have not examined the impact of the level and volatility of economic agents sentiment on banks' lending behavior. As each type of agent acts on a specific set of (imperfect) information that emanate from the state of the economy, rational inattention, or their own asymmetric goals and strategies, it is important find out whether bank managers respond to changes and variability in sentiment. To carry out our investigation, we construct a large panel of commercial, co-operative, and savings banks collected from the Bankscope database for the G7 countries including Canada, Germany, France, the UK, Italy, Japan, and the US. This database provides detailed bank-level information yet the sample size is constrained due to the fact that we seek to examine the role of Core Tier 1 capital on banks' lending. The final dataset that we employ in our analysis is comprised of more than 9,000 banks and retains bank, country and time dimensions. The analysis covers the period between 1999-2014. The investigation implements GMM and fixed effects models to test various hypotheses. We show that the changes in economic agents' sentiment and its volatility affect bank lending negatively, while the impact sizes differ across indicators. We also find that the impact of volatility effects on banks' loan growth varies at excessive levels. We highlight the role of several bank-specific characteristics in transmission of uncertainty effects on the growth of bank loans, as uncertainty affects extenuate or mitigate through them.
    Keywords: G7, Finance, Monetary issues
    Date: 2016–07–04
  16. By: Lydon, Reamonn (Central Bank of Ireland); McCann, Fergal (Central Bank of Ireland)
    Abstract: In this Letter we study the evolution of the prevalence of groups of households from across the population income distribution in the Irish mortgage market. We document a period of financial liberalization between 1994 and 2007, where the share of new mortgages issued going to those in the top income quintile fell from 57 to 27 per cent, while those in the middle quintile increased their share from 13 to 29 per cent. The impact of the recent crisis is shown to have had a pronounced impact in the Previous-Owner mortgage market, where negative equity has impeded many households from purchasing property with a second or subsequent mortgage: the share of the top income quintile in this market segment has risen from 27 to 65 per cent in the period 2007 to 2014, marking a significant reversal relative to the pre-2007 period. The Buy to Let segment is shown to be composed predominantly of those at the top of the income distribution, with little variation across the 1994-2014 period. Finally, higher-income households are shown to borrow with higher Loan to Value but lower Loan to Income mortgages in all periods.
    Date: 2017–04
  17. By: Stephen Morris (Princeton University); Hyun Song Shin (Bank for International Settlements; Princeton University)
    Abstract: We provide a theoretical decomposition of bank credit risk into insolvency risk and illiquidity risk, defining illiquidity risk to be the counterfactual probability of failure due to a run when the bank would have survived in the absence of a run. We show that illiquidity risk is (i) decreasing in the "liquidity ratio"--the ratio of realizable cash on the balance sheet to short-term liabilities; (ii) decreasing in the excess return of debt; and (iii) increasing in the solvency uncertainty--a measure of the variance of the asset portfolio.
    JEL: G21 G32 G33
    Date: 2016–05
  18. By: Byrne, David (Central Bank of Ireland); Kelly, Robert (Central Bank of Ireland); O'Toole, Conor (Central Bank of Ireland)
    Abstract: One channel through which monetary policy can affect loan default in the mortgage market is by altering the affordability of borrower repayments. Quantifying the exact impact of this relationship is complex as it depends on both the structure and passthrough of a given mortgage market. This paper uses a quasi-natural experiment to identify the impact of changes in interest rates on mortgage default. Using a panel of loan level administrative data for Ireland, we deal with selection bias that is inherent in identifying the impact of interest rates by exploiting the variation between two types of adjustable rate mortgage that were offered to Irish borrowers for a particular period in the mid-2000s. We map changes in interest rates to default by quantifying the direct effect through changes in borrower installments. Using a pass-through approach, we find a strong and highly statistically significant impact of interest rates on mortgage default, with a 1 per cent reduction in installment associated with a 5.8 per cent decrease in the likelihood of default over the following year. We also find evidence that negative equity offsets the some of the gains arising from lower policy rates indicating an interaction between monetary policy and asset price shocks in the mortgage market.
    Keywords: Monetary Policy, Mortgage Default
    JEL: E52 E58 G01 G21
    Date: 2017–03
  19. By: Kamiar Mohaddes; Mehdi Raissi; Anke Weber
    Abstract: This paper examines whether a tipping point exists for real GDP growth in Italy above which the ratio of non-performing loans (NPLs) to total loans falls significantly. Estimating a heterogeneous dynamic panel-threshold model with data on 17 Italian regions over the period 1997-2014, we provide evidence for the presence of growth-threshold effects on the NPL ratio in Italy. More specifically, we find that real GDP growth above 1.2 percent, if sustained for a number of years, is associated with a significant decline in the NPLs ratio. Achieving such growth rates requires decisively tackling long standing structural rigidities and improving the quality of fiscal policy. Given the modest potential growth outlook, however, under which banks are likely to struggle to grow out of their NPL overhang, further policy measures are needed to put the NPL ratio on a firm downward path over the medium term.
    Keywords: Italy, non-performing loans, real output growth, panel tests of threshold effects
    JEL: C23 E44 G33
    Date: 2017–04
  20. By: Zachary Feinstein
    Abstract: Gringotts Wizarding Bank is well known as the only financial institution in all of the Wizarding UK as documented in the works recounting the heroics of Harry Potter. The concentration of power and wealth in this single bank needs to be weighed against the financial stability of the entire Wizarding economy. This study will consider the impact to financial risk of breaking up Gringotts Wizarding Bank into five component pieces, along the lines of the Glass-Steagall Act in the United States. The emphasis of this work is to calibrate and simulate a model of the banking and financial systems within Wizarding UK under varying stress test scenarios simulating rumors of Lord Voldemort's return or the release of magical creatures into an unsuspecting muggle populace. We conclude by comparing the economic fallout from financial crises under the two systems: (i) Gringotts Wizarding Bank as a monopoly and (ii) the split-up financial system. We do this comparison on the level of minimal system-wide capital injections that would be needed to prevent the financial crisis from surpassing the damage caused by Lord Voldemort.
    Date: 2017–03
  21. By: Teruyoshi Kobayashi; Taro Takaguchi
    Abstract: The global financial crisis in 2007-2009 demonstrated that systemic risk can spread all over the world through a complex web of financial linkages. In particular, interbank credit networks shape the core of the financial system, in which interconnected risk emerges from a massive number of temporal transactions between banks. However, the lack of fundamental knowledge about the dynamic nature of interbank networks makes it difficult to evaluate and control systemic risk. Here, we analyze the dynamics of real interbank networks at a daily temporal resolution. While daily networks have been flexibly changing their structure from day to day, entailing entries and exits of banks, we discover explicit dynamical patterns that have been surprisingly stable over time even amid the global financial crisis. The emergence of these dynamical patterns is accurately reproduced by a model, in which banks' demand for trading follows a random walk. The discovery of fundamental patterns in the daily evolution of interbank networks will enhance our ability to evaluate systemic risk and could contribute to the dynamic management of financial stability.
    Date: 2017–03

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