nep-ban New Economics Papers
on Banking
Issue of 2019‒03‒04
sixteen papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Bank Income Smoothing, Institutions and Corruption By Ozili, Peterson K
  2. Systemic Risk and the Great Depression By Das, Sanjiv; Mitchener, Kris James; Vossmeyer, Angela
  4. Deposit Insurance, Market Discipline and Bank Risk By Alexei Karas; William Pyle; Koen Schoors
  5. The Bank Capital-Competition-Risk Nexus - A Global Perspective By E Philip Davis; Dilruba Karim; Dennison Noel
  8. Mentally Spent: Credit Conditions and Mental Health By Qing Hu; Ross Levine; Chen Lin; Mingzhu Tai
  9. Global Banking Network and Regional Financial Contagion By Park, Cyn-Young; Shin, Kwanho
  10. Size, Efficiency, Market Power, and Economies of Scale in the African Banking Sector By Asongu, Simplice; Odhiambo, Nicholas
  12. A Dynamic Model of Intermediated Consumer Credit and Liquidity By Gomis-Porqueras, Pedro; Sanches, Daniel R.
  13. The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling By Tim Xiao
  14. Bank Leverage Ratios, Risk and Competition - An Investigation Using Individual Bank Data By E Philip Davis; Dilruba Karim; Dennison Noel
  15. Pricing Financial Derivatives Subject to Multilateral Credit Risk and Collateralization By Tim Xiao
  16. Banking Regulation with Risk of Sovereign Default By D'Erasmo, Pablo; Livshits, Igor; Schoors, Koen

  1. By: Ozili, Peterson K
    Abstract: This study investigates bank income smoothing, focusing on the effect of corruption on the extent of income smoothing by African banks. I find that banks use loan loss provisions to smooth positive (non-negative) earnings particularly in the post-2008 crisis period and this behaviour is reduced by strong investor protection. Also, I find that banks in highly corrupt environments smooth their positive (non-negative) earnings as opposed to smoothing the entire profit distribution. Finally, cross-country variation in bank income smoothing is observed. The findings have implications.
    Keywords: Loan loss provisions, Earnings Management, Investor Protection, Corruption, Income Smoothing, Bank, Profitability,
    JEL: G21 G28 M48
    Date: 2019
  2. By: Das, Sanjiv; Mitchener, Kris James; Vossmeyer, Angela
    Abstract: We employ a unique hand-collected dataset and a novel methodology to examine systemic risk before and after the largest U.S. banking crisis of the 20th century. Our systemic risk measure captures both the credit risk of an individual bank as well as a bank's position in the network. We construct linkages between all U.S. commercial banks in 1929 and 1934 so that we can measure how predisposed the entire network was to risk, where risk was concentrated, and how the failure of more than 9,000 banks during the Great Depression altered risk in the network. We find that the pyramid structure of the commercial banking system (i.e., the network's topology) created more inherent fragility, but systemic risk was nevertheless fairly dispersed throughout banks in 1929, with the top 20 banks contributing roughly 18% of total systemic risk. The massive banking crisis that occurred between 1930-33 raised systemic risk per bank by 33% and increased the riskiness of the very largest banks in the system. We use Bayesian methods to demonstrate that when network measures, such as eigenvector centrality and a bank's systemic risk contribution, are combined with balance sheet data capturing ex ante bank default risk, they strongly predict bank survivorship in 1934.
    Keywords: banking networks; financial crises; Global Financial Crisis; Great Depression; marginal likelihood; systemic risk
    JEL: E42 E44 G01 G18 G21 L1 N12 N22
    Date: 2018–12
  3. By: Hans Degryse; Alexei Karas; Koen Schoors (-)
    Abstract: We exploit uncertainty regarding banks' involvement in money laundering activities as a natural experiment to study the functioning of the interbank market in uncertain times. We show that bank couples with a stronger relationship (i.e., more frequent and reciprocal interactions before the event) are more likely to continue lending to one another, and at lower interest rates. This is in line with a "helping hand" or "flight to friends" hypothesis during crisis.
    Keywords: banks, interbank market, trust crisis, relationship banking, helping-hand hypothesis
    JEL: G21
    Date: 2019–01
  4. By: Alexei Karas; William Pyle; Koen Schoors (-)
    Abstract: Using evidence from Russia, we explore the e ect of the introduction of deposit insurance on bank risk. Drawing on within-bank variation in the ratio of firm deposits to total household and firm deposits, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate for private, domestic banks that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a di erence-in-di erence setting in which state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control..
    Keywords: deposit insurance, market discipline, moral hazard, risk taking, banks, Russia
    JEL: E65 G21 G28 P34
    Date: 2019–01
  5. By: E Philip Davis; Dilruba Karim; Dennison Noel
    Abstract: The Global Financial Crisis (GFC) highlighted the importance of a number of unresolved empirical issues in the field of financial stability. First, there is the sign of the relationship between bank competition and financial stability. Second, there is the relation of capital adequacy of banks to risk. Third, the introduction of a leverage ratio in Basel III following the crisis leaves open the question of its effectiveness relative to the risk adjusted capital ratio (RAR). Fourth, there is the issue of the relative stability of advanced versus emerging market financial systems, and whether similar factors lead to risk, which may have implications for appropriate regulation. Finally, there is the nature of the relation between bank competition and bank capital. In this context, we address these five issues via estimates for the relation between capital adequacy, bank competition and other control variables and aggregate bank risk. We undertake this for different country groups and time periods, using macro data from the World Bank’s Global Financial Development Database over 1999-2015 for up to 120 countries globally, using single equation logit and GMM estimation techniques and panel VAR. This is an overall approach that to our knowledge is new to the literature. The results cast light on each of the issues outlined above, with important implications for regulation: (1) The results for the Lerner Index largely underpin the “competition-fragility” hypothesis of a positive relation of competition to risk rather than “competition stability” (a negative relation) and show a widespread impact of competition on risk generally. (2) There is a tendency for both the leverage ratio and the RAR to be significant predictors of risk, and for crises and Z score they are supportive of the “skin in the game” hypothesis of a negative relation between capital ratios and risk, whereas for provisions and NPLs they are consistent with the “regulatory hypothesis” of a positive relation of capital adequacy to risk. (3) The leverage ratio is much more widely relevant than the RAR, underlining its importance as a regulatory tool. The relative ineffectiveness of risk adjusted measures may relate to untruthful or inaccurate assessments of bank real risk exposure. (4) There are marked differences between advanced countries and EMEs in the capital-risk-competition nexus, with for example a wider impact of competition in EMEs (although both types of country need to pay careful attention to the evolution of competition in macroprudential surveillance). Similar pattern to EMEs are apparent in many cases for the global sample pre crisis, which arguably are more consistent with normal market functioning than post crisis. (5) Competition reduces leverage ratios significantly in a Panel VAR, with impulse responses showing that more competition leads to lower leverage ratios and vice versa. This result is consistent over a range of subsamples and risk variables. In the variance decomposition, we find that competition is autonomous, while the variance of both risk and capital ratios are strongly affected by competition. The Panel VAR results give some indication of the transmission mechanism from competition to risk and financial instability.
    Keywords: Macroprudential policy, capital adequacy, leverage ratio, bank competition, bank risks, emerging market economies, logit, GMM, Panel VAR
    JEL: E58 G28
    Date: 2019–02
  6. By: Koen Schoors; Maria Semenova; Andrey Zubanov (-)
    Abstract: We analyze whether bank familiarity affects depositor behavior during financial crisis. Familiarity is measured by regional or local cues in the bank’s name. Depositor behavior is measured by the depositor’s sensitivity to observable bank risk (market discipline). Using 2001-2010 bank-level and region-level data for Russia, we find that depositors of familiar banks become less sensitive to bank risk after a financial crisis relative to depositors of unfamiliar banks. To validate that our results stem from a flight to familiarity during crisis and not from implicit guarantees from regional governments, we interact the variables of interest with measures of regional affinity and trust in local governments. The flight to familiarity effect is strongly confirmed in regions with strong regional affinity, while the effect is absent in regions with more trust in regional and local governments, lending support to the thesis that our results are driven a flight to familiarity rather than implicit guarantees.
    Keywords: Market discipline, Bank, Personal deposit, Region, Russia, Flight to familiarity, Trust, Implicit guaranty, Regional authorities.
    JEL: G21 G01 P2
    Date: 2019–02
  7. By: Marnix Van Soom; Milan Van Den Heuvel; Jan Ryckebusch; Koen Schoors (-)
    Abstract: Since the 2007-2009 financial crisis, substantial academic effort was dedicated to improving our understanding of interbank lending networks (ILNs). Because of data limitations, the literature largely lacks loan maturity information. We employ a complete interbank loan contract dataset to investigate whether maturity details are informative of the network structure. Applying the layered stochastic block model of Peixoto (2015)1 and other tools from network science on a time series of bilateral loans with multiple maturity layers in the Russian ILN, we find that collapsing all such layers consistently obscures mesoscale structure. The optimal maturity granularity lies between completely collapsing and completely separating the maturity layers and depends on the development phase of the interbank market, with a more developed market requiring more layers for optimal description. Closer inspection of the inferred maturity bins associated with the optimal maturity granularity reveals specific economic functions, from liquidity intermediation to financing. Collapsing a network with multiple underlying maturity layers, common in interbank research, is therefore not only an incomplete representation of the ILN’s mesoscale structure, but also conceals existing economic functions. This holds important insights and opportunities for theoretical and empirical studies on interbank market contagion, stability, and on the desirable level of regulatory data disclosure.
    Date: 2019–01
  8. By: Qing Hu; Ross Levine; Chen Lin; Mingzhu Tai
    Abstract: In light of the human suffering and economic costs associated with mental illness, we provide the first assessment of whether local credit conditions shape the incidence of mental depression. Using several empirical strategies, we discover that bank regulatory reforms that improved local credit conditions reduced mental depression among low-income households and the impact was largest in counties dominated by bank-dependent firms. On the mechanisms, we find that the regulatory reforms boosted employment, income, and mental health among low-income individuals in bank-dependent counties, but the regulatory reforms did not increase borrowing by these individuals.
    JEL: D14 G21 I1 R23
    Date: 2019–02
  9. By: Park, Cyn-Young (Asian Development Bank); Shin, Kwanho (Korea University)
    Abstract: This paper investigates and tests the role of regional exposures in financial contagion from advanced to emerging market economies through the global banking network using data on cross-border bilateral bank claims and liability positions. We first examine whether an economy can become more susceptible to capital outflows, regardless of its own bank exposures, if economies in the same region are heavily exposed to crisis countries. Second, we test whether the same region lenders tend to reduce exposures to the emerging market borrowers less than do different region lenders during crises. Using bilateral data from the Bank for International Settlements international banking statistics, we obtain evidence for both hypotheses. First, we find that direct exposures of a country’s own and the overall region’s banking sectors to crisis-affected countries are systematically related to bank capital outflows during the global financial crisis. Also, some of our empirical results indicate that an emerging economy’s financial vulnerability can be influenced by its region’s indirect exposures to crisis countries. Second, a further analysis suggests more favorable behavior of the same region lender toward emerging economies during crisis.
    Keywords: capital outflows; contagion; direct/indirect exposures; global financial crisis; regional
    JEL: E44 F15 F21 F34 F42
    Date: 2018–05–24
  10. By: Asongu, Simplice; Odhiambo, Nicholas
    Abstract: There is a growing body of evidence that interest rate spreads in Africa are higher for big banks compared to small banks. One concern is that big banks might be using their market power to charge higher lending rates as they become larger, more efficient, and unchallenged. In contrast, several studies found that when bank size increases beyond certain thresholds, diseconomies of scale are introduced that lead to inefficiency. In that case, we also would expect to see widened interest margins. This study examines the connection between bank size and efficiency to understand whether that relationship is influenced by exploitation of market power or economies of scale. Using a panel of 162 African banks for 2001–2011, we analyzed the empirical data using instrumental variables and fixed effects regressions, with overlapping and non-overlapping thresholds for bank size. We found two key results. First, bank size increases bank interest rate margins with an inverted U-shaped nexus. Second, market power and economies of scale do not increase or decrease the interest rate margins significantly. The main policy implication is that interest rate margins cannot be elucidated by either market power or economies of scale. Other implications are discussed.
    Keywords: Sub-Saharan Africa; banks; lending rates; efficiency; Quiet Life Hypothesis; competition
    JEL: E42 E52 E58 G21 G28
    Date: 2018–01
  11. By: Mustafa Disli; Koen Schoors (-)
    Abstract: We analyze the dynamic effects of bank rebranding in a sample of Turkish banks. We hypothesize that bank rebranding resorts positive effects if the rebranding strategy exploits familiarity bias, which refers to the behavioral heuristic that investors favor firms they are more familiar with. We measure the effect of bank rebranding on depositor attitudes by the change in depositor discipline. In line with our hypothesis, rebranding from a foreign into a Turkish name (increased familiarity) is associated with reduced depositor discipline, while rebranding from a Turkish into a foreign name (reduced familiarity) is associated with increased depositor discipline instead. Local projections indicate that the positive familiarity bias effect of rebranding lasts up to four years.
    Keywords: depositor discipline; rebranding; familiarity bias
    Date: 2019–01
  12. By: Gomis-Porqueras, Pedro (Deakin University); Sanches, Daniel R. (Federal Reserve Bank of Philadelphia)
    Abstract: We construct a model of consumer credit with payment frictions, such as spatial separation and unsynchronized trading patterns, to study optimal monetary policy across different interbank market structures. In our framework, intermediaries play an essential role in the functioning of the payment system, and monetary policy influences the equilibrium allocation through the interest rate on reserves. If interbank credit markets are incomplete, then monetary policy plays a crucial role in the smooth operation of the payment system. Specifically, an equilibrium in which privately issued debt claims are not discounted is shown to exist provided the initial wealth in the intermediary sector is sufficiently large relative to the size of the retail sector. Such an equilibrium with an efficient payment system requires setting the interest rate on reserves sufficiently close to the rate of time preference.
    Keywords: Intermediation; liquidity; payments system; rediscounting
    JEL: E42 E58 G21
    Date: 2019–02–20
  13. By: Tim Xiao (University of Toronto)
    Abstract: This article presents a comprehensive framework for valuing financial instruments subject to credit risk. In particular, we focus on the impact of default dependence on asset pricing, as correlated default risk is one of the most pervasive threats in financial markets. We analyze how swap rates are affected by bilateral counterparty credit risk, and how CDS spreads depend on the trilateral credit risk of the buyer, seller, and reference entity in a contract. Moreover, we study the effect of collateralization on valuation, since the majority of OTC derivatives are collateralized. The model shows that a fully collateralized swap is risk-free, whereas a fully collateralized CDS is not equivalent to a risk-free one. Acknowledge: The data were provided by FinPricing at
    Keywords: asset pricing,credit risk modeling,unilateral,bilateral,multilateral credit risk,collateralization,comvariance,comrelation,correlation
    Date: 2019–02–18
  14. By: E Philip Davis; Dilruba Karim; Dennison Noel
    Abstract: Following experience in the global financial crisis (GFC), when banks with low leverage ratios were often in severe difficulty, despite high-risk-adjusted capital measures, a leverage ratio was introduced in Basel III to complement the risk-adjusted capital ratio (RAR). Empirical testing of the leverage ratio, individually and relative to regulatory capital is, however, sparse. More generally, the capital/risk/competition nexus has been neglected by regulators and researchers. In this paper, we undertake empirical research that sheds light on leverage as a regulatory tool controlling for competition. We assess the effectiveness of a leverage ratio relative to the risk-adjusted capital ratio (RAR) in predicting bank risk given competition for up to 8216 banks in the EU and 1270 in the US, using the Fitch-Connect database of banks’ financial statements. On balance, US banks tend to behave in a manner consistent with “skin in the game” (a negative relation of competition to risk) while European banks tend to follow the “regulatory hypothesis” (positive relation), although there are exceptions to these generalisations. Accordingly, the expected effect of changes in capital on risk needs careful attention by regulators. There is a tendency for the leverage ratio to be more often significant than the risk-adjusted measure in a number of the regressions. This observation favours its use in macroprudential policy. The effect of capital on risk varies considerably over time and cross sectionally for Europe vis a vis the US; effects often differ between low-leverage and high-leverage ratio banks as well as pre- and post-crisis and for individual EU countries. The overall results are robust to a number of variations in sample and specification. We consider the inclusion of competition as a control variable to be a major contribution that adds to the relevance of our study. The results show that bank competition, allowing for capital, is a significant macroprudential indicator in virtually all regressions and hence more note should be taken of this by regulators, notably in the US where there is mainly evidence of competition-fragility (a positive link of competition to risk). On the other hand we note that exclusion of competition does not markedly change the effect of capital. Finally there are differences in the relation of risk both to competition and capital adequacy for banks at different levels of risk that need to be taken into account by regulators both in Europe and the US. There is some evidence of greater vulnerability of weaker banks to low capital and high competition than would be shown by the sample average or median.
    Keywords: Macroprudential policy, capital adequacy, leverage ratio, bank competition, bank risks, panel estimation, quantile regressions
    JEL: E58 G28
    Date: 2019–02
  15. By: Tim Xiao (University of Toronto)
    Abstract: This article presents a new model for valuing financial contracts subject to credit risk and collateralization. Examples include the valuation of a credit default swap (CDS) contract that is affected by the trilateral credit risk of the buyer, seller and reference entity. We show that default dependency has a significant impact on asset pricing. In fact, correlated default risk is one of the most pervasive threats in financial markets. We also show that a fully collateralized CDS is not equivalent to a risk-free one. In other words, full collateralization cannot eliminate counterparty risk completely in the CDS market. Acknowledge: The work was sponsored by FinPricing at
    Keywords: asset pricing,credit risk modeling,collateralization,comvariance,comrelation,correlation,CDS
    Date: 2019–02–18
  16. By: D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia); Livshits, Igor (Federal Reserve Bank of Philadelphia); Schoors, Koen (Ghent, HSE)
    Abstract: Banking regulation routinely designates some assets as safe and thus does not require banks to hold any additional capital to protect against losses from these assets. A typical such safe asset is domestic government debt. There are numerous examples of banking regulation treating domestic government bonds as “safe,” even when there is clear risk of default on these bonds. We show, in a parsimonious model, that this failure to recognize the riskiness of government debt allows (and induces) domestic banks to “gamble” with depositors’ funds by purchasing risky government bonds (and assets closely correlated with them). A sovereign default in this environment then results in a banking crisis. Critically, we show that permitting banks to gamble this way lowers the cost of borrowing for the government. Thus, if the borrower and the regulator are the same entity (the government), that entity has an incentive to ignore the riskiness of the sovereign bonds. We present empirical evidence in support of the key mechanism we are highlighting, drawing on the experience of Russia in the run-up to its 1998 default and on the recent Eurozone debt crisis.
    Keywords: Banking; Sovereign default; Prudential regulation; Financial crisis
    JEL: F34 G01 G28
    Date: 2019–02–22

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