The eurosystem money market auctions: A banking perspective

This paper analyzes the individual bidding behavior of German banks in the money market auctions conducted by the ECB from the beginning of 2000:IIIQ to the end of 2001:IQ. Our approach takes a variety of characteristics of the individual banks into account, particularly variables that capture the different use of liquidity and the different attitude towards liquidity risk of the individual banks. It turns out that these characteristics are reflected in banks’ bidding behavior. Thus, our study contributes to a deeper understanding of the way liquidity risk is managed in the banking sector.     

Anatomy of banking crises in developing and emerging market countries

This paper uses a Binary Classification Tree (BCT) model to analyze banking crises in 50 emerging market and developing countries during 1990-2005. The BCT model identifies three conditions (and the specific threshold of the key indictors) at which the vulnerability to banking crisis increases—(i) very high inflation, (ii) highly dollarized bank deposits combined with nominal depreciation or low bank liquidity, and (iii) low bank profitability—which highlight that foreign currency risk, poor financial soundness, and macroeconomic instability are important drivers of banking crises. The results also emphasize the importance of conditional thresholds in triggering crises, in that banking crises are underlined by a combination of vulnerabilities—or a sequence of (non-linear) conditions—rather than the deterioration of a unique factor.     

The role of household and business credit in banking crises

Private credit expansions are an important predictor of subsequent banking crises. We revisit that result with a new dataset from developed and developing countries that decomposes private credit into household credit and enterprise credit. We argue that household credit growth raises debt levels without much effect on long-term income. Rapid household credit expansions generate vulnerabilities that can precipitate a banking crisis. Enterprise credit expansions can have the same effects but it is tempered by the associated increase in income. Our estimates show that household credit expansions have been a statistically and economically significant predictor of banking crises. Enterprise credit expansions are also associated with banking crises but their effect is weaker and less robust.     

International diversification gains and home bias in banking

This paper studies international diversification in banking, exploiting a bank-level dataset that covers the operations of 38 global banks and their subsidiaries overseas during 1995–2004. The paper finds that banks with a larger share of assets allocated to subsidiaries in emerging market countries were able to attain higher risk-adjusted returns. These gains were somewhat reduced by the concentration of bank subsidiaries in specific geographical regions, which is typical of the observed international expansion strategies. The paper also finds a substantial home bias in the international allocation of bank assets relative to the results of a mean–variance portfolio optimization model.     

Identifying the balance sheet and the lending channels of monetary transmission: A loan-level analysis

We make a novel attempt at comparing the strength of the lending and balance sheet channels of monetary transmission. To make this comparison, we use loan-level data to determine how borrower balance sheets and bank liquidity are related to bank lending decisions and how monetary policy can affect these relationships. The key innovation in this paper is the use of loan-level data. This enables us to measure the independent effects of the two channels and directly account for borrower balance sheets and lender liquidity instead of using proxies. Our results show that the balance sheet channel is the main mechanism through which monetary policy shocks are transmitted to the economy and that the lending channel does not play a significant role.     

Efficiency and risk in European banking

We assess the inter-temporal relationship between bank efficiency, capital and risk in a sample of European commercial banks employing several definitions of efficiency, risk and capital and using the Granger-causality methodology in a panel data framework. Our results suggest that lower bank efficiency with respect to costs and revenues Granger-causes higher bank risk and that increases in bank capital precede cost efficiency improvements. We also find that more efficient banks eventually become better capitalized and that higher capital levels tend to have a positive effect on efficiency levels. These results are generally confirmed by a series of robustness tests. The results have potentially important implications for bank prudential supervision and underline the importance of attaining long-term efficiency gains to support financial stability objectives.     

Multinational banking and the international transmission of financial shocks: Evidence from foreign bank subsidiaries

Using bank-level data on 368 foreign subsidiaries of 68 multinational banks in 47 emerging economies during 1994–2008, we present consistent evidence that internal capital markets in multinational banking contribute to the transmission of financial shocks from parent banks to foreign subsidiaries. We find that internal capital markets transmit favorable and adverse shocks by affecting subsidiaries’ reliance on their own internal funds for lending. We also find that the transmission of financial shocks varies across types of shocks; is strongest among subsidiaries in Central and Eastern Europe, followed by Asia and Latin America; is global rather than regional; and becomes more conspicuous in recent years. We also explore various conditions under which the international transmission of financial shocks via internal capital markets in multinational banking is stronger, including the subsidiaries’ reliance on funds from their parent bank, the subsidiaries’ entry mode, and the capital account openness and banking market structure in host countries.     

The international transmission of bank capital requirements: Evidence from the UK

We use data on UK banks? minimum capital requirements to study the impact of changes to bank-specific capital requirements on cross-border bank loan supply from 1999Q1 to 2006Q4. By examining a sample in which each recipient country has multiple relationships with UK-resident banks, we are able to control for demand effects. We find a negative and statistically significant effect of changes to banks? capital requirements on cross-border lending: a 100 basis point increase in the requirement is associated with a reduction in the growth rate of cross-border credit of 5.5 percentage points. We also find that banks tend to favor their most important country relationships, so that the negative cross-border credit supply response in “core” countries is significantly less than in others. Banks tend to cut back cross-border credit to other banks (including foreign affiliates) more than to firms and households, consistent with shorter maturity, wholesale lending which is easier to roll off and may be associated with weaker borrowing relationships.     

Money and liquidity in financial markets

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests on the stock market are supportive. Tighter interbank markets are associated with relatively more volume in more liquid stocks; selling pressure, especially in more liquid stocks; and transitory negative returns. We control for market-wide uncertainty and in the process also contribute to the literature on portfolio rebalancing. Our general point is that money matters in financial markets.     

The macroeconomic sources of systemic risk in the banking sectors of five new EU member states

Rapid credit growth has been one of the most pervasive developments in recent years in Central and Eastern Europe. Our estimates support the hypothesis that the growth of credit and the amount of available finance might harm banking performance and deteriorate non-performing loans (NPL) dynamics, most probably due to the overheating of economies in the five NMSs. The procyclicality of banking sector performance and high economic activities growth is a signal of an economy overheating and therefore a slowdown in economic activity is likely to accelerate the growth of the NPL ratio.     

Money, intermediation, and banking

The business of money creation is conceptually distinct from that of intermediation. Yet, these two activities are frequently—but not always—combined together in the form of a banking system. We develop a simple model to examine the question: When is banking essential? There is a role for money due to a lack of record-keeping and a role for intermediation due to the existence of private information: both money and intermediation are essential. When monitoring costs associated with intermediation are sufficiently low, the two activities can be separated from one another. However, when monitoring costs are sufficiently high, a banking system that combines these two activities is essential.     

Bank panics and the endogeneity of central banking

Central banking is intimately related to liquidity provision to banks during times of crisis, the lender-of-last-resort function. This activity arose endogenously in certain banking systems. Depositors lack full information about the value of bank assets, so that during macroeconomic downturns they monitor their banks by withdrawing in a banking panic. The likelihood of panics depends on the industrial organization of the banking system. Banking systems with well-diversified big banks are less prone to inefficient bank runs because diversification alleviates the information asymmetry. In addition, big banks can self-monitor through publicly observable branch closure. Systems of many small banks form incentive-compatible bank coalitions to emulate the big banks during times of crisis. Such coalitions improve efficiency by monitoring member banks and issuing money that is a kind of deposit insurance—a precursor of central banking.     

Financial dollarization: The role of foreign-owned banks and interest rates

Why in many economies households and firms borrow and make deposits in foreign currency? Expanding on the existing literature, our framework addresses this question allowing for interest rate differentials and access to foreign funds to play a role in explaining this process of asset substitution or financial dollarization. Using a newly compiled data set on transition economies and employing a standard panel as well as a panel-VAR methodology we find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits.     

Bank capital regulation and credit supply

Banks can meet the need to increase their capital ratio either by issuing new equity or by reducing loans. It is generally known that banks prefer to reduce assets due to the high cost of equity. With a simple banking model we show that, if incumbent shareholders are to benefit, banks may prefer to reduce loans, even though they can recapitalize by issuing new equity without any cost. The result holds when banks hold relatively small amounts of long-term loans, or when the economy is in downturn.     

Did the crisis induce credit rationing for French SMEs?

This paper focuses on the access of independent French SMEs to bank lending and analyzes whether the observed evolution of credit to SMEs over the recent period was “demand driven” as a result of the decrease in firms’ activity and investment projects or was “supply driven” with an increase in credit “rationing” stemming from a more cautious behavior of banks. Based on a sample of around 60,000 SMEs, we come to the conclusion that, despite the stronger standards used by banks when granting credit, French SMEs do not appear to have been strongly affected by credit rationing since 2008. This result goes against the common view that SMEs suffered from a strong credit restriction during the crisis but is perfectly in line with the results of several surveys about the access to finance of SMEs recently conducted in France.     

How do banks respond to shocks? A dynamic model of deposit-taking institutions

This paper proposes a dynamic model of the optimal choices of a bank that benefits from market power and takes into account the impact of the deposit generation process. Interbank lending/borrowing emerges as a buffer that assists the bank in smoothing intertemporal adjustments in interdependent loan and deposit choices. The bank smooths the impact of interest-rates shocks on its customers to minimize the adjustments over time of the stocks of deposits and loans. It does not, however, provide insurance against negative shocks of real origin that increase its expected default costs. The predictions of the model help to shed light on the available empirical evidence and to analyze some recent developments of the banking industry.     

Bank runs and investment decisions revisited

We examine how the possibility of a bank run affects the investment decisions made by a competitive bank. Cooper and Ross [1998. Bank runs: liquidity costs and investment distortions. Journal of Monetary Economics 41, 27-38] have shown that when the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur; precautionary or “excess” liquidity will not be held. This result allows us to show that when the cost of liquidating investment early is high, an increase in the probability of a run will lead the bank to invest less. However, when liquidation costs are moderate, the level of investment is increasing in the probability of a run.     

Bank health in varying macroeconomic conditions: A panel study

Using panel data on selected Financial Soundness Indicators (FSIs) this paper investigates the potential strengths and vulnerabilities of financial intermediaries across more than 50 countries. Our econometric analysis reveals strong influence of business cycle, inflation, and real effective exchange rates, and size of the industry on capital adequacy —a core indicator of banks' financial soundness. Furthermore, our analyses provide evidence that banks' profitability is determined by a combination of macroeconomic, bank specific and industry characteristics such as business cycle, inflation, credit risk, capital adequacy, and the level of competition.     

A computational approach to the optimal structure of bank input prices

Most bank deposits contain an embedded option which permits the depositor to withdraw funds at will. Demand deposits generally allow costless withdrawal, while time deposits often require payment of an early withdrawal penalty. Managing the risk that depositors will exercise their withdrawal option is an important aspect of input pricing. This paper acknowledges the threat of deposit withdrawal and then solves for the optimal structure of bank deposit rates.