Assessing optimal credit growth for an emerging banking system

The paper sets forth a novel way to estimate the optimal level of credit growth for an emerging banking system. Contrary to the traditional credit-to-GDP gap indicator, credit growth is considered to be optimal when it does not accelerate credit risk measured by loan loss provisions. We provide empirical support for modelling the provision charge ratio dynamic by the quadratic function of the credit growth deviation from its optimal level. The operational framework consists of a simplified financial satellite with two equations representing credit growth and change in the provision charge ratio. Our empirical results show that a 3 percent (±1 pp margin) quarterly increase in credit to the private sector is, in nominal terms, optimal for financial stability and sustainable growth in Romania.     

The effect of episodes of large capital inflows on domestic credit

This paper analyses the effect of capital inflow surges on the evolution of domestic credit. Using a panel of developed and emerging economies from 1970 to 2007, it is shown that in the two years following the beginning of a capital inflow surge the credit-to-GDP ratio increases by about 2 percentage points. The effect is reversed in the medium-term with the credit-to-GDP ratio decreased by almost 4 percentage points seven years after the initial surge. The paper also finds that the effect is different depending on the type of flows characterising the episode (debt vs. portfolio equity vs. FDI), with large capital inflows that are debt-driven having the largest effect. The results of the paper also suggest that the short-term effect of capital inflow surges on domestic credit depends on countries’ macroeconomic policy stances. In particular, it is found that this effect is lower in countries with higher real exchange rate flexibility and fiscal policy counter-cyclicality.     

Does lending behaviour of banks in emerging economies vary by ownership? Evidence from the Indian banking sector

While much has been discussed about the relationship between ownership and financial performance of banks in emerging markets, literature about cross-ownership differences in credit market behaviour of banks in emerging economies is sparse. Using a portfolio choice model and bank-level data from India for 9 years (1995–96 to 2003–04), we examine banks’ behaviour in the context of credit markets of an emerging market economy. Our results indicate that, in India, the data for the domestic banks fit well the aforementioned portfolio-choice model, especially for private banks, but the model cannot explain the behaviour of foreign banks. In general, allocation of assets between risk-free government securities and risky credit is affected by past allocation patterns, stock exchange listing (for private banks), risk averseness of banks, regulations regarding treatment of NPA, and ability of banks to recover doubtful credit. It is also evident that banks deal with changing levels of systematic risk by altering the ratio of securitized to non-securitized credit.     

Low interest rate policy and the use of reserve requirements in emerging markets

This paper sheds light on the link between the interest rate policy in large advanced economies with international funding and reserve currencies (the United States and the euro area) and the use of reserve requirements in emerging markets. Using reserve requirement data for 28 emerging markets from 1998 to 2012, we provide evidence that emerging market central banks tend to raise reserve requirements when interest rates in international funding markets decline or financial inflows accelerate, most likely to preserve financial stability. In contrast, when global liquidity risk rises and funding from the large advanced economies dries up, emerging markets lower reserve requirements.     

Credit behavior and financial stability in an emerging economy

One relevant issue for the management of financial stability is the monitoring of the credit market. In this sense, Basel III proposed the credit gap as the most appropriate measure to anticipate financial stability issues. However, the adoption of the credit gap has been criticized, especially for emerging markets. Through panel data analysis, this study investigates the effect of the credit gap and the credit growth rate on financial stability in Brazil, which represents a relevant emerging economy. For this purpose, we use a set of financial stability measures traditionally found in the literature: the z-score, regulatory capital and credit risk. The results suggest that the credit gap and credit growth rates are adequate metrics to indicate the sustainability of credit growth in Brazil. However, credit growth rates are more attractive, since they indicate a threshold for credit growth in the Brazilian economy concerning financial stability.     

The great rotation in global credit risks

• ? The pattern of global credit risks looks very different today than in 2007. Risks are now mostly centred in China and emerging markets. “Excess” private debt in China is as high as $3 trillion compared with $1.7 trillion in the US a decade ago. Yet some pockets of significant risk still exist in advanced economies, which not only implies vulnerability to rising interest rates, but also that the scope for rate rises may be limited.
• ? With policy normalisation underway in the US and the scaling back of asset purchases expected to start soon in the Eurozone, we focus on assessing vulnerabilities across global credit markets. This article explores the topic using a top‐down, cross‐country approach. We find that although private debt and debt service ratios look more benign in advanced economies than a decade ago, they have deteriorated markedly in many emerging markets in recent years.
• ? Based on a measure of excess private debt – comparing private credit‐to‐GDP ratios with their trend – China, Hong Kong and Canada are the riskiest. When comparing debt service ratios relative to their long‐term averages, risks are also mainly concentrated in emerging countries. But Canada, Australia and some smaller European countries also have high debt service ratios that have failed to drop since 2007, despite the slump in global interest rates.
• ? Overall, aggregate private debt indicators look less worrying than in 2007. We would also argue that the concentration of excess private debt levels in China reduces the risk of a sudden financial crisis based on massive credit losses, such as the one in 2007–2010. But with corporate debt levels in the US, Canada and some other G7 countries above their long‐term trend, investors need to be attentive to these considerable pockets of risk.

     

Predictability of tail risks of Canada and the U.S. Over a Century: The role of spillovers and oil tail Risks☆

We examine the tail risk spillovers between Canada and U.S. stock markets using over a century data, and also account for the roles of tail risks of other advanced economies (France, Germany, Japan, Italy, Switzerland, and the UK) and oil-market tail risk. We use the “best” tail risk measure obtained from different variants of the Conditional Autoregressive Value at Risk (CAViaR) model developed by Engle and Manganelli (2004) in the predictive model and compare its performance with that of an AR(1) benchmark model. We find strong evidence of risk spillovers between the two stock markets. We find contrasting evidence for the predictability of oil-market tail risk, with positive predictability in case of the net oil exporter and negative in case of the net oil importer. Further results using tail risks of other advanced economies (combined) support possible diversification potential for Canadian stocks in the presence of market risks of advanced economies other than the U.S. Our findings have implications for investors and are robust to various out-of-sample forecast horizons, alternative data frequencies, data splits, and 1% and 5% VaRs.     

Evaluating early warning indicators of banking crises: Satisfying policy requirements

Ideally, early warning indicators (EWI) of banking crises should be evaluated on the basis of their performance relative to the macroprudential policy maker’s decision problem. We translate several practical aspects of this problem — such as difficulties in assessing the costs and benefits of various policy measures, as well as requirements for the timing and stability of EWIs — into statistical evaluation criteria. Applying the criteria to a set of potential EWIs, we find that the credit-to-GDP gap and a new indicator, the debt service ratio (DSR), consistently outperform other measures. The credit-to-GDP gap is the best indicator at longer horizons, whereas the DSR dominates at shorter horizons.     

Trading constraints penalizing default: A recursive approach

This paper proves existence of an ergodic Markov equilibrium for a class of general equilibrium economies with infinite horizon, incomplete markets, and default. Agents may choose to deny their liabilities and face trading constraints that depend on the adjusted amount of past default on each asset. These constraints replace the usual utility penalties and explore intertemporal tie-ins that appear in dynamic economies. The equilibrium prices and solvency rates present stationary properties that are usually required in econometric models of credit risk.     

Performance of microfinance institutions in Europe—Does social capital matter?

This paper investigates performance drivers of microfinance suppliers in Europe. As such suppliers, in contrast to advanced microfinance suppliers in developing economies, typically focus on uncollateralized microcredit services to individuals at the margins of society and of labor markets, we draw on the theory of social capital and empirically investigate the role that social capital may play in the overall performance of European microfinance suppliers. We build a unique, unbalanced panel data set of 302 microfinance service providers in Europe covering the years 2008–2015, and measure their performance in terms of credit risk, financial and social performance, and efficiency. Pursuing an econometric approach, we test a series of hypotheses using various measures of conditions conducive to building social capital on both the institutional and the country level, such as the client base of a microfinance supplier and the level of cultural fractionalization in a society. Our findings confirm that a higher intensity of social capital is positively associated with all areas of the performance of microfinance suppliers in Europe. Our conclusions could help in the design and launch of microfinance institutions in those European countries in which microfinance markets are developed not at all or only to a very limited extent. Our paper thus contributes to the nascent literature on microfinance in developed economies by applying and extending the theoretical framework and empirical models on social capital and microfinance that were originally elaborated for developing economies.     

Procyclical ratings and market reactions

We investigate stock price reactions to credit rating changes during competing economic environments. Prior research has shown that credit rating assignments differ during times of economic expansion and economic contraction. We investigate if equity prices adjust differently to changes in credit quality in different economic environments. Our results show that markets react more strongly to negative ratings news during times of economic contraction. When the economy is expanding, markets also overreact by pushing prices higher than they otherwise would during an economic downturn.     

Internationalization strategies of frontier Lusophone-African multinational enterprises: Comparative case studies of Angola and Mozambique

Internationalization theories suggest that enterprises from emerging and frontier markets will adopt different entry modes than those in advanced economies. Very few studies to date, however, examine the process of how multinational enterprises (MNEs) from frontier markets internationalize or evaluate which factors influence their mode of entry into global markets. This research investigates the internationalization strategies of Lusophone Africa MNEs from Angola and Mozambique, more specifically their entry mode, to expand the framework for entry mode strategies to include the motivations and issues of MNEs from emerging and frontier economies. Surveys, as well as in-depth, in-country, qualitative interviews reveal that these frontier and emerging market MNEs opted for equity-based investment strategies as their preferred mode of entry. A significant second group opted for e-commerce/e-business strategies, and direct and indirect exports. Finally, a smaller portion of the interviewees chose Greenfield investment as a mode of entry. Many of these MNEs could be classified as born global/INV.     

Opportunities for disruption

In view of the importance of Disruptive Innovations (DIs) in both emerging and advanced economies, a better understanding of how to cultivate opportunities for DIs is called for. We provide case study exemplars that illustrate how entrepreneurs have deliberately undertaken DIs for customers of low-end and new markets. Our findings show how the entrepreneurial opportunities embedded in these DIs are purposefully discovered and created. By extending research on the generation of entrepreneurial opportunities into the arena of disruptive innovations, the paper aims to contribute to understanding of both DI and the nature of opportunity generation and to provide a basis for guidance to practitioners.     

Predictability in sovereign bond returns using technical trading rules: Do developed and emerging markets differ?

The study examines the predictability of 48 sovereign bond markets based on a strategy of 27,000 technical trading rules. These rules represent four popular trading rule classes, they are: moving average, filtering, support and resistance, and channel breakout rules, with numerous variants in each class. Empirical results show that (i) investing in sovereign bond markets is predictable, based on the buy-sell signals generated by trading rules, with the predictability of the emerging Asian markets being significantly higher than those of the advanced markets; (ii) the predictability is generally higher when the US tightens its monetary policies or undergoes recession or a financial crisis; (iii) two-thirds of sovereign bond markets have a higher predictability when we use a machine learning algorithm to determine the best trading rule strategy; and (iv) the predictability of a sovereign bond market is higher when the economy has a less effective government, lower regulatory quality, lower degree of financial openness, higher political risk, lower income and faster real money growth. Our results suggest that shocks originating from US monetary policy or economic conditions could have a considerable spillover effect on sovereign bond markets, particularly the emerging Asian markets.     

Does income inequality lead to banking crises in developing countries? Empirical evidence from cross-country panel data

This study empirically examines whether increasing income inequality results in banking crises using panel data for 68 countries covering the years 1973 to 2010. The results show that developing countries with high inequality tend to have higher levels of domestic credit and that domestic credit booms increase the probability of banking crises. We also find that developing economies display direct channels from inequality to banking crises without an association with credit booms. We find no consistent evidence that income inequality contributes to banking crises in advanced economies. In developing countries, the probability of banking crises increases dramatically as income inequality levels increase: The probability of a systemic banking crisis within three years is 9.5% when the Gini is as low as 0.2 in developing countries and increases to 57.4% when the Gini is 0.4. These results are robust to several specifications.     

Volatility spillovers among the U.S. and Asian stock markets: A comparison between the periods of Asian currency crisis and subprime credit crisis

This paper examines the changing nature of volatility spillovers among the U.S. and eight East Asian stock markets between two financial crises: the Asian currency crisis and the U.S. subprime credit crisis. Our empirical results suggest that volatility is not always spilled over from the directly affected markets to surrounding markets in crisis periods. The East Asian markets who directly suffered from the Asian currency crisis are the ones to which volatility is spilled over from other markets during the Asian currency crisis period, whereas uni-directional volatility spillovers from the U.S. market to other markets are observed during both crisis periods. This difference can be explained by a pre-determined hierarchy in which volatility spillovers tend to start from the U.S. market regardless of the geographical origin of the crisis. Furthermore, our results reveal that the markets in three major Asian financial hubs, i.e., Japan, Hong Kong and Singapore, are the markets to which volatility is spilled over uni-directionally from several other countries during the subprime credit crisis period, but not during the Asian currency crisis period. We attribute this difference to crisis-specific (currency or credit crisis), market-specific (credit derivatives market participation and foreign currency reserves), and time-specific (more integrated global market) factors.     

Emerging market mutual fund performance: Evidence for Poland

This paper provides evidence on the performance of mutual funds in a prominent emerging market; Poland. Studying an emerging market provides an excellent opportunity to test whether the consensus on the inability of mutual funds in developed and highly efficient markets to beat the market, also holds in less efficient markets. While the weaknesses of legal institutions and underdeveloped capital markets in emerging countries could negatively contribute to performance, a certain level of market inefficiency might also enable fund managers to successfully apply security selection and therefore beat the market. This paper presents an overview of the Polish mutual fund industry and investigates mutual fund performance using a survivorship bias controlled sample of 140 funds. The latter is done using the Carhart (1997) 4-factor asset-pricing model. In addition, we investigate whether Polish fund managers exhibit “hot hands”, persistence in performance. Finally the influence of fund characteristics on risk-adjusted performance is considered. Our overall results suggest that Polish mutual funds on average are not able to add value, as indicated by their negative net alphas. Interestingly, domestic funds outperform internationally investing funds, which points at informational advantages of local over foreign investors. Finally, we detect strong persistence in mean returns up to 1 year. It is striking that “winning” funds are able to significantly beat the market, based on their significantly positive alpha's. These results deviate from studies on developed markets that conclude that even past winners are not able to significantly beat the market.     

Equity market contagion during the global financial crisis: Evidence from the world's eight largest economies

The global financial crisis (2007–2009) saw sharp declines in stock markets around the world, affecting both advanced and emerging markets. In this paper we test for the existence of equity market contagion originating from the US to advanced and emerging markets during the crisis period. Using a latent factor model, we provide strong evidence of contagion effects in both advanced and emerging equity markets. In the aggregate equity market indices, contagion from the US explains a large portion of the variance in stock returns in both advanced and emerging markets. However, in the financial sector indices we find less evidence of contagion than in the aggregate indices, and this is particularly the case for the advanced markets. The results suggest that contagion effects are not strongly related to high levels of global integration.     

Income diversification and bank risk in Asia Pacific

This paper investigates the effect of income diversification on bank risk for a large sample of commercial banks in 14 Asia Pacific economies over the period 2011–2016. Using a dynamic panel data model with a system generalized methodof moments estimator, we find that banks with a higher level of income diversification are less risky in general. We further consider both developed and emerging economies according to the International Monetary Fund's classification of the level of economic development. Specifically, for emerging economies, the results indicate that banks with a higher level of income diversification face less risk. However, the diversification of commercial bank income has no significant impact on bank risk in developed Asia Pacific economies.     

Economies of diversification in the US credit union sector

Significant scale economies have been recently cited to rationalize a dramatic growth in the US retail credit union sector over the past few decades. In this paper, we explore another plausible supply‐side explanation for the growth of the industry, namely economies of diversification. We focus on the fact that credit unions differ among themselves in the range of financial services they offer to their members. Since larger credit unions tend to offer a more diversified financial service menu than credit unions of a smaller size, the incentive to grow in size may be fueled not only by present scale economies but also by economies of diversification. This paper provides the first robust estimates of such economies of diversification for the credit union sector. We estimate a flexible semiparametric smooth coefficient quantile panel data model with correlated effects that is capable of accommodating a four‐way heterogeneity among credit unions. Our results indicate the presence of non‐negligible economies of diversification in the industry. We find that as many as 27–91% (depending on the type and the cost quantile) of diversified credit unions enjoy substantial economies of diversification; the cost of most remaining credit unions is invariant to the scope of services. We also find overwhelming evidence of increasing returns to scale in the industry.