Ratings based capital adequacy for securitizations

This paper develops a framework to measure the exposure to systematic risk for pools of asset securitizations and measures empirically whether current ratings-based rules for regulatory capital of securitizations under Basel II and Basel III reflect this exposure. The analysis is based on a comprehensive US dataset on asset securitizations for the time period between 2000 and 2008. We find that the shortfall of regulatory capital during the Global Financial Crisis is strongly related to ratings. In particular, we empirically show that insufficient capital is allocated to tranches with the highest rating. These tranches account for the greatest part of the total issuance volumes. Furthermore, this paper is the first to calibrate risk weights which account for systematic risk and provide sufficient capital buffers to cover the exposure during similar economic downturns. These policy-relevant findings suggest a re-calibration of RBA risk weights and may contribute to the current efforts by the Basel Committee on Banking Supervision and others to re-establish sustainable securitization markets and to improve the stability of the financial system.     

Price incentives and consumer payment behaviour

In this paper we estimate the effect of particular price incentives on consumer payment patterns using transaction-level data. We find that participation in a loyalty program and access to an interest-free period tend to increase credit card use at the expense of alternative payment methods, such as debit cards and cash. Interestingly though, the pattern of substitution from cash and debit cards differs according to the price incentive. An implication of the findings is that the Reserve Bank reforms of the Australian payments system are likely to have influenced observed payment patterns.     

A leverage ratio rule for capital adequacy

This paper studies the economic foundations for maximum leverage ratio capital adequacy rules. The paper makes three contributions to the literature. First, we show how to determine the maximum leverage ratio such that the probability of insolvency is less than some predetermined quantity. Two, we show that a leverage ratio rule controls for the same risks as does a Value-at-Risk (VaR) capital adequacy rule. Third, we argue that leverage ratio rules are better than VaR rules because they are more intuitive and easier to compare across firms.     

Bank loan recovery rates: Measuring and nonparametric density estimation

In this paper we analyse a comprehensive database of 149,378 recovery rates on Italian bank loans. We investigate a new methodology to compute the recovery percentage that we suggest to consider as a mixed random variable. To estimate the probability density function of such a mixture, we propose the mixture of beta kernels estimator and we analyse its performance by Monte Carlo simulations. The application of these proposals to the Bank of Italy’s data shows that, even if we remove the endpoints from the support of the recovery rate, the density function estimate is far from being a beta function.     

关于资产证券化的资本计量

由于美国住房抵押贷款证券化产品的暴跌是次贷危机引爆器,因此,人们在研究加强资本监管时,会对证券化的资本计量给予特别关注。本文从理论结合实践的角度,对证券化产品各类市场参与者的相关资本计量问题进行了思考,梳理并归纳了资产证券化发起机构、投资机构和中介机构在各自资本计量过程中需遵循的原则及思路。     

Does adding up of economic capital for market- and credit risk amount to conservative risk assessment?

There is a tradition in the banking industry of dividing risk into market risk and credit risk. Both categories are treated independently in the calculation of risk capital. But many financial positions depend simultaneously on both market risk and credit risk factors. In this case, an approximation of the portfolio value function separating value changes into a pure market risk plus pure credit risk component can result not only in an overestimation, but also in an underestimation of risk. We discuss this compounding effect in the context of foreign currency loans and argue that a separate calculation of economic capital for market risk and for credit risk may significantly underestimate true risk.     

A systematic approach to multi-period stress testing of portfolio credit risk

We propose a new method for analysing multi-period stress scenarios for portfolio credit risk more systematically than in current macro stress tests. The plausibility of a scenario is quantified by its distance from an average scenario. For a given level of plausibility, we search systematically for the most adverse scenario. This ensures that no plausible scenario will be missed. We show how this method can be applied to some models already in use by practitioners. While worst case search requires numerical optimisation we show that we can work with reasonably good linear approximations to the portfolio loss function. This makes systematic multi-period stress testing computationally efficient and easy to implement. Applying our approach to data from the Spanish loan register we show that, compared to standard stress test procedures, our method identifies more harmful scenarios that are equally plausible.     

Influence of disclosure and governance on risk of US financial services firms following Sarbanes-Oxley

This study finds significant changes in capital market measures of risk following the passage of Sarbanes-Oxley for US financial services firms. Shorter-term measures of risk shifts are positive, on average, and consistent with the mandatory nature of the disclosure and governance provisions. Longer-term total and unsystematic risk shifts are negative, on average, and consistent with reductions in investor uncertainty as transparency improved. We find that the changes in shorter-term and longer-term risk measures vary inversely with the strength of disclosure and governance characteristics. The financial market rewarded (punished) firms with stronger (weaker) disclosure and stronger (weaker) governance.     

Ownership structure, market discipline, and banks’ risk-taking incentives under deposit insurance

The paper studies the effects of market discipline by creditors and ownership structure on banks’ risk taking in the presence of partial deposit insurance. An agency-cost model explains how the effects of creditor discipline and shareholder control are interdependent, the non-monotonic effect of shareholder control, and the role of leverage. Panel regressions on several hundred banks worldwide 1995-2005 confirm a negative individual risk effect of creditor discipline and the expected convex effect of shareholder control. Increased shareholder control significantly strengthens the negative effect of market discipline on asset risk, but joint effects on overall default risk are limited.     

Capital management in mutual financial institutions

Capital management by mutual financial institutions (such as credit unions) provides a valuable testing ground for assessing the impact of capital regulation and theories of managerial behaviour in financial institutions. Limited access to external equity capital means that capital accumulation must be met primarily by reliance on retained earnings. To deal with shocks to the capital position and avoid breaching regulatory requirements, managers will aim to have a buffer of capital in excess of the regulatory minimum. Moreover, mutual governance arrangements and an absence of capital market discipline mean that managers have discretion to set target capital ratios which differ significantly from industry averages. This paper develops a formal model of capital management and risk management in mutual financial institutions such as credit unions which reflects these industry characteristics. The model is tested using data from larger credit unions in Australia, which have been subject to the Basel Accord Risk Weighted Capital Requirements since 1993. The data supports the hypothesis that credit unions manage their capital position by setting a short term target profit rate (return on assets) which is positively related to asset growth and which is aimed at gradually removing discrepancies between the actual and desired capital ratio. Desired capital ratios vary significantly across credit unions. There is little evidence of short run adjustments to the risk of the asset portfolio to achieve a desired capital position.     

Understanding merger incentives and outcomes in the US mutual fund industry

This paper examines the incentives of acquirers and targets in the merger market. Using data on acquisitions among mutual fund management companies from 1991 to 2004, I estimate a two-sided matching model of the merger market jointly with equations representing merger outcomes. According to the empirical investigation, although the desire to achieve a sufficient scale to attract investors is a key driver for mergers, some mergers seem to be driven by objectives other than shareholder value maximization. I find that companies that are potentially prone to misaligned incentives between owners and managers are more acquisitive than others, yet have significantly worse post-merger operating performance. I also find that these acquirers, despite their higher willingness to pay for targets, are not any more likely to match with high-quality targets, potentially due to targets’ incentive to avoid bad organizations.     

Capital shocks, bank asset allocation, and the revised Basel Accord

In contrast to the 1988 Basel Accord (Basel I), the revised risk-based capital standards (Basel II) propose regulatory capital requirements based on credit ratings. This paper develops a theoretical model to analyze how banks will adjust their low and high credit risk commercial loans under the proposed newer standard. Capital-constrained banks respond to an adverse capital shock by reducing high credit risk loans, while under certain circumstances, low credit risk loans may actually increase. When compared to Basel I, it is shown that high-risk loans are reduced more under Basel II, but whether a bank reduces total lending more under Basel I or under the revised standards depends on a complex interaction of factors.     

The Basel III Net Stable Funding Ratio and bank net interest margins

The Net Stable Funding Ratio (NSFR) is a new Basel III liquidity requirement designed to limit funding risk arising from maturity mismatches between bank assets and liabilities. This study explains the NSFR and estimates this ratio for banks in 15 countries. Banks below the ratio need to increase stable sources of funding and to reduce assets requiring funding. The most cost-effective strategies to meet the NSFR are to increase holdings of higher-rated securities and to extend the maturity of wholesale funding. These changes reduce net interest margins by 70–88 basis points on average, or around 40% of their year-end 2009 values. Universal banks with diversified funding sources and high trading assets are penalized most by the NSFR.     

Capital requirements under the credit risk-based framework

This work aims to study the hypothesis of lower capitalization of banks under the risk-based rules introduced in Basel II. In this sense, an assessment of the impact of these rules on the capital requirements for non-financial firms’ credit risk is performed. A comparison with Basel I is presented and intervals of variation for the risk drivers such that capital requirements exceed the ones under Basel I are established. Data for a European country supports the hypothesis of a smaller capitalization of banks under the risk-based framework, as far as credit risk in concerned.     

Breaking down the barriers: Competition,syndicate structure,and underwriting incentives

We argue that the entry of commercial banks into bond underwriting led to the evolution of co-led underwriting arrangements and lowered the screening incentives of underwriters. Lead underwriters in co-led syndicates faced weaker incentives to screen issuer quality. In boom markets, issues underwritten by co-led syndicates were more likely to be involved in financial misrepresentation events. Underwriter incentives in co-led syndicates were particularly weak in industries where commercial banks stole substantial market share. Similar patterns do not hold in bust markets where investors are likely to engage in their own information collection efforts. Our results suggest that competition may have an adverse effect on the incentives of financial intermediaries in market environments where their information production is more valuable to investors.     

Interaction of market and credit risk

Experience during the financial crisis illustrates that the integrated measurement and management of different forms of risk remains a challenge for industry practitioners, researchers and financial supervisors alike. In the context of related literature, this article summarizes new research on the interaction of market and credit risk and implications for risk management that is presented in this special issue. The research covered highlights in particular the errors that can occur in the aggregation of the two types of risk and the strong relationships between them that suggest caution in the use of pragmatic distinctions between them. The article also touches on some research-based lessons for supervisory policies and suggests some directions for future research.     

Financial crisis,structure and reform

In this study, we examine the relationship between the structure of financial systems and financial crises. Using cross-country data on financial structures and crises, we find that there is a significant short-term reversal in development of the banking sector and the stock market during both bank crises and market crashes, with the corporate bond market moving in the same direction as bank credit. However, the results are significant for countries with market-based financial systems but not for countries with bank-based financial systems. Emerging markets have mainly bank-based financial systems, which may explain why these markets require more time to recover from economic downturns after a financial crisis. Therefore, we argue that governments should emphasize a balanced financial system structure as it helps countries to recover from financial crises more quickly compared with countries that lack such balanced structures.     

Dynamics of Banks' Capital Accumulation

We construct a dynamic neoclassical model of banking capital where the dynamics are governed by the process of financial capital accumulation and credit risk realizations in a structure where stylized banking characteristics are maintained. This is aimed at focusing on how the profit‐maximizing capital ratio of banks evolves and how it reacts to exogenous shocks particularly so during periods of prolonged downturn of the economy. We examine impulse responses of our model to credit risk shock, business cycle shock, and monetary policy shock. The convergence of financial capital to its optimal level is also explored.     

Bank incentives and suboptimal lending decisions: Evidence from the valuation effect of bank loan announcements in Japan

Using a sample of bank loan announcements in Japan, we examine whether or not banks have incentives to engage in suboptimal lending that results in wealth transfer from the banks to the borrowing firms. We find that abnormal returns for borrowing firms are significantly positive, but those for lending banks are sometimes significantly negative. Furthermore, the announcement returns for borrowing firms are negatively related to those for lending banks, especially when poorly performing firms borrow from financially healthy (low-risk) banks. Our results suggest that the positive valuation effect of bank loan announcements for borrowing firms is mainly due to a wealth transfer from lending banks.     

Valuation of insurers’ contingent capital with counterparty risk and price endogeneity

This study develops a structural framework to value insurers’ contingent capital with counterparty risk (CR) and overcomes the problem of price endogeneity (PE) in the valuation model. Our results on the focal contingent capital instrument – catastrophe equity put option (CatEPut) – indicate that prices can be significantly overestimated without considering CR and be significantly underestimated without considering PE. This study also examines how CatEPuts affect the buyer’s probability of default (PD). Our results show that buying a CatEPut lowers the PD for high-risk insurers, but not necessarily so for low-risk insurers; however, without taking CR and PE into account, one may significantly overestimate the credit enhancement provided by the CatEPuts.