Credit risk and the business cycle: What do we know?

We perform a meta-regression analysis to characterize the relationship between ex post credit risk, measured through non-performing loans and real GDP growth. Although the prior empirical literature reveals a statistically significant inverse association, the precise effect of growth performance to credit quality diverges and remains subject to several qualifications. Using estimates from 56 studies and applying a Bayesian meta-regression analysis we explore the systematic patterns of the heterogeneity in the reported estimates. According to our evidence, the specification form as well as features related to the type of data, and the sample period are factors that systematically influence the estimated results.     

Credit risk transfer in U.S. commercial banks: What changed during the 2007–2009 crisis?

Following the debate on the role of credit risk transfer (CRT) in exacerbating the 2007–2009 crisis, this paper investigates the usage and effects of loan sales, securitization, and credit derivatives in U.S. commercial banks over the last decade, with special emphasis on the financial crisis. We find that in times of severe funding constraints, the need to raise financial resources becomes the principal incentive behind CRT. We document some beneficial effects of CRT on the economy, since the funds released through CRT are subsequently invested by banks to sustain credit supply, also in recession. However, we report higher overall riskiness in banks that engage intensively in loans sales and securitization, which translates into higher default rates during the crisis. Interestingly, the benefits and drawbacks of CRT are much stronger for loan sales and securitization than for credit derivatives.     

What do investment banks charge to underwrite American Depositary Receipts?

We investigate how investment banks determine the gross spreads paid by American Depositary Receipts (ADRs) from 1980 to 2004. We begin by comparing the gross spreads of ADR IPOs and ADR SEOs to those of matching US IPOs and US SEOs. We document clustering at the 7% level for our ADR IPO sample (44% for the ADR IPO firms without a previous equity listing), whereas our ADR SEO sample exhibits no discernable clustering at any level. We then find that ADR IPO gross spreads can be explained by firm and offer characteristics (similar to our matched sample of US IPOs), and by whether the ADR IPO firm has a previous equity listing. ADR SEO gross spreads can be explained more by offer characteristics (more similar to our matched sample of US SEOs).     

Why do (or did?) banks securitize their loans? Evidence from Italy

This paper investigates the ex ante determinants of bank loan securitization by using different econometric methods on Italian individual bank data from 2000 to 2006. Our results show that bank loan securitization is a composite decision. Banks that are less capitalized, less profitable, less liquid and burdened with troubled loans are more likely to perform securitization, for a larger amount and earlier.     

What determines the profitability of banks? Evidence from Spain

This paper empirically analyses the factors that determine the profitability of Spanish banks for the period of 1999–2009. We conclude that the high bank profitability during these years is associated with a large percentage of loans in total assets, a high proportion of customer deposits, good efficiency and a low doubtful assets ratio. In addition, higher capital ratios also increase the bank’s return, but only when return on assets (ROA) is used as the profitability measure. We find no evidence of either economies or diseconomies of scale or scope in the Spanish banking sector. Finally, our study reveals differences in the performance of commercial and savings banks.     

What do financial intermediaries do?

This paper presents evidence that the traditional banking business of accepting deposits and making loans has declined significantly in the US in recent years. There has been a switch from directly held assets to pension funds and mutual funds. However, banks have maintained their position relative to GDP by innovating and switching from their traditional business to fee-producing activities. A comparison of investor portfolios across countries shows that households in the US and UK bear considerably more risk from their investments than counterparts in Japan, France and Germany. It is argued that in these latter countries intermediaries can manage risk by holding liquid reserves and intertemporally smoothing. However, in the US and UK competition from financial markets prevents this and risk management must be accomplished using derivatives and other similar techniques. The decline in the traditional banking business and the financial innovation undertaken by banks in the US is interpreted as a response to the competition from markets and the decline of intertemporal smoothing.     

How do banks adjust their capital ratios?

We analyze the dynamics of banks’ regulatory capital ratios. Using monthly regulatory data of large German banks, we estimate the target level and the adjustment speed of the capital ratio for each bank separately. There exists a target level for a substantial percentage of banks. Unlike with panel regressions, we can estimate individual adjustment speeds and find large variation across banks. Adjustments on the liability side are most effective, although adjustment rates on the asset side are higher. Private commercial banks (neither state-owned nor cooperative) and banks with a high level of proprietary trading are more likely to adjust their capital ratio tightly. Banks with a target capital ratio compensate for low target ratios with low asset volatilities and high adjustment speeds. They seem to care mainly about the resulting probability to comply with the regulatory minimum. Assuming low variation of this probability explains most of the large cross-sectional variation of bank capital.     

Credit risk interconnectedness: What does the market really know?

We analyze the relation between market-based credit risk interconnectedness among banks during the crisis and the associated balance sheet linkages via funding and securities holdings. For identification, we use a proprietary dataset that has the funding positions of banks at the bank-to-bank level for 2006–2013 in conjunction with investments of banks at the security level and the credit register from Germany. We find asymmetries both cross-sectionally and over time: when banks face difficulties to raise funding, the interbank lending affects market-based bank interconnectedness. Moreover, banks with investments in securities related to troubled classes have a higher credit risk interconnectedness. Overall, our results suggest that market-based measures of interdependence can serve well as risk monitoring tools in the absence of disaggregated high-frequency bank fundamental data.     

The credit crisis around the globe: Why did some banks perform better?

Though overall bank performance from July 2007 to December 2008 was the worst since the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been put forth as having contributed to the poor performance of banks during the credit crisis. The evidence is supportive of theories that emphasize the fragility of banks financed with short-term capital market funding. The better-performing banks had less leverage and lower returns immediately before the crisis. Differences in banking regulations across countries are generally uncorrelated with the performance of banks during the crisis, except that large banks from countries with more restrictions on bank activities performed better and decreased loans less. Our evidence poses a substantial challenge to those who argue that poor bank governance was a major cause of the crisis because we find that banks with more shareholder-friendly boards performed significantly worse during the crisis than other banks, were not less risky before the crisis, and reduced loans more during the crisis.     

How do banks price liquidity? The role of market power.

We empirically examine the effects of different measures of liquidity on interest margins of a sample of U.S. commercial banks from 2001 to 2018. Overall, the results reveal that liquidity ratios exert a positive influence on bank margins. Furthermore, the study investigates the role of market power in the relationship between liquidity and interest margins. It is documented that dominant banks incorporate the costs associated with investing in liquidity into the bank margins to a lesser extent than banks with less market power, suggesting that the cost of complying with regulatory liquidity standards is reduced when the competition in the banking sector is less intense. The study highlights that market competition might be important in the design and implementation of liquidity regulations.     

Bank mergers: What should policymakers do?

These remarks discuss why the “cluster” of financial services and local banking markets are still relevant for antitrust analysis in banking. A key portion of the Federal Reserve’s Order approving the NationsBank–Barnett merger is interpreted, and the extent to which antitrust is a practical constraint on the development of a nationwide banking structure is commented upon.     

What drives local lending by global banks?

We find that the lending behavior of global banks’ subsidiaries throughout the world is more closely related to local macroeconomic conditions and their financial conditions than to those of their owner-specific counterparts. This inference is drawn from a panel dataset populated with bank-level observations from the Bankscope database. Using this database, we identify ownership structures and incorporate them into a unique methodology that identifies and compares the owner and subsidiary-specific determinants of lending. A distinctive feature of our analysis is that we use multi-dimensional country-level data from the BIS international banking statistics to account for exchange rate fluctuations and cross-border lending.     

What drives portfolio investments of German banks in emerging capital markets?

After decades of steady liberalization and financial market development, emerging capital markets experienced unparalleled capital inflows in the aftermath of the emerging markets crisis of the 1990s. This paper studies portfolio investment decisions of German banks in emerging capital markets from 2002 to 2007. The use of a dynamic time-series cross-section framework and the micro database External Position Report provided by Deutsche Bundesbank permit insights into the various determinants of portfolio investments in ECMs. For example, there is evidence that German banks take into account the various dimensions of financial market development in their portfolio investment decisions and anticipate the special risks inherent in emerging markets. Proxies for the overall development and efficiency of capital markets have the highest economic significance of all variables. The introduction of depositary receipts programs has a positive impact on stock market investment. Moreover, there is evidence that global risk aversion exerts a significant influence in times of financial turmoil.     

What drives the cost of US dollar bond funding for banks?

This paper decomposes issue spreads on US dollar-denominated bonds issued by LIBOR panel banks into credit risk and liquidity premium components. We attribute the recent increase in issue spreads to the investor perception that banks are less creditworthy than in the past. Although the behaviour of the credit risk component is well-explained by a structural model of default, this mechanism is nullified by the introduction of government guarantees. The behaviour of the liquidity premium component is partially explained by the bid/ask spread in the secondary market and issue size. Government guarantees also reduce the liquidity component of the issue spread.     

Credit unions vs. commercial banks,who takes more risk?

A unique feature of the financial services industry is that both shareholder-owned banks and member-owned credit unions coexist and compete against each other. In this study, we investigate two research questions. First, we compare risk-taking by banks and credit unions, with an additional consideration as to how regulatory oversight (state or federal) relates to such risk-taking. Second, we examine how competition affects the difference in risk-taking between these two types of financial institutions. To answer both questions, we rely on a matched sample (by loan type, size, and county) of commercial banks and credit unions, covering the period between 2010 and 2017. We use three empirical proxies for risk-taking, the Z-score, measuring an institution’s insolvency risk, as well as the ratios of non-performing loans to total loans and loan charge-offs to total loans, measuring the credit risk. Our results suggest that banks tend to engage in more risk-taking than credit unions; however, state regulatory oversight reduces the risk-taking gap, especially in terms of the Z-score. We further find that competition induces different risk-taking behaviors in banks and credit unions. Our results are robust to several alternative specifications.     

Capital structure of Islamic banks: How different are they from conventional banks?

This paper uses comprehensive data for 112 Islamic and 709 conventional banks from 23 countries over 1995–2015 to compare the capital structure of Islamic banks (IBs) and conventional banks (CBs) from several perspectives. We find that IBs and CBs seem to face different cost pressures in the process of adjusting towards the target capital structure. Asset growth is a key driver of capital structure change, and CBs adjust leverage more aggressively in response to changes in total assets compared to IBs, because they have an advantage in obtaining external funds and can achieve leverage adjustments faster and at a low cost. IBs have more regulatory capital, but their ability to respond to risks is weaker than traditional banks. The results of this paper suggest that Islamic banks are in a disadvantaged position compared to CBs in capital structure management. The conclusion suggests that IBs need to expand its financing tools and funding sources to reduce adjustment costs and improve their capability to deal with asset risk.     

What Drives the Cross‐Section of Credit Spreads?: A Variance Decomposition Approach

I decompose the variation of credit spreads for corporate bonds into changing expected returns and changing expectation of credit losses. Using a log‐linearized pricing identity and a vector autoregression applied to microlevel data from 1973 to 2011, I find that expected returns contribute to the cross‐sectional variance of credit spreads nearly as much as expected credit loss does. However, most of the time‐series variation in credit spreads for the market portfolio corresponds to risk premiums.     

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.