Banking Competition,Risk and Regulation*

In a dynamic framework, commercial banks compete for customers by setting acceptance criteria for granting loans, while taking into account regulatory requirements. By easing its acceptance criteria a bank faces a trade‐off between attracting more demand for loans, thus making higher per‐period profits, and deterioration in the quality of its loan portfolio, thus tolerating a higher risk of failure. Our main results state that more stringent capital adequacy requirements lead banks to set stricter acceptance criteria, and that increased competition in the banking industry leads to riskier bank behaviour. It is shown that risk‐adjusted regulation is effective. In an extension of our basic model, we show that it may be beneficial for a bank to hold more equity than prescribed by the regulator, even though issuing equity is more expensive than attracting deposits.     

The transmission of bank capital requirements and monetary policy to bank lending in Germany

We investigate the transmission of changes in bank capital requirements and monetary policy, and their interaction, on German banks’ corporate loan growth and lending rates. Our results show that increases in capital requirements are associated with an immediate decrease in total domestic and cross‐border bank lending. Changes in the euro area's monetary policy stance are positively related to corporate loan interest rates in general. Regarding the interacting effect of national bank capital requirements and euro area monetary policy, we observe that the transmission of accommodative euro area monetary policy to corporate lending rates can be attenuated by contemporaneous increases in bank capital requirements. Moreover, more strongly capitalized banks increase their loan growth in response to accommodative monetary policy whereas, for weaker banks, increasing capital requirements implies a decrease in their corporate loan growth. Our results confirm a tradeoff between higher capital requirements and accommodating monetary policy originating from banks’ capital constraints.     

Surplus liquidity,central bank losses and the use of reserve requirements in emerging markets

Since the turn of the millennium, stocks of foreign reserves held by central banks in many emerging markets and developing countries have exceeded currency in circulation. To steer money market rates, these central banks have been absorbing liquidity from, rather than providing it to, the banking sector in their regular monetary policy operations. When interest rates in countries with major reserve currencies are low, the yield on foreign reserves is low. A higher interest rate on liquidity‐absorbing operations may expose central banks to losses. Although a central bank is not a profit‐maximizing institution, central bank losses can undermine the independence of the central bank. Using data for a large panel of central banks, this paper provides some evidence that central banks tend to apply low‐remunerated reserve requirements when profitability is at stake.     

BANK CAPITAL FORBEARANCE AND PUBLIC POLICY

Recently, the bank regulatory agencies have adopted capital forbearance programs to permit some troubled agriculture and energy banks to operate temporarily with capital levels below the regulatory minimum requirement. In a world with federal deposit insurance and a lender of last resort, bank capital is no longer viewed by all depositors as the primary protector of their funds. Thus, they reduce their market discipline. Bank owners/ managers are likely to respond by increasing their risk exposure in an attempt to regain profitability. If they win, they keep all the gains; if they lose, the losses are passed on to the Federal Deposit Insurance Corporation (FDIC). A preferred policy is to require these banks to raise additional capital at this time or to be sold. Capital forbearance is forbearance of incumbent bank management/owners, not of bank customers.     

Basel II procyclicality: The case of South Africa

This paper studies the impact of bank capital regulation on business cycle fluctuations. In particular, we study the procyclical nature of Basel II claimed in the literature. To do so, we adopt the Bernanke et al. (1999) “financial accelerator” model (BGG), to which we augment a banking sector. We first study the impact of a negative shock to entrepreneurs' net worth and a positive monetary policy shock on business cycle fluctuations. We then look at the impact of a negative net worth shock on business cycle fluctuations when the minimum capital requirement increases from 8 percent to 12 percent. Our comparison studies between the augmented BGG model with Basel I bank regulation and the one with Basel II bank regulation suggest that, in the presence of credit market frictions and bank capital regulation, the liquidity premium effect further amplifies the financial accelerator effect through the external finance premium channel, which, in turn, contributes to the amplification of Basel II procyclicality. Moreover, under Basel II bank regulation, in response to a negative net worth shock, the liquidity premium and the external finance premium rise much more if the minimum bank capital requirement increases, which, in turn, amplify the response of real variables. Finally, small adjustments in monetary policy can result in stronger response in the real economy, in the presence of Basel II bank regulation in particular, which is undesirable.     

Cyclical behavior of the financial stability of eurozone commercial banks

In light of the financial crisis and the European sovereign debt crisis, we investigate the cyclical behavior of the financial stability of banks of the Eurozone, using an unbalanced dynamic panel of 722 commercial banks covering the period 1999–2013, and the generalized method of moments system. We find a negative relationship between business cycle and bank risk-taking, indicating that financial stability is procyclical. In addition, the study shows that lending activity increases risk-taking while rising capital requirements boost financial stability. Moreover, our findings suggest positive co-movements between the business cycle and lending, compared to bank's capital, whereby the procyclicality of lending and bank capital have negative effects on the financial stability of commercial banks in the Eurozone. We notice then that the cyclical behavior of commercial banks, in terms of capital requirements and lending activities, depends on their size. Therefore, lending and capital of smaller banks are procyclical while lending and capital of larger banks are countercyclical. Finally, we find the Troika institutions’ bailouts programs significantly impacted banking stability in the Eurozone.     

BANK RUNS: DEPOSIT INSURANCE AND CAPITAL REQUIREMENTS*

Diamond and Dybvig provide a model of intermediation in which deposit insurance can avoid socially undesirable bank runs. We extend the Diamond–Dybvig model to evaluate the costs and benefits of deposit insurance in the presence of moral hazard by banks and monitoring by depositors. We find that complete deposit insurance alone will not support the first‐best outcome: depositors will not have adequate incentives for monitoring and banks will invest in excessively risky projects. However, an additional capital requirement for banks can restore the first‐best allocation.     

资本监管、银行信贷与货币政策非对称效应

本文通过对在单一约束的商业银行利润函数中植入监管当局惩罚函数的静态理论模型的分析得出:监管当局以提高资本充足率为核心的监管行为不仅有效地影响了商业银行的信贷行为和风险意识,而且强化了"逆风向行事"的货币政策的非对称效应,接着本文对我国1998年以来经历的两次经济波动进行了实证分析,其结论是:1998年以来,监管当局对商业银行以降低坏账率、提高资本充足率为核心的监管行为强化了我国货币政策非对称效应。     

Competition Among Banks, Capital Requirements and International Spillovers

The design of prudential bank capital requirements interacts with the industrial organization of the banking sector, in particular, with the level of competition among banks. Increased competition leads to excessive risk-taking by banks which may have to be counteracted by tighter capital requirements. When capital requirements are internationally uniform but the levels of competition among banks in different countries are not, international spillovers arise on financial integration of these countries. This result begs a more careful analysis of the effect of financial liberalization on the stability of banking sectors in emerging countries. It also calls into question the merits of employing uniform capital requirements across countries that diverge in the industrial organization of their banking sectors.
(J.E.L.: G21, G28, G38, F36, E58, D62)     

Regulating the banking industry in transition economies: Exploring interactions between capital and reserve requirements

This paper examines the ‘prudential' role of reserve requirements in transition economies using a general-equilibrium banking model. The analysis stresses the role that reserve requirements may play in enforcing an adequate level of bank capitalization in a context in which it is difficult to assess the true value of bank assets. The paper also explores the interactions that exist between capital and reserve requirements and the effect of these regulations on the financial structure of banks and on the level of credit and interest rates.     

A MODEL OF SELF‐FULFILLING FINANCIAL CRISES*

This paper combines the structural weakness and the self‐fulfilling panic view to explain the cause of the East Asian crises. In this model economy, the diversification strategies induce conglomerate firms to overinvest. They accumulate losses due to their unprofitable sectors and then compensate by obtaining bank loans. Domestic banks, which borrow from foreign banks, lend money as long as the total amount of accumulated loans remains within the firms’ collateral value. The model shows that if the debt to collateral value ratio belongs to a certain range a self‐fulfilling crisis can occur due to the self‐fulfilling expectations of foreign investors.     

Optimal regulation of deposit taking financial intermediaries: A correction

This paper corrects a paper of David Miles, published in the European Economic Review in 1995, reversing some of the conclusions he draws. Solving his model correctly it turns out that, because depositors are unable to monitor the default risk of individual banks, moral hazard gives banks an incentive to increase risky lending. Prudential capital requirements reduce incentives to hold risky loans.     

Shocks to bank capital: evidence from UK banks at home and away

This article assesses how shocks to bank capital may influence a bank's portfolio behaviour using novel evidence from a UK bank panel data set from a period that predates the recent financial crisis. Focusing on the behaviour of bank loans, we extract the dynamic response of a bank to innovations in its capital and in its regulatory capital buffer. We find that innovations in a bank's capital in this (precrisis) sample period were coupled with a loan response that lasted up to 3 years. The international presence of UK banks allows us to identify a specific driver of capital shocks in our data, independent of bank lending to UK residents. Specifically, we use write-offs on loans to nonresidents to instrument bank capital's impact on UK resident lending. A fall in capital brought about a significant drop in lending in particular, to Private Nonfinancial Corporations (PNFC). In contrast, household lending increased when capital fell, which may indicate that, in this precrisis period, banks substituted into less risky assets when capital was short.     

REFORMING BANK CAPITAL REGULATION: USING SUBORDINATED DEBT TO ENHANCE MARKET AND SUPERVISORY DISCIPLINE

In 1988 the Basel Capital Accord introduced minimum risk-weighted capital requirements for internationally active banks. In recent years there has been a growing realization that there are significant problems with the capital guidelines. As financial firms have become more sophisticated and complex they have effectively arbitraged the requirements and have become so good at it that the regulations have essentially ceased being a safety and soundness issue for supervisors and have become more of a compliance issue. Indeed, the Basel Committee is now evaluating reforms to the capital accord and is considering various means to improve the risk-capital relationship and to increase the role of market discipline. The authors argue that many of the problems that currently exist can be addressed, and some additional benefits not previously possible under the current capital guidelines can be realized, by increasing the role of subordinated debt in the bank capital structure. The authors discuss the potential benefits and offer a capital reform proposal that would improve both market and supervisory oversight. This should lead to more prudent risk management behavior by the larger, more complex banking organizations, resulting in a safer industry with less potential for systemic problems.     

What impact do differences in financial structure have on the macro effects of bank capital requirements in the United States and Australia?

We investigate the influence of jurisdictional differences in financial structure on the economic consequences of bank capital regulation. We use two disaggregated financial computable general equilibrium models to compare the impacts of identical increases in bank capital adequacy ratios in the U.S. and Australia. In both models, this raises bank equity financing shares, and lowers banks’ risk-weighted asset holdings. Thereafter however, differences in financial structure drive contrasting outcomes: in the U.S., average costs of capital fall, stimulating real investment, while we find the opposite outcome for Australia. We attribute this to differences in the structure of bank assets (U.S. banks hold more risk-free assets) and the importance of banks as intermediaries (bank finance is more important to capital formation in Australia). This may explain why capital regulations encompass non-banks in the U.S. but not Australia.     

Capital and liquidity in a dynamic model of banking

This paper analyzes capital requirements in combination with a particular kind of cash reserves, that are invested in the risk-free asset, from now on, compensated reserves. We consider a dynamic framework of banking where competition may induce banks to gamble. In this set up, we can capture the two effects that capital regulation has on risk, the capital-at-risk effect and the franchise value effect (Hellman et al., 2000). We show that while capital alone is an inferior policy, compensated reserves, will complement capital requirements, by creating franchise value, and are therefore efficient in solving moral hazard problems.     

Inside the bank lending channel

This paper tests cross-sectional differences in the effectiveness of the bank lending channel. The results, derived from a comprehensive sample of Italian banks, suggest that heterogeneity in the monetary policy pass-through exists. After a monetary tightening the decrease in lending is lower for well-capitalized banks that are perceived as less risky by the market and are better able to raise uninsured deposits. Liquid banks can protect their loan portfolio against monetary tightening simply by drawing down cash and securities. The presence of internal capital markets in bank holding companies also contributes to insulate monetary shocks. Bank size is never relevant.     

资本要求、“多而不倒” 救助与系统性风险

本文从银行之间资产回报相关性的角度研究系统性风险，通过构建理论模型考察了存在“多而不倒”救助时资本要求对系统性风险的影响，并且以11个国家（地区）2006-2012年的相关数据为样本进行实证检验。研究结果表明，一定条件下“多而不倒”救助是监管者的最优选择，然而当存在这种“事后”最优政策时，资本要求的提高可能会通过影响银行“事前”投资决策的方式扩大银行之间的系统相关性，提高系统性风险隐患。这一效应在金融自由化程度较低的国家表现得更为显著。中国的资本监管改革应注意与金融市场化改革相协调。     

Over- and Underbidding in Central Bank Open Market Operations Conducted as Fixed Rate Tender

Abstract. Open market operations play a key role in allocating central bank funds to the banking system and thereby in steering short‐term interest rates in line with the stance of monetary policy. Many central banks apply so‐called ‘fixed rate tender’ auctions in their open market operations. This paper presents, on the basis of a survey of central bank experience, a model of bidding in such tenders. In their conduct of fixed rate tenders, many central banks faced specifically an ‘under‐’ and an ‘overbidding’ problem. These phenomena are revisited in the light of the proposed model, and the more general question of the optimal tender procedure and allotment policy of central banks is addressed.     

Banks' Capital Structure and the Liquid Asset – Policy Implication of Taiwan

Banks' size, liquidity and profitability are the main determinants of their capital ratios in Taiwan. Large banks implicitly substitute bank capital for regulator's capital and banks mainly depend on internal cash flows for capitalization. However, medium-sized banks in Taiwan use liquidity as a substitute for bank capital, and small banks with low liquidity tend to have lower capital ratios. Regulators should pay close attention to these banks since they may be undercapitalized.