The simple economics of bank fragility

Banks are linked through the interbank deposit market, participations like syndicated loans and deposit interest rate risk. The similarity in exposures carries the potential for systemic breakdowns. This potential is either strong or weak, depending on whether the linkages remain or vanish asymptotically. It is shown that the linearity of the bank portfolios in the exposures, in combination with a condition on the tails of the marginal distributions of these exposures, determines whether the potential for systemic risk is weak or strong. We show that if the exposures have marginal normal distributions the potential for systemic risk is weak, while if e.g. the Student distributions apply the potential is strong.     

Competitive and value effects of bank privatization in developed countries

A special issue of the Journal of Banking and Finance (2005) devoted to the performance of privatized banks in middle- and low-income countries shows mixed results. In this paper, we present evidence that shows that privatized banks in developed countries have experienced significant improvements in operating performance. The improvement in performance remains significant after controlling for persistence in bank performance. A comparison of the performance of privatized banks in developed and developing countries suggests that privatization has encouraged excessive risk taking among privatized banks in developing countries, with the consequence that those banks carry large non-performing assets than their counterparts in the developed countries. We also observe that consistent with the competitive effects hypothesis, investors view privatization announcements as foreshadowing bad news for rival banks.     

Financial sector liberalization,bank privatization,and efficiency: Evidence from Pakistan

The Pakistani banking system has been transformed over the past 15 years through liberalization, the entry of private banks, the privatization of public-sector banks, and the tightening of prudential regulations. The effects of these changes on bank productivity and relative efficiency are investigated using various techniques. Bank productivity in terms of profits has increased, and new entrants have been efficient, but the dispersion of efficiency remains wide. The privatized banks improved their profit efficiency in the period immediately following their privatization, but in the subsequent years only one significantly improved its efficiency, whereas the other did not differentiate itself in terms of efficiency from the remaining state-owned banks. The new private domestic banks generally proved to be among the most efficient, and sometimes out-performed the foreign banks.     

Mexico’s experiments with bank privatization and liberalization, 1991–2003

During the 1990s Mexico conducted two experiments with its banking system. In the first experiment (1991–96) it privatized the banks. This experiment took place with weak institutions to enforce contract rights. It also took place without institutions that encourage prudent behavior by bankers. The result was reckless behavior by banks, and a collapse of the banking system. In the second experiment (1997–2003), Mexico reformed many of the institutions that promoted bank monitoring and it opened up the industry to foreign investment. It was less successful, however, in reforming the institutions that promote the enforcement of contract rights. The result was that bankers behaved prudently, but prudent behavior in the context of weak contract rights implies that banks are reluctant to extend credit to firms and households.     

The direct and indirect impact of bank privatization and foreign entry on access to credit in Argentina’s provinces

Privatization and increased foreign ownership transformed the Argentine banking sector during the 1990s. While both improved sector efficiency, there was concern that they might reduce access to credit outside of Buenos Aires. The results in this paper suggest that these fears were exaggerated. Provinces that privatized their banks suffered only temporary reductions in credit associated with cleaning the portfolio of the privatized banks. Typically, growth in lending by the privatized entity and by other banks restored credit to pre-privatization levels within a few years. In addition, increased foreign ownership coincided with more, not less, lending outside of Buenos Aires.     

The bank capital channel and bank profits

This paper develops a microeconomic model of banking to highlight an endogenous loan creation process that emerges from bank profits via the capital accumulation of retained earnings and uses a simple bank capital‐loan multiplier to illustrate constraints on lending. The study also analyzes how sufficient net interest margins are important for banks to maintain lending portfolios and avoid financial fragility. The model offers support to bank capital channel (BKC) economists by illustrating how changes in interest rates may influence bank lending through the bank's internal capital accumulation growth rate and on a bank's portfolio choices.     

Do privatized banks in middle- and low-income countries perform better than rival banks? An intra-industry analysis of bank privatization

This paper presents a comprehensive analysis of the pre- and post-privatization operating performance and stock market performance of privatized banks and their rivals in middle- and low-income countries. First, we find that privatization announcements elicit negative abnormal returns for rival banks. The effects are more pronounced for subsequent tranche sales where the proportion of government ownership in the privatized bank is reduced. Second, we observe that the privatized banks underperformed the benchmark index in the long run. Investors who bought shares of the privatized banks on the first day of trading and held them for 5 years (instead of investing in the market index) lost 24% of their wealth. The underperformance is consistent with the negative long run returns that have been documented for initial public offerings. Third, we document marginal improvements in the post-privatization operating performance of the privatized banks. Though the privatized banks in middle- and low-income countries are better capitalized than rival banks, they carry higher problem loans and are overstaffed relative to other private banks in the post-privatization period. Since most of the sample firms are partially privatized, we submit that perhaps the continued government ownership of the privatized banks might have hindered managers’ ability to restructure the firms.     

The economics of well-being

Gross domestic product has long been the chief measure of national success. But there's been a lot of talk lately about changing that, from economists and world leaders alike. GDP is under siege for three main reasons. First, it is flawed even on its own terms: It misses lots of economic activity (unpaid household work, for example) and, as a single-number representation of vast, complex systems, is inevitably skewed. Second, it fails to account for economic and environmental sustainability. And third, readily available alternative measures may reflect well-being far better, by taking into account factors such as educational achievement, health, and life expectancy. HBR's Justin Fox surveys historical and current views on how to assess national progress, from Jeremy Bentham to Robert Kennedy to Nicolas Sarkozy. He also looks at where we may be headed. The biggest success so far in the campaign to supplant or at least supplement GDP, he finds, is the UN's Human Development Index-on which the United States has never claimed the top spot.     

The economics of PIPEs

Private investments in public equities (PIPEs) are an important source of finance for public corporations. PIPE investor returns decline with holding periods, while time to exit depends on the issue's registration status and underlying liquidity. We estimate PIPE investor returns adjusting for these factors. Our analysis, which is the first to estimate returns to investors rather than issuers, indicates that the average PIPE investor holds the stock for 384 days and earns an abnormal return of 19.7%. More constrained firms tend to issue PIPEs to hedge funds and private equity funds in offerings that have higher expected returns and higher volatility. PIPE investors’ abnormal returns appear to reflect compensation for providing capital to financially constrained firms.     

The productivity effects of privatization: The case of Polish cooperatives

This paper evaluates the productivity effects associated with privatization of producer cooperatives. The results, based on a sample of 2164 Polish cooperatives, indicate that privatized cooperatives have: (1) 1% lower total factor productivity (TFP) the year prior to privatization and 3-20% higher TFP in the year of privatization and three years post-privatization, (2) 9-36% higher labor productivity, (3) capital productivity effects of − 16-6%. The evidence is consistent with governance and incentive mechanisms of cooperatives being more effective outside of state interference, and with competition and hard budget constraints leading to pressure to restructure and adopt practices that improve productivity.     

Transforming frameworks of accountability: The case of water privatization

The U.K. Government's belief in the innate inefficiency of traditional public sector provision of goods and services has inspired a number of initiatives which have resulted in management of public sector enterprises being confronted by an increasingly commercial environment, tighter financial controls, increased competition, and in some cases transfer to the private sector through privatization. This paper is concerned with investigating the ways in which accounting and accounting information has contributed to and shaped processes of organizational change in one area of the public sector, the ten Regional Water Authorities of England and Wales. In the early 1980s, the Water Authorities were subject to pressures from new Government financial controls and performance aims to become more efficient. These pressures intensified when the Government announced its intention to privatize them in 1986, and continued up to 1989 when privatization took effect. Since privatization the Water Authorities have been subject to “yardstick” competition under a new regulatory framework, and comparative judgements by the financial markets. In considering these changes, the paper examines the constitutive role of accounting in articulating changing organizational priorities, and in promoting first a vocabulary of costs and subsequently a vocabulary of profits as languages of organizational motive.     

The economics of interest rates

The paper looks at the behavior of investors in an economy consisting of a production process controlled by a state variable representing the state of technology. The participants in the economy maximize their individual utilities of consumption. Each participant has a constant relative risk aversion. The degrees of risk aversion, as well as the time preference functions, differ across participants. The participants may lend and borrow among themselves, either at a floating short rate, or by issuing or buying term bonds. We derive conditions under which such an economy is in equilibrium, and obtain equations determining interest rates.     

The economics of hedge funds

Hedge fund managers trade off the benefits of leveraging on the alpha-generating strategy against the costs of inefficient fund liquidation. In contrast to the standard risk-seeking intuition, even with a constant-return-to-scale alpha-generating strategy, a risk-neutral manager becomes endogenously risk-averse and decreases leverage following poor performance to increase the fund's survival likelihood. Our calibration suggests that management fees are the majority of the total compensation. Money flows, managerial restart options, and management ownership increase the importance of high-water-mark-based incentive fees but management fees remain the majority. Investors' valuation of fees are highly sensitive to their assessments of the manager's skill.     

The economics of politically-connected firms

Political connections between firms and autocratic regimes are not secret and often even publicly displayed in many developing economies. We argue that tying a firm’s available rent to a regime’s survival acts as a credible commitment forcing entrepreneurs to support the government and to exert effort in its stabilization. In return, politically-connected firms get access to profitable markets and are exempted from the regime’s extortion. We show that such a gift exchange between government and politically-connected firms can only exist if certain institutional conditions are met. In particular, the stability of the regime has to be sufficiently low and the regime needs the power to exploit independent firms. We also show that building up a network of politically-connected firms acts as a substitute for investments in autonomous stability (such as spending on military and police force). The indirect strategy of stabilizing a regime via politically-connected firms gradually becomes inferior when a regime’s exploitative power rises.     

The economics of network neutrality

Under the current regime for Internet access, “network neutrality,” parties are billed only by the Internet service provider (ISP) through which they connect to the Internet; pricing is not contingent on the content being transmitted. Recently, ISPs have proposed that content and applications providers pay them additional fees for accessing the ISPs’ residential clients, as well as fees to prioritize certain content. We analyze the private and social implications of such fees when the network is congested and more traffic implies greater delays. We derive conditions under which network neutrality would be welfare superior to any feasible scheme for prioritizing service.