Heterogeneous Banks Research Articles

Financial (In)Stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach

This paper develops a dynamic stochastic general equilibrium model with interactions between an heterogeneous banking sector and other private agents. We introduce endogenous default probabilities for both firms and banks, and allow for bank regulation and liquidity injection into the interbankmarket. Our aim is to understand the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real data and used for simulations. We show that liquidity injections reduce financial instability but have ambiguous effects on output fluctuations. The model also confirms the partial equilibrium literature results on the procyclicality of Basel II.

CAPITAL ADEQUACY REQUIREMENTS AND THE FINANCIAL ACCELERATOR CAUSED BY BANK CAPITAL

This paper develops a computable dynamic general equilibrium model with heterogeneous banks, a portion of which may be constrained by capital adequacy requirements and the remainder of which may not, in order to examine what effects the capital requirements and bank capital induce in the macroeconomy. Applying the parameterized expectations algorithm, the model economy shows that binding bank capital constraints induce the financial accelerator, the hump-shaped dynamic behaviour of output, and ineffectuality of monetary policy, and that all the results are derived from the individual banks’ cross-sectional asymmetric responses that are consistent with the empirical evidence.

The stabilizing effect of resting egg banks of the Daphnia longispina species complex for longitudinal taxon heterogeneity in long and narrow reservoirs

We compared the spatial distribution of taxa from the Daphnia longispina complex (D. longispina, D. galeata, D. cucullata, and their hybrids) in the active water column community and in resting egg banks in five long narrow reservoirs in the Czech Republic (Central Europe). In each reservoir, we sampled at both ends of the longitudinal gradient: in the inflow region and at the dam. Ephippia abundance in the sediments significantly increased in the downstream direction, reflecting differences in the sedimentation regime and Daphnia population size. Similarly to the active zooplankton community, in which D. cucullata and D. longispina tended to occur at opposite ends of the reservoirs, Daphnia species and interspecific hybrids in resting eggs revealed a spatially diversified pattern; however, we observed some differences in taxon distributions between sediments and water columns. High relative abundances of hybrid genotypes (up to 16% of resting eggs, and 74% of Daphnia in the water column) confirm that interspecific hybridization is frequent in these reservoirs, and some hybrids are successful in competition with the parental taxa. We assume that the spatial heterogeneity of Daphnia taxonomic composition in reservoirs, being affected by the seasonal selection of taxa within the mixed reservoir species pool, is substantially strengthened by the presence of spatially heterogeneous egg banks.

Liquidity Stress-Tester: A Model for Stress-testing Banks' Liquidity Risk

This article presents a stress-testing model for liquidity risks of banks. It takes into account the first- and second-round (feedback) effects of shocks, induced by reactions of heterogeneous banks, and reputation effects. The impact on liquidity buffers and the probability of a liquidity shortfall is simulated by a Monte Carlo approach. An application to Dutch banks illustrates that the second-round effects in specific scenarios could have more impact than the first-round effects and hit all types of banks, indicative of systemic risk. This lends support policy initiatives to enhance banks' liquidity buffers and liquidity risk management, which could also contribute to prevent financial stability risks. (JEL Codes: C15, E44, G21, G32) Copyright , Oxford University Press.

Information Acquisition and Market Power in Credit Markets

Investment in information acquisition can be used strategically by banks as a commitment device to augment market power. A static two-period economy with informationally heterogeneous banks is analysed. Information acquisition limits asymmetries of information and competitors' rents ex post. If projects yield insufficient returns in the first period, competitors' ex ante break even constraints are tightened, and competition inhibited. Market power can thereby be substantially augmented, and monopoly rents obtained. Welfare is lower with information acquisition, while banks are better off. With more than two banks, information acquisition is characterised by strategic complementarities: hence, multiple equilibria may exist.

Bank Ownership, Market Structure and Risk

This paper presents a model of a banking industry with heterogeneous banks that delivers predictions on the relationship between banks' risk of failure, market structure, bank ownership, and banks' screening and bankruptcy costs. These predictions are explored empirically using a panel of individual banks data and ownership information including more than 10,000 bank-year observations for 133 non-industrialized countries during the 1993-2004 period. Four main results obtain. First, the positive and significant relationship between bank concentration and bank risk of failure found in Boyd, De Nicolo and Al Jalal (2006) is stronger when bank ownership is taken into account, and it is strongest when state-owned banks have sizeable market shares. Second, conditional on country and firm specific characteristics, the risk profiles of foreign (state-owned) banks are significantly higher than (not significantly different from) those of private domestic banks. Third, private domestic banks do take on more risk as a result of larger market shares of both state-owned and foreign banks. Fourth, the model rationalizes this evidence if both state-owned and foreign banks have either larger screening and/or lower bankruptcy costs than private domestic banks, banks' differences in market shares, screening or bankruptcy costs are not too large, and loan markets are sufficiently segmented across banks of different ownership.

Bank Ownership, Market Structure and Risk

This paper presents a model of a banking industry with heterogeneous banks that delivers predictions on the relationship between banks' risk of failure, market structure, bank ownership, and banks' screening and bankruptcy costs. These predictions are explored empirically using a panel of individual banks data and ownership information including more than 10,000 bank-year observations for 133 non-industrialized countries during the 1993-2004 period. Four main results obtain. First, the positive and significant relationship between bank concentration and bank risk of failure found in Boyd, De Nicolo and Al Jalal (2006) is stronger when bank ownership is taken into account, and it is strongest when state-owned banks have sizeable market shares. Second, conditional on country and firm specific characteristics, the risk profiles of foreign (state-owned) banks are significantly higher than (not significantly different from) those of private domestic banks. Third, private domestic banks do take on more risk as a result of larger market shares of both state-owned and foreign banks. Fourth, the model rationalizes this evidence if both state-owned and foreign banks have either larger screening and/or lower bankruptcy costs than private domestic banks, banks' differences in market shares, screening or bankruptcy costs are not too large, and loan markets are sufficiently segmented across banks of different ownership.

Towards a measure of financial fragility

The paper proposes a measure of financial fragility that is based on economic welfare in a general equilibrium model calibrated against UK data. The model comprises a household sector, three active heterogeneous banks, a central bank/regulator, incomplete markets, and endogenous default. We address the impact of monetary and regulatory policy, credit and capital shocks in the real and financial sectors and how the response of the economy to shocks relates to our measure of financial fragility. Finally we use panel VAR techniques to investigate the relationships between the factors that characterise financial fragility in our model, i.e. banks’ probabilities of default and banks’ profits – to a proxy of welfare.

A Time Series Analysis of Financial Fragility in the UK Banking System

This paper extends the model proposed by Goodhart, Sunirand, and Tsomocos (2003,2004a, b) to an infinite horizon setting. Thus, we are able to assess how the model conforms with the time series data of the U.K. banking system. We conclude that, since the model performs satisfactorily, it can be readily used to assess financial fragility given its flexibility, computability, and the presence of multiple contagion channels and heterogeneous banks and investors.

Bank Capital, Liquidity, and Systemic Risk

We analyze the impact of capital adequacy regulation on bank insolvency and aggregate investment. We develop a model of the banking system that is characterized by the interaction of many heterogeneous banks with the real sector, interbank credit relations as a consequence of bank liquidity management and an insolvency mechanism. This allows us to study the impact of capital adequacy regulation on systemic risk. In particular we can analyze the impact of regulation on contagious defaults arising from mutual credit relations. We show that the impact of capital adequacy on systemic stability is ambiguous and that systemic risk might actually increase as a consequence of imposing capital constraints on banks. Furthermore we analyze the indirect consequences of capital adequacy regulation that are transmitted to the real economy by their impact on equilibrium interbank rates and thus the opportunity costs of liquidity within the banking system.

A risk assessment model for banks

The objective of this paper is to propose a model to assess risk for banks. Its main innovation is to incorporate endogenous interaction between banks, recognising that the actual risk to which an individual bank is exposed also depends on its interaction with other banks and other private sector agents. To this end, we develop a two-period general equilibrium model with three active heterogeneous banks, incomplete markets, and endogenous default. The setting of three heterogeneous banks allows us to study not only interaction between any two individual banks, but also their interaction with the rest of the banks in the banking system. We show that the model is analytically tractable and can be calibrated against real UK banking data and therefore can be implemented as a risk assessment tool for financial regulators and central banks. We address the impact of monetary and regulatory policy as well as credit and capital shocks in the real and financial sectors.

Bank Capital, Liquidity, and Systemic Risk

We analyze the impact of capital adequacy regulation on bank insolvency and aggregate investment. We develop a model of the banking system that is characterized by the interaction of many heterogeneous banks with the real sector, interbank credit relations as a consequence of bank liquidity management and an insolvency mechanism. This allows us to study the impact of capital adequacy regulation on systemic risk. In particular we can analyze the impact of regulation on contagious defaults arising from mutual credit relations. We show that the impact of capital adequacy on systemic stability is ambiguous and that systemic risk might actually increase as a consequence of imposing capital constraints on banks. Furthermore we analyze the indirect consequences of capital adequacy regulation that are transmitted to the real economy by their impact on equilibrium interbank rates and thus the opportunity costs of liquidity within the banking system.

Liquidity, Information, and the Overnight Rate

We model the interbank market for overnight credit with heterogeneous banks and asymmetric information. An unsophisticated bank just trades to compensate its liquidity imbalance, while a sophisticated bank will exploit its private information about the liquidity situation in the market. It is shown that with positive probability, the liquidity effect (Hamilton, 1997) is reversed, i.e., a liquidity drainage from the banking system may generate an overall decrease in the market rate. The phenomenon does not disappear when the number of banks increases. We also show that private information mitigates the effect of an unexpected liquidity shock on the market rate, suggesting a conservative information policy from a central bank perspective. JEL Classification: G14, G21, E52

Equilibrium Analysis, Banking, Contagion and Financial Fragility

This paper contains a general equilibrium model of an economy with incomplete markets (GEI) with money and default. The model is a simplified version of the real world consisting of a non-bank private sector, banks, a central bank, a government and a regulator. The model is used to analyse actions by policy-makers and to identify policy relevant empirical work. Key analytical results are: a financially fragile system need not collapse; efficiency can be improved with policy intervention; and a system with heterogeneous banks is more stable than one with homogeneous ones. Existence of monetary equilibria allows for positive default levels in equilibrium. It also characterises contagion and financial fragility as an equilibrium phenomenon. A definition of financial fragility is proposed. Financial fragility occurs when aggregate profitability of the banking sector declines and defaults in the non-bank and banking private sectors increase. Thus, equilibria with financial fragility require financial vulnerability in the banking sector and liquidity shortages in the non-bank private sector. The model will be used as a basis to carry out empirical work on the costs of financial instability, to quantify the effectiveness of particular regulatory tools such as capital requirements, and to identify trade-offs between increasing stability through action by authorities and the efficiency of the financial system.

Heterogeneous Banks, Loan Decisions, and their Informational Externality

It is widely accepted in the financial literature that banks are better informed about their borrowers than is the investing public, and banks' loan decisions externalize information to the stock market. In this study, we model a signaling game between banks and financial analysts who follow their stocks, and characterize a perfect Bayesian equilibrium to examine how heterogeneous banks lending to the same customer may impact the informativeness of their loan decisions. Distinguishing between H-banks and L-banks, those with high or low lending ability, we illustrate how two factors can work to bring an L-bank to act rationally against its valuable information about its borrower in the loan decision-making (called uninformed lending), blunting thereby the signal to the public. The factors are: 1) the asymmetry arising from banks being privately informed about their own lending abilities; and 2) the concern of the banks to have the financial analysts following their stocks assess favorably such abilities. We identify the equilibrium conditions under which L-banks would make uninformed lending. The analysis yields implications that are supported by empirical evidences and, more interestingly, reconcile some puzzling results documented in the literature.

Towards a Single Retail Banking Market? New Evidence from Euroland

Our study reviews the process towards creating a single European retail banking market. The EU has aimed at integrating the traditionally heterogeneous banking market in Europe by means of harmonizing legislation. While the wholesale banking market integration is considered to be more advanced, retail banking integration is still in its infancy. Cross-border lending, cross-border mergers, and the promises of new technologies have not yet delivered the creation of a single retail banking market. In this paper we provide new evidence on this issue. In particular, we find that there are some tendencies for a more integrated corporate lending market, while consumer lending markets are still remaining more fragmented. We identify three reasons for a lack of integration: A lack of international arbitrage, a limited pass-through of interest rate changes onto lending rates, and a limited national and international competitive retail banking environment. The results also suggest that the introduction of the single currency may have already made a positive impact on retail banking market integration.

Are buybacks back? Menu-driven debt reduction schemes with heterogeneous creditors

We analyze the mechanics of menu-driven debt reduction deals, similar to those recently initiated by debtor countries, in which heterogeneous banks choose freely between selling or retaining their debt claims. We show that menu deals can facilitate discrimination across heterogeneous banks because of imperfections in the secondary market for debt. This implies that menu deals are likely to dominate market buybacks and pure concerted relending agreements, particularly when banks differ widely in their valuation of claims on the debtor.

A Theory of Oligopoly

A Theory of Oligopoly