Procyclical Impact Research Articles

Externalities of residential property flipping

AbstractThis study investigates whether flipping activities impose an externality on the transaction prices of the neighboring nonflipped properties. Using a data set of residential property transactions in Clark County, Nevada for the period 2003–2013, we find that flippers impose a significant positive impact on the price of neighboring nonflipped properties in an up market, but a significant negative effect in a down market. This procyclical impact of flipping activity contributes to the volatility of housing prices, hence magnifying boom and bust cycles and increasing the likelihood of a mortgage crisis.

The Impact of Remittances of Ukrainian Migrants on the Stabilisation of the Economy During the Covid Crisis

International labour migration is a global process that has affected the populations of all countries and continents. Today, migrants face a new additional barrier – the COVID-19 pandemic, which has drastically affected all forms of human mobility. Today, labour-based migration from Ukraine is directed mainly to EU Member States. The main motives for international labour migration is the potential of earning money, financial security of the family etc. Accordingly, the consequence of international migration is the inflow of money into the country of migrant origin. Remittances from migrant workers are an important source of income for Ukraine. Despite the COVID-19 pandemic, there has been an increase in migrant remittances, contributing to the development of households, human potential, the reduction of poverty and inequality, and the inflow of foreign currency. This article proposes an econometric model of the impact of migrant remittances on the stabilisation of the country’s economy during the pandemic. As a result of the calculations, it was found that the income from people working abroad initially reduces the deviation of GDP from the equilibrium trend, but over time there is a clear procyclical impact. This feature is favourable for the Ukrainian economy and may mean that migrant transfers in times of crisis help to overcome the effects of global economic downturns.

IFRS 9 and its behavior in the cycle: The evidence on EU countries

AbstractThe purpose of this paper is to analyze empirically the behavior of expected loan loss provisions during the economic cycle. The provisioning rules under IFRS 9 require the creation of reserves to cover expected credit losses, were anticipated to act countercyclically, and thus replaced the rules under IAS 39, which are widely presumed to have a procyclical impact. Observing the dynamics of the economic cycle during the economic downturn resulting from the COVID restrictions, a panel regression was performed to test the hypothesis that loan loss provisioning rules under IFRS 9 have a procyclical impact. The hypothesis was not rejected on the basis of a sample of the member countries of the European Union for the period of 1Q 2015 – 3Q 2020. Since the conclusions about procyclicality of loan loss provisions under IFRS 9 might be sensitive to the choice of models applied by the banks or to the assumptions applied to forward‐looking information used in the models, there are certain areas that supervisory and regulatory authorities might look into to increase the quality of ECL models and their predictive power and help to eliminate potential triggers of procyclicality.

Procyclical Effects of IFRS 9 – Illustrated by a Simulation on the Hungarian Banking System

The impact of the IFRS1 9 accounting standard on amplifying procyclical bank behaviour has been hotly debated since the introduction of the standard. This paper contributes to the debate by a unique simulation, in which we estimated, what the losses and capital position of the Hungarian banking system would have been during the 2008–2013 crisis episode if at international level subsequently adopted IFRS 9 had already been in effect at that time. Our results show that IFRS 9 would have led to the recognition of losses, which would have been more concentrated in the beginning of this crisis episode, (but not early enough, in the pre-crisis period). As a result, the banking system’s aggregated capital adequacy ratio would have been more than 20 per cent (2.7 percentage points) lower at the onset of the crisis (end of 2008) than it was in reality (9.1 per cent rather than 11.8 per cent). This could have forced bank owners to undertake capital increases sooner and in larger amounts or to push their banks towards even stronger deleveraging, i.e. towards more procyclical behaviour. Our results are in line with the findings in the literature that the introduction of IFRS 9 increases the procyclicality of banks’ impairments in such a manner that it shifts the recognition of impairments towards beginning of crises (but not towards pre-crisis periods!). Although the procyclical effect of IFRS 9 demonstrated in our simulation is quite large, this is attributable to the special depth and complexity of the 2008 crisis episode in Hungary, which involved a sovereign crisis, a banking crisis and a credit crunch at the same time. Thus, our results suggest that the procyclical impact of IFRS 9 can be more easily managed under ‘normal’ recession circumstances

Do macroprudential policy instruments reduce the procyclical impact of capital ratio on bank lending? Cross-country evidence

ABSTRACTIn this paper, we ask about the capacity of macroprudential policies to reduce the procyclical impact of capital ratio on bank lending. We focus on aggregated macroprudential policy measures and on individual instruments and test whether their effect on the association between lending and capital depends on bank size. Applying the GMM 2-step Blundell and Bond approach to a sample covering over 60 countries, we find that macroprudential policy instruments reduce the procyclical impact of capital on bank lending during both crisis and non-crisis times. This result is stronger in large banks than in other banks. Of individual macroprudential instruments, only borrower-targeted LTV caps and DTI ratio weaken the association between lending and capital and thus act countecyclically. Generally, with our study we are able to support the view that macroprudential policy has the potential to curb the procyclical impact of bank capital on lending and therefore, the introduction of more restrictive international capital standards included in Basel III and of macroprudential policies are fully justified.

Time-varying effects of cyclical fluctuations in China's energy industry on the macro economy and carbon emissions

This study first used principal component analysis to calculate an operating index for China's energy industry and applied the index to investigate cyclical fluctuation trends. Subsequently, a time-varying parameter structural vector auto-regressive model was adopted to analyse the time-varying characteristics of the cyclical fluctuations in the macro economy and carbon emissions. The results showed that cyclical changes in the energy industry lagged fluctuations in the macroeconomic environment. The average length of the cycle was three years. Industrial shocks had a clear pro-cyclical impact on production levels and prices. During periods of prosperous growth, these positive shocks can sustain increased output and price levels. During recessionary periods, positive shocks have a short-term effect and are not favourable for output growth or price rebounds in the long run. The macroeconomic effect of cyclical fluctuations in the energy industry clearly has a stronger price effect than output effect and a greater impact on producer price inflation than consumer price inflation. In addition, the effect of energy shocks on carbon emissions has gradually weakened over time. We argue that promoting supply-side structural reform policies and eliminating excessive energy capacity within the industry while continuing to promote green energy strategies are key solutions to reversing supply-demand imbalances and downward price trends.

The impact of accounting standards on hedging decisions

PurposeThe purpose of this paper is to study the effects of financial accounting standards on the economic decisions of managers. The primary research question addressed in the paper is whether the hedging behavior of corporate treasurers in France has been affected by the issuance of International Accounting Standard No. 39 and International Financial Reporting Standard No. 9 dealing with financial instruments and hedging.Design/methodology/approachIn all, 48 semi-structured interviews were conducted with French corporate treasurers. The interview instrument is included as an exhibit to this paper. The interviews were recorded and transcribed. In addition, three interviews were conducted with representatives of Big 4 audit firms who are experts in accounting for financial instruments. The empirical findings are interpreted using a theoretical framework derived from Jean Baudrillard who argues that the “map” (accounting results) tends to define the “territory” (economic decision-making) in a period of “hyperreality” (when the underlying economic reality is confused). In other words, accounting standards, and the reported numbers that result from such standards, can influence the economic decisions of managers and not merely represent the outcome of economic decisions already taken.FindingsCorporate treasurers often make decisions based on earnings impact. This finding is similar to findings in prior literature regarding the effects of accounting standards on economic decisions taken by managers. A fear of increased earnings volatility is central to the treasurers’ concerns. Also key is the complexity of the process for qualifying financial instruments for hedge accounting treatment. The authors also find that the behavior of corporate treasurers is neither stable nor homogeneous. The behavior appears to be the outcome of a collective learning process in which the corporate treasurer is only one actor.Research limitations/implicationsThe type of qualitative research undertaken in this study has its limitations. It cannot be demonstrated that the findings are generalizable. There is a contextual specificity to the treasurer’s function, which reinforces a particular focus on accounting results. The CFO is simultaneously the superior of the treasurer and responsible for financial reporting, and consequently subject to a conflict of interest that does not necessarily apply to other types of managers. Therefore the findings cannot apply to all managerial functions.Practical implicationsThe authors found that corporate treasurers focus on accrual-based earnings despite engaging in a function that is supposed to focus on cash flows. Even if the IASB believes that accounting standards should be used primarily by investors and creditors, they should acknowledge that there is a fear of earnings volatility by managers, and that there is an temptation toward increased use of other comprehensive income as an alternative to reporting volatile earnings numbers.Social implicationsThe research provides support for those who argue that international accounting standards that require fair value accounting for financial instruments have had a negative pro-cyclical impact on the real economy.Originality/valueThis paper is a qualitative research study conducted in an area of research where there have previously been only quantitative studies. The access to a large number of French corporate treasurers is unique. The study supports prior findings regarding the influence of accounting standards on managerial behavior, but with an added theoretical interpretation related to Baudrillard’s arguments regarding the nature of the “map” and the “territory” in complex economic systems.

Credit Risks and Forward-looking Provision Requirement in Industrial Sector:From the Perspective of Leverage and Financing Costs

The forward-looking loan loss provisions management can smooth the pro-cyclical impact of bank credit supply on macro-economy, but there are few empirically estimable loan loss provisions management approaches with dynamic and forward-looking characteristics, thus limiting the use and effect of this macro-prudential policy tool. In the case that the borrower's asset growth follows a mean reverting stochastic process, this paper derives the dynamic random motion of borrower's asset values and characterizes the credit risk factors and forward-looking provision requirement within the framework of structural credit risk model. Different from the structural model, the asset growth in this paper has the characteristics of periodicity and stationary, which is not only fit for the inherent requirement of the forward-looking provision management, but also contributes to the empirical estimation and implementation promotion of the model. Based on the assets and liabilities data of industrial sector from 1993 to 2013, this paper also empirically estimates future credit risks and forward-looking provision requirement of the industrial sector and its sub-industries. Meanwhile, it also estimates the forward-looking provision component of regulatory requirement and that of the actual provisions in the banking system based on the following two official documents:PBOC[2002] No.98 and CBRC[2010] No.98, and judges their appropriateness combining with the portfolio status of borrower target leverage and financing costs based on the theoretical model. This paper deeply reveals the credit risks and their evolution trends of the industrial sector at all levels under different leverage and financing costs, and answers the hot issues such as the appropriateness of forward-looking provision requirement of the actual situation in the banking system and that stipulated by the regulatory authorities.

Asset correlations and procyclical impact

Asset correlations and procyclical impact

Do Macroprudential Policy Instruments Affect the Link between Lending and Capital Ratio? Cross-Country Evidence

In this paper we ask about the capacity of macroprudential policies to reduce the positive association between loans growth and the capital ratio. We focus on aggregated macroprudential policy measures and on individual instruments and test whether their effect on the association between lending and capital depends on bank size, the economic development of a country as well as on the extent of capital account openness. Applying the GMM 2-step Blundell and Bond approach to a sample covering over 60 countries, we find that macroprudential policy instruments reduce the impact of capital on bank lending during both crisis and non-crisis times. This result is stronger in large banks than in other banks. Of individual macroprudential instruments, only borrower-targeted LTV caps and DTI ratio weaken the association between lending and capital. Our results also show that the effect of macroprudential policies on the association between lending and the capital ratio in non-crisis periods is stronger in advanced countries than in emerging countries. Additionally, differentiating by the level of capital account openness, we find that macroprudential policies are more effective in increasing the resilience of banks and thus weakening the association between loan supply and capital ratio for relatively closed economies but less effective for relatively open economies. Generally, with our study we are able to support the view that macroprudential policy has the potential to curb the procyclical impact of bank capital on lending and therefore, the introduction of more restrictive international capital standards included in Basel III and of macroprudential policies are fully justified.

Loan Loss Provisions, Income Smoothing and Loan Growth: Evidence from Islamic Banks

This paper analyses income smoothing behavior and procyclical effect of loan loss provisions in Islamic bank. The model includes the use of loan loss provisions for discretionary and non-discretionary purposes in Islamic banks and relates it to the ways of Islamic banks disburse loans. The empirical results show that Islamic banks use loan loss provisions for non-discretionary purposes, while well-capitalized banks and banks focusing on lending activities may use loan loss provisions for income smoothing to a lesser extent. Moreover, it is documented that higher non-discretionary component of loan loss provisions results in a decline in loan growth and hence, non-discretionary provisions are procyclical. In contrast, the discretionary component of loan loss provisions does not exhibit any significant impact on loan growth. Finally, the findings show that the negative link between non-discretionary provisions and loan growth does not hold for well-capitalized banks, and banks focusing on lending activities. This paper, therefore, highlights that higher capitalization and higher loan asset portfolios tend to neutralize the procyclical impact of non-discretionary provisions through their income smoothing behaviour. In this regard, the provisioning system is particularly recommended for less-capitalized banks and banks which do not focus on lending activities since they do not conduct income smoothing strategies.

Business cylce and museum visitors in Taiwan

From the educational/cultural aspect of the demand for museum visits, there is a theoretical prediction for the negative relation of museum visits to the business cycle. From the viewpoint of recreational tourism, there is an expected pro-cyclical impact of macroeconomic factors on museum visits. This paper thus employs the GARCH (generalized autoregressive conditional heteroscedastic) model with an error correction term to investigate the relationship between the business cycle and museum visits in Taiwan. Our empirical evidence shows that the unemployment rate, exchange rate, and real money balance have a procyclical impact on museum visits, indicating the recreational components of such visits.

The Impact of Capital on Lending in Economic Downturns and Investor Protection The Case of Large EU Banks

This paper attempts to find out whether better quality of investor protection matters for the effect of capital ratio on loan growth of large EU banks in 1996-2011. We focus on several measures of the quality of investor protection with a proven track record in the banking literature, i.e.: anti-self-dealing index, ex-ante-control and ex-post-control of anti-self-dealing indices, and creditor protection rights index. Our results show that better investor protection increases the procyclical impact of capital on lending in the sample of banks reporting unconsolidated data. This is consistent with the view that better shareholders rights protection induces bank borrowers to take more loans and to engage in more risk-taking, in particular during economic booms, which results in greater sensitivity of bank lending to capital ratios in economic downturns. The opposite effect is found in the sample of banks reporting consolidated data. This effect is consistent with the view that better minority shareholders protection may reduce risk-taking incentives of large banks and result in better risk management of credit portfolio (and other investments of such banks).

Shadow banking, relationship banking, and the economics of depression

The paper explores whether a theory of banks doing ‘finance through money creation’ implies a reconsideration of demand-side macro theory as well. To this aim, a simple methodological accounting model of the influence of financial markets over the real economy is presented. The model allows a tidy comparison of relationship and shadow banking, interpreted as alternative schemes of liquidity (not credit) risk management. The model emphasizes the interdependencies in entrepreneurs’ animal spirits, liquidity risk management schemes adopted by financial institutions, and effective demand of households. The underlying idea is that fluctuations in the composition of property incomes trigger fluctuations in non-financial investment that, in turn, drive fluctuations in spending. The article finds that both relationship and shadow banking must have a pro-cyclical impact, and differences are essentially based on different liquidity risk management aggregate cost functions. The model developed here suggests that securitisation does not per se affect the financial sustainability of the growth process, but regulatory measures aimed at checking predatory lending and re-securitisation activities are needed to avoid possible adverse impacts on animal spirits. JEL codes: E44, G20, O16

The Effects of Capital on Bank Lending in EU Large Banks The Role of Procyclicality, Income Smoothing, Regulations and Supervision

This paper aims to find out what the impact is of bank capital ratios on loan supply in the EU and what factors explain the potential diversity of this impact. Applying the Blundell and Bond (1998) two step GMM estimator, we show that, in the EU context, the role of capital ratio for loan growth is stronger than previous literature has found for other countries. Our study sheds some light on whether procyclicality of loan loss provisions and income smoothing with loan loss provisions contribute to procyclical impact of capital ratio on loan growth. We document that loan growth of banks that have more procyclical loan loss provisions and that engage less in income smoothing is more sensitive to capital ratios. This sensitivity is slightly increased in this sample of banks during contractions. Moreover, more restrictive regulations and more stringent official supervision reduce the magnitude of the effect of capital ratio on bank lending. Taken together, our results suggest that capital ratios are an important determinant of lending in large EU banks.

La percepción del riesgo y su relación con la actual crisis económico-financiera global

El objetivo de este artículo es analizar los principales factores de la excesiva prociclicidad de los sistemas financieros, debido al incremento innecesario de las oscilaciones en el nivel de actividad, lo cual pone en riesgo la estabilidad financiera con repercusiones negativas en la economía real de los países.El normal crecimiento económico real de un país va en paralelo con el crecimiento de los sistemas financieros en general y con el crecimiento de los créditos en particular, ocasionando una prociclicidad lógica y deseable muy fuerte entre estos, siempre poniendo en evidencia cómo las balanzas de pagos nacionales se corresponden como elementos interdependientes de un sistema monetario global de suma cero.La problemática se plantea en la medida en que existen factores inherentes al comportamiento de los agentes económicos que actúan dentro de los sistemas financieros o que se derivan de la regulación prudencial que aumentan la volatilidad en forma anormal respecto de sus niveles considerados como fundamentales, teniendo una repercusión procíclica de amplitud en el ciclo económico, siempre inconveniente por la generación de inestabilidad y turbulencia en los precios.La actual crisis financiera alcanza magnitudes de pérdidas sin precedentes y todavía está cobrando víctimas, es claro que la función de riesgos de las entidades financieras jugará un papel clave, adaptando su gestión a los mercados, considerando los aspectos conductuales y de percepción de los agentes económicos.Con relación a la percepción del riesgo y al crédito, un aspecto preocupante en el escenario actual es cómo finalmente serán afectados los dos canales principales de financiación del sistema financiero mundial, el canal del crédito bancario y la financiación en los mercados de capitales.Es necesario, hoy en día, probar que los beneficios esperados, sobre los que se sustenta la valoración financiera, realmente pueden efectivizarse, dado que se basan en la ganancia que se extraería del futuro como producto de la especulación más que del valor generado por el trabajo realmente productivo.

La percepción del riesgo y su relación con la actual crisis financiera global

El objetivo de este artículo es analizar los principales factores de la excesiva prociclicidad de los sistemas financieros, debido al incremento innecesario de las oscilaciones en el nivel de actividad lo cual pone en riesgo la estabilidad financiera con repercusiones negativas en la economía real de los países. El normal crecimiento económico real de un país va en paralelo con el crecimiento de los sistemas financieros en general y con el crecimiento de los créditos en particular, ocasionando una prociclicidad lógica y deseable muy fuerte entre estos, siempre poniendo en evidencia como las balanzas de pagos nacionales se corresponden como elementos interdependientes de un sistema monetario global de suma cero. La problemática se plantea en la medida en que existen factores inherentes al comportamiento de los agentes económicos que actúan dentro de los sistemas financieros o que se derivan de la regulación prudencial que aumentan la volatilidad en forma anormal respecto de sus niveles considerados como fundamentales, teniendo una repercusión procíclica de amplitud en el ciclo económico, siempre inconveniente por la generación de inestabilidad y turbulencia en los precios. La actual crisis financiera alcanza magnitudes de pérdidas sin precedentes, y todavía está cobrando víctimas, es claro que la función de riesgos de las entidades financieras jugará un papel clave, adaptando su gestión a los mercados, considerando los aspectos conductuales y de percepción de los agentes económicos. Con relación a la percepción del riesgo y al crédito, un aspecto preocupante en el escenario actual es cómo finalmente serán afectados los dos canales principales de financiación del sistema financiero mundial, el canal del crédito bancario y la financiación en los mercados de capitales. Es necesario, hoy en día, probar que los beneficios esperados, sobre los que se sustenta la valoración financiera, realmente pueden efectivizarse, dado que se basan en la ganancia que se extraería del futuro como producto de la especulación más que de el valor generado por el trabajo realmente productivo.

What drives bank earnings? Evidence for 28 banking sectors

The crisis has revived interest in the determinants of bank earnings. We investigate the relationship between profitability and balance sheet composition of 28 national banking sectors. Using Statistical Cost Accounting, we find a plausible pattern of individual assets’ and liabilities’ contributions to earnings and costs. Both wholesale and retail activities yield positive margins, while interbank lending and customer deposits are the most expensive funding sources. Wholesale finance has a positive effect on profitability, which may explain banks’ increasing reliance on it prior to the crisis. Economic growth and unemployment have a procyclical impact, while inflation tends to erode profitability.

An Equilibrium Model of Credit Rating Agencies

We develop a model of credit rating agencies (CRAs) based on reputation concerns. Ratings affect investors' choice and, thereby, also issuers' access to funding and default risk. We show that - in equilibrium - the informational content of credit ratings is inferior to that of CRAs' private information. We find that CRAs have a pro-cyclical impact on default risk: in a liquidity boom CRAs help resolve investors' coordination problem, and lower the probability of default; in a liquidity crunch CRAs raise the probability of default. Furthermore, rating standards tend to be pro-cyclical, while biased CRA-incentives will ultimately be selfdefeating.

The Cyclical Effects of Accounting Rules on Basel III Liquidity Regulation

Basel III introduces the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) to enhance bank liquidity regulation. This paper investigates whether accounting rules have pro-cyclical effects on these liquidity requirements. By rearranging and simplifying the formulae for the LCR and the NSFR, the paper analyses the linkages among accounting rules, capital rules and liquidity ratios. Due to these linkages, recurring fair value measurements are found to have pro-cyclical effects on both the LCR and the NSFR whereas the provision for loan losses is found to have positive effects on the NSFR although it has little impact on the LCR. The expected loss (EL) model for loan loss provisioning will introduce a new pro-cyclical impact on the NSFR even though it will lessen the pro-cyclical impact of the incurred-loss impairment model on the leverage ratio. Therefore, the contribution of accounting rules to the pro-cyclicality in the regulatory system will be enhanced as the paper also finds that the Basel III liquidity rules and the Basel III capital rules will reinforce each other’s pro-cyclicality.