Credit Quality Research Articles

Macroeconomic impact and stock returns' vulnerability by size, solvency, and financial distress

We examine how firms' equity value, financing and credit quality respond to changing macroeconomic indicators. We provide evidence that the value of small, low-credit quality, and financially distressed companies are more vulnerable to labor market changes. Our findings show that the equity value of U.S. companies deteriorates when the economy experiences increased cost of capital from an inflation hike, a decrease in domestic output, and uncertainty in the labor market. Our findings are robust to changes in the sample period and after controlling for disparities across industries, states, and firms.

Through-the-cycle to Point-in-time Probabilities of Default Conversion: Inconsistencies in the Vasicek Approach

While regulators generate and advocate the use of through the cycle (TtC) probabilities of default (PDs) for regulatory capital calculations, accounting standards (such as IFRs9) require organisations to use point in time (PiT) PDs. TtC PDs are based on long-term average conditions and do not adequately capture current credit risk conditions, underestimating credit losses during economic downturns or periods of financial stress. PiT PDs reflect the specific risk conditions prevailing at a given moment in time and provide a more granular assessment of credit risk. While many techniques measure PiT PDs directly, mathematical approaches also exist which convert TtC PDs into PiT PDs. PiT PDs are also routinely forecasted, projected into the future to allow estimation of the present value of future possible credit-related losses. Vasicek’s (1987) model is in common use for this purpose. Using a stylistic range of possible input values for Vasicek’s model, loan credit quality is found to be differentially affected (improving for some and deteriorating for others) for some of these values. This is counterintuitive and reflects a functional flaw in the model.

Social Responsibility, Media Attention and Financial Risk of Listed Real Estate Companies in China

In the past two years, real estate companies have been actively exploring new development models at the policy level. For the future sustainable development of real estate companies, ESG performance can reflect the overall credit quality of companies in non-financial aspects, while the fulfillment of social responsibility is an important factor in measuring the ESG performance of companies, and therefore gradually becomes a focus of attention. In order to analyse the relationship between social responsibility fulfillment and financial risk of real estate companies, this paper proposes hypotheses based on theories such as stakeholder theory, introduces media attention into the analysis framework, and selects data of Chinese A-share real estate listed companies from 2010 to 2019 for empirical testing. It is found that the fulfillment of social responsibility by real estate companies is negatively related to financial risk, while media attention plays a negative moderating role in this regard. The findings provide empirical support for the mechanism of the impact of social responsibility fulfillment on real estate companies' financial risk and offer policy options for real estate companies to reduce their own financial risk.

Credit Quality as a Moderating Effect of Capital Adequacy and Credit Distribution on the Profitability of Village Credit Institutions

Profitability is one measure of the achievements of Village Credit Institution (LPD) in managing them so that they can continue to grow and develop amidst increasingly fierce competition between financial institutions. Capital adequacy, loan disbursement, and quality of credit disbursed are several factors that affect LPD profitability. This study uses a qualitative descriptive approach with secondary data sources. The research population is all LPDs in Denpasar City totaling 35 units. Determination of the sample using purposive sampling so that 34 units of LPD were obtained as samples and 170 observational data. The research instrument uses documentation techniques or non-participant observation. Methods of data analysis using descriptive analysis and inferential analysis with moderation analysis for moderated regression analysis. The research results show that Capital Adequacy Ratio has a significant positive effect on Return on Asset. Loan to Deposit Ratio significant positive effect on Return on Asset. Credit quality is able to moderate (weaken) the influence of Capital Adequacy Ratio to Return on Asset. Credit quality is not able to moderate the effect of Loan to Deposit Ratio to Return on. The implication of the research is that this research provides information for LPDs in Denpasar City regarding the influence Capital Adequacy Ratio and Loan to Deposit Ratio to Return on Asset which is moderated by credit quality so that LPD management in Denpasar City can determine future policy directions in order to increase the profitability and progress of LPDs in Denpasar City.

The impact of Fintech on the nexus between household debt and financial crises: A global perspective

This study investigates whether fintech development shapes the nexus between household debt and financial crises. Prior research has demonstrated a positive relationship between household debt and financial crises but has neglected to explore the heterogeneity of this effect resulting from the rapid fintech development. We used a dataset of 100 countries from 2006 to 2019 and revealed that fintech development elevates the probability of a household debt expansion resulting in a financial crisis. This effect primarily operates through increased risk-taking among traditional banks, which tend to relax their credit standards to compete with fintech lenders. Furthermore, the amplification effect of fintech development is more pronounced in countries characterized by more developed financial systems, more advanced information-sharing systems, less stringent financial regulations, and higher digitalization. These findings have enriched our understanding of how fintech influences household credit quality, providing insights into its economic consequences from the vantage point of financial crises.

An investigation of the Volatility Adjustment

AbstractWe use market data to reconstruct the volatility adjustment, a component of the Solvency II framework designed to mitigate the impact of market risk on insurance liabilities, of different countries on a monthly basis. Only partially in agreement with the regulation, we observe that the volatility adjustment, especially the proposed new mechanism, is not affected by credit quality, illiquidity of bonds, and investors’ risk appetite, but by turbulence in financial markets and equity market performance. We also show that the new mechanism proposed by EIOPA performs differently with respect to the one in force at the time of writing the current paper, yielding higher and smoother values and providing a relief to insurance companies on the Solvency II capital requirement front.

Procyclical Credit Rating Policy*

AbstractThis paper examines whether credit rating agencies applied consistent rating standards to US corporate bonds in the periods surrounding the 2008 financial crisis. Based on estimates of issuing firms' credit quality from a structural model, I find that rating standards are in fact procyclical: ratings are stricter during an economic downturn than during an economic expansion. As a result, firms receive overly pessimistic ratings in a recession, relative to during an expansion. I further show that a procyclical rating policy amplifies the variation in corporate credit spreads, accounting for, on average, 11% of the increase in spreads during a recession. In the cross‐section, firms with a higher rollover rate of debt, fewer alternative channels to convey their credit quality to the market, and firms with businesses that are more sensitive to economic cycles are more affected by the procyclical rating policy.

Killing two birds with one stone? Sound investment with social impact

AbstractThis paper uses a novel dataset on investments by the European Bank for Reconstruction and Development to quantify a (sizeable) trade‐off between the impact and financial objectives of a large lender. The unique feature of this dataset is ex ante records of impact. These are made at the early stages of work on each transaction alongside probability‐of‐default scores. Impact scores are further updated at the final approval stage with around 55 percent of transaction concepts translating into signed deals. We show that this approach delivers a simultaneous selection of debt investments on the quality of credit and impact with a sizable trade‐off between pursuing commercial and development objectives. For commercially riskier investments, impact characteristics have a greater bearing on the probability of an investment going ahead. We further use machine‐learning analysis to show that the impact of some investments is strengthened prior to project approval.

Impact of Restructuritation Strategies and Financial Instruments for Loan Loss Provision

When the COVID-19 pandemic started in April 2020, there was a swift change for portfolio banks in the lending sector. Loan at risk still dominated all of the lending portfolio banks. As a result, the quality of the portfolio and bank assets is getting worse. Furthermore, the banking industry is advised to continue paying attention to the adequacy of loan loss provisioning for impairment losses in anticipating the potential for deteriorating credit quality. The condition of the banking business portfolio, especially in the lending sector, is experiencing worsening conditions due to the COVID-19 pandemic. Loan loss provisioning as the bank’s anticipation of the risk of losing productive assets could contribute in a significant way to the financial crisis in the banking sector. This study analyzes the restructuritation, bank size, capital, inflation, operating expenses management, and productivity growth on loan loss provision. Data collection is done by recording every data needed from The Financial Services Authority (OJK) in the audited financial report. The data were collected for five years quarterly from Q2 2017–Q4 2022, with the object of research being ten banks of group BUKU IV. In total, there are 220 data observations. The dependent variable in this study is loan loss provision. Moreover, the independent variables in this study are restructuritation, bank size, capital, inflation, operating expenses management, and productivity growth. This study uses a quantitative approach with an explanatory or causal design. The data analysis used in this study is panel data regression with the help of the EViews 13 program. The results show that restructuritation policy, inflation rate, and bank size during the COVID-19 pandemic have a significant positive impact on loan loss provision. However, capital bank productivity growth before the COVID-19 pandemic occurred. Also, the operating expense management during the restructuring policy implementation period significantly negatively affects loan loss provision.

Implementation of a Business Intelligence Model for Analysis Banking and Credit Management

The 2008 global financial crisis affected the pace of the economy by reducing the level of public trust in banks. Seeing these conditions, Bank XYZ needs to know and analyze the factors that influence bank lending. Debtor data processing at Bank XYZ is well integrated, but in fact, Bank XYZ still needs to pay attention to the principle of prudence in making decisions to provide credit facilities to debtors with minimal risk so that credit can be extended consistently and based on sound credit principles. In monitoring and analyzing the credit system at Bank XYZ, there is one factor that serves as a reference for measuring a bank's ability to bear the risk of credit failure by debtors through NPLs (non-performing loans). In addition to NPLs, the growth in the number of debtors, the amount of credit disbursement, the amount of outstanding credit provided in various sectors, and the amount of collectibility of debtors also play an important role in decision-making by management; therefore, the author proposes a business intelligence model to analyze credit data at XYZ Bank in the form of data visualization in dashboard form. The dashboard was built using the Tablue for Students software. The results of this study are a business intelligence model in the form of a dashboard application to be able to monitor debtor data growth, analyze loans extended in various economic sectors, and analyze outstanding loans using the NPL value as a reference based on credit quality as a decision support tool.

Economic and financial developments of the USA before and after the pandemic of covid-19

The global pandemic of Covid-19, being an unpredicted event, has caused a collapse in the entire world economy. Different countries have taken different approaches to deal with the economic problems derived from it. This paper aims to make an analysis of the economic and financial developments of the USA by figuring out the condition before and after the pandemic. An important stress will be put on the monetary policy followed by the government of the USA. For a good analysis, a comparison between economic indicators and their behavior, before and after the pandemic, will be done, ft will be discussed about the economic activity, the labor market, inflation and the economic and financial stability. These unusual conditions have their effect also in the financial market. The credit quality of firms as well as the performance of financial institutions is mostly affected. The yields on securities and the spread of yields of bonds in comparison with treasury bills is also an important indicator to be studied. Given the problematic situation the government of the USA tried to influence through the monetary and the fiscal policy. The increase on the money supply by keeping the FED interest rates near to zero has been one of the measures for recovering the economy. Another important measure to address the problem has been the safeguarding of the market functioning. On the other hand, the help of the government by the fiscal policy has been immediate, even though it is expected to increase the government outlays. The methodology used by this paper will be a theoretical comparison of economic development before and after the pandemic, based on row data generated by the reports of Federal Reserves. Statistical data will also be used in order to support the analysis. ft concludes that the pandemic has affected the entire world, not only from the health viewpoint bat economically as well. The USA, as the leading economy in the world faced the challenge of finding the most appropriate measures to recover from the downturn. The effects of its policies will continue in the long run and there is needed some time to overcome them.

Features of credit behavior of Russian youth: trends and risks

The article discusses the current aspects of the credit behavior of Russians, including changes in the volume of borrowings over the past 4 years, as well as the dynamics of indebtedness, including overdue loans. Based on the results of the author’s sociological research (two measurements — in 2022 and 2023), the features of active actions and attitudes of young people in the field of debt behavior are identified. The analysis showed strengthening of the vector on the willingness to involve this age group of the population in credit practices. There was carried out a comparison of the attitudes of young people regarding the conditions under which evasion of obligations to repay debts is justified: 1) debts to credit institutions; 2) to relatives and acquaintances. The views of Russian youth on the censure for such evasion practices in Russian society are examined. The survey results show that the presence of a loan agreement of respondents contributes to formation of a more responsible behavior regarding compliance with payment deadlines, in contrast to the situation of the absence of debt (only with the intention to enter into debt relations). The position of young people in relation to the violation of loan repayment terms is different in different groups: the youngest respondents (17–20 years old) see more reasons for the possibility of non-repayment of the loan. Among the reasons why it is permissible, in the opinion of young people, not to repay debts, the most compelling for respondents are the situations when the loan was issued by fraudsters without the consent of the person himself (67%), in case of serious health problems and the need to spend on treatment (38%), if the lender increased the interest on the loan unilaterally (34%), in case of job loss (26%). Credit risks typical not only for young people, but also for all age groups of Russians are highlighted: deterioration of the “credit quality” of borrowers and risks of breach of obligations (non-payment and violation of repayment terms) on loans due to a decrease in real income.

Credit Quality Evaluation on a Dynamic Network with Latent Variables

Credit Quality Evaluation on a Dynamic Network with Latent Variables

Complexity and the default risk of mortgage-backed securities

We study the impact that lower complexity in bank securitisations has on mortgage quality and the securitisation structure. We find that mortgages issued after the announcement of new European regulation that aims to reduce deal complexity are characterised by up to 0.38% lower annual delinquency rates than in the pre-regulation period. Similarly, we show that mortgage securitisations that meet the new ‘simplicity, transparency and standardisation’ (STS) criteria have 0.77% lower annual delinquency rates and are more resilient to adverse macro-economic shocks. We find that the increased quality of the underlying loans outweighs the potential negative effects of thinner subordinated tranches in securitisations that comply with the new regulation. Overall, our findings suggest that the new European securitisation regulation has contributed to improving credit quality in the securitisation market in Europe.

How do industry tournament incentives affect firm debt maturity?

Our study investigates the effect of external industry tournament incentives on debt maturity structure. Prior research shows that industry tournament incentives motivate managers to employ more risky strategies. Recognizing this stronger tendency for risk-taking, creditors may shorten debt maturity and subject managers to more frequent scrutiny by debt markets. Consistent with this notion, our results show that stronger industry tournament incentives lead to significantly more short-term debt. This effect is more pronounced in firms with low credit quality, in areas with a high density of firms from the same industry, and in industries with more CEO positions.

Counterparty Risk and Counterparty Choice in the Credit Default Swap Market

We investigate how market participants price and manage counterparty credit risk using confidential trade repository data on single-name credit default swap (CDS) transactions. We find that counterparty risk has a modest impact on the pricing of CDS contracts but a large impact on the choice of counterparties. For contracts ineligible for central clearing, we show that market participants are significantly less likely to trade with counterparties whose credit risk is highly correlated with the credit risk of the reference entities and with counterparties whose credit quality is low. For clearable contracts, we find that nondealers are more likely to clear during a crisis and less likely to clear when the reference entity is a large U.S. dealer or a sovereign. This paper was accepted by Kay Giesecke, finance. Supplemental Material: The internet appendix and data are available at https://doi.org/10.1287/mnsc.2023.4870 .

The marginal impact of predicted climate risk scenarios on portfolio credit risk stress testing

This paper adapts the methodology developed by de Oliveira Campino et al. (June 2021) to account for predicted climate risk shocks' impact on a sovereign portfolio's credit quality on a forward-looking basis and in probabilistic terms. In particular, the portfolio stress testing capability is enhanced by adjusting the severity of the credit shocks to account for climate risk-related events on an additive basis. The benefit to risk managers is that it allows understanding of the impact of climate risk in marginal terms in relation to the original credit shock. The recently created NGFS (the Network for Greening the Financial System) database makes this exercise possible. Moreover, the described approach translates the marginal impact of climate risk scenarios on the portfolio's credit risk stress testing into capital adequacy metrics dislocations, which facilitates communicating the marginal impact of climate risk scenarios as capital consumption amounts. The paper presents an overview of the underlying model, and the methodological approach developed to adapt the credit risk stress-testing capabilities to account for climate risk using the NGFS database. Moreover, it applies the methodology to a hypothetical sovereign loan portfolio and discusses the results. Over the period considered, the study finds that the transition aspect of climate risk has a more pronounced marginal impact on a sovereign portfolio's credit risk than the chronic physical aspect of climate risk. Moreover, the results indicate that as the world takes action to transition away from carbon, the credit risk of sovereign portfolios may be exacerbated, especially if there are delays and a lack of coordination across countries and sectors.

Determinants of the Intensity of Bank-Firm Relationships: Evidence from Japan

Abstract Focusing on the Japanese setting, this study investigates the standard firm characteristics that affect the intensity of bank-firm relationships (IBR) and how these characteristics relate to the decline in IBR. The regression results show that firm size, credit quality, investment opportunities, and ownership concentration are negatively associated with IBR, while firm age, pledgeability, and managerial ownership are positively associated. This study also finds that (1) an increase in credit quality, (2) a decrease in the positive impact of managerial ownership, and (3) an increase in the negative impact of ownership concentration cause the decline in IBR. (JEL G21, G32, L14) Received March 15, 2023; editorial decision July 11, 2023 by Editor Isil Erel. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Does fintech lending expansion disturb financial system stability? Evidence from Indonesia

Literature suggests two contradictory views regarding the impacts of fintech lending on banks. The competition-instability proponents believe that fintech lending expansion erodes bank market and threatens banks as traditional intermediaries, thereby intensifying bank risk-taking and potentially disturbing financial stability. In contrast, the competition-stability proponents believe fintech lending reduces asymmetric information in the credit market, thus reducing bank risk-taking and increasing bank resilience to a systematic shock. This paper aims to examine the impacts of fintech lending expansion on bank-risk taking, i.e., credit channeling activity and bank risk. This study utilizes the OLS, random effects, fixed effects, and two-step GMM regressions to test the conjectures. Consistent with the competition-stability hypothesis, our evidence indicates that shadow banking increases as banks actively seek channels to diversify their risks but are less likely to use fintech lending as a credit channel. This paper also corroborates the notion that fintech lending expansion encourages banks to diversify their risks. Pertaining to the relationship between fintech lending and bank risk, our results suggest that fintech lending expansion encourages banks to work more efficiently to improve their credit quality rather than to intensify bank risk-taking. These findings also indicate that synergy between fintech lending and banks would increase bank credit quality. This paper also examines the reasonable credit limits for fintech lending firms based on MSMEs’ characteristics. Employing the threshold regression, we find that IDR5 billion is the maximum credit provision to induce the profitability of MSMEs whereas IDR6 billion is the maximum credit provision to minimize the default risk of MSMEs.

THE CORRELATION IN CORPORATE DEFAULTS: EVIDENCE FROM NON-FINANCIAL LISTED COMPANIES IN SRI LANKA

Default correlation is the extent to which one company's default causes another's default. It measures the relationship between a firm’s individual default probability and the joint default probability among firms. This study makes theoretical contributions by examining the degree of default correlation among non-financial listed firms in terms of credit quality, time horizon, systematic risk, firm size, and liquidity. The researcher selected 550 firm-year observations (240 for default and 310 for non-default) consisting of 55 non-financial listed companies in Sri Lanka from 2012 to 2021. The default firms are selected using the three criteria during the selection period: suffering from losses, having negative net worth, or suffering from negative operating cash flows for more than three consecutive years. The non-default firms are selected by a couple with the default firms based on the same industry and the highest market capitalization. Altman’s (1968) Z-score model is used to determine the credit ratings as high, medium, and low. The study follows Lucas’s (1995) proposed standard binomial approach to measure the default correlation. The study revealed that time horizon, poor credit ratings, high beta, and small size increase the default correlation in the Sri Lankan context; however, liquidity is not a good measurement for default correlation analysis in Sri Lankan context. Credit risk management could underestimate the portfolio credit risk without considering the default correlation. The dynamic nature of default correlation shows that an increment in default risk of individual credit assets engages with a disproportionate increment in portfolio credit assets.