Unsecured Borrowing Research Articles

Credit card and payday loan borrowing: Evidence in the SCF 2010–2019

Unsecured borrowing plays an important role for consumers in smoothing consumption. Each year , almost 40 using a high-cost payday loan. This paper aims to explore the similarities and differences between both types of borrowers. Using the Survey of Consumer Finances (SCF) from 2010 to 2019, I document that: (1) credit card borrowers are middle-aged, upper-middle-class, with some college exposure, and financially literate; (2) payday loan borrowers are young, low-income and low-wealth, less educated, and less financially literate; and (3) payday loan borrowers lack the financial knowledge of inflation and risk diversification, but not of compound interest. • I document the similarities and differences between credit card and payday loan borrowers using the Survey of Consumer Finances. • Credit card borrowers are middle-aged, upper-middle-class, with some college exposure, and financially literate. • Payday loan borrowers are young, low-income and low-wealth, less educated, and less financially literate. • Although payday loan borrowers are less financially literate, they lack knowledge of inflation and risk diversification, but not of compound interest.

XVA metrics for CCP optimization

Abstract Based on an XVA analysis of centrally cleared derivative portfolios, we consider two capital and funding issues pertaining to the efficiency of the design of central counterparties (CCPs). First, we consider an organization of a clearing framework, whereby a CCP would also play the role of a centralized XVA calculator and management center. The default fund contributions would become pure capital at risk of the clearing members, remunerated as such at some hurdle rate, i.e. return-on-equity. Moreover, we challenge the current default fund Cover 2 EMIR sizing rule with a broader risk based approach, relying on a suitable notion of economic capital of a CCP. Second, we compare the margin valuation adjustments (MVAs) resulting from two different initial margin raising strategies. The first one is unsecured borrowing by the clearing member. As an alternative, the clearing member delegates the posting of its initial margin to a so-called specialist lender, which, in case of default of the clearing member, receives back from the CCP the portion of IM unused to cover losses. The alternative strategy results in a significant MVA compression. A numerical case study shows that the volatility swings of the IM funding expenses can even be the main contributor to an economic capital based default fund of a CCP. This is an illustration of the transfer of counterparty risk into liquidity risk triggered by extensive collateralization.

Repo Rates and the Collateral Spread Puzzle

Repo rates frequently exceed unsecured rates in practice. As an explanation, this paper derives a constrained-arbitrage relation between the unsecured rate, the repo rate, and the illiquidity adjusted expected rate of return of the underlying collateral. The theory is based on unsecured borrowing constraints in the market for liquidity. Repos and security cash-market trades are alternative means to get liquidity. Collateral spreads (unsecured less repo rate) can turn negative if borrowing constraints tighten, unsecured rates spike down, or from a depressed and illiquid security market. The constrained-arbitrage theory sheds light on the evolution of collateral spreads over time.

Interest on Reserves and Arbitrage in Post-Crisis Money Markets

In this note, we use confidential, daily data on wholesale unsecured borrowing and reserve balances to empirically document several salient features of IOR arbitrage trades.

Interest on Reserves and Arbitrage in Post-Crisis Money Markets

Currently, Eurodollars and fed funds markets combined trade about $220 billion in funds daily, the vast majority of which with overnight tenor. In this paper, we document several features of these wholesale unsecured dollar funding markets. Using daily confidential data on wholesale unsecured borrowing and reserve balances, we show that foreign banks, which make up most of the trading volumes in these markets, keep around 99% of each additional Eurodollar and 80% of each fed fund borrowed as reserve balances. With these risk-free trades, banks earn the spread between interest on reserves and the borrowing rate. Relative to foreign banks, large domestic institutions borrow less often, but when they do, they keep around 99% of each additional Eurodollar or fed fund raised as reserves. Small domestic banks do not display any correlation between net borrowing and their reserves accumulation. We also discuss how regulatory costs affect trading patterns and interest rate differentials in wholesale dollar funding markets.

Unsecured and Secured Funding

We provide the first joint analysis of the secured and unsecured money markets of the euro area using bank-level data. After the Lehman crisis, two important substitution mechanisms emerge: banks with higher credit risk offset reductions of unsecured borrowing with secured funding. Riskier banks replace unsecured lending by granting more secured loans. However, high leverage and reliance on short-term funding hamper banks' ability to substitute. Moreover, banks enduring money market strains contribute to the credit crunch. Overall, our findings suggest that the secured segment of the euro money market contributes to financial stability, mitigating systemic effects such as short-term funding strains and contagion.

The Determinants of Unsecured Credit Constraint

This paper studies the determinants of households' unsecured credit limits by using the Survey of Consumer Finances data. We use instrumental variables of net worth for controlling the endogeneity issue that arises between an unsecured credit limit and net worth. The empirical results show that the wages or income of a household head is the most significant determinant of the household's unsecured borrowing limit. The credit limit increases as the mean of the rate of income growth increases or its volatility decreases. Home and business ownership, instrumented net worth or demographic variables exhibit a limited role in determination of the limit.

Improving retail banking loans recovery via data mining techniques: a case study from Indian market

In 2006-2007, the Indian banks saw a phenomenal increase in their loans, because of global growth, and mortgage market in the USA. But this was a 'bubble', hence did not sustain. Then global recession set in affecting the financial market in India. The default rates on unsecured borrowing rose and recovery became difficult. Banks spent more resources for their recovery. But in the process, borrower information was ignored, although credit bureau information about the borrower was available. This paper demonstrates that data mining techniques can find out defaulters who are most likely to pay, hence focusing recovery efforts on them. We tested the predictive power of neural network (NN), CART (DT) and logistic regression (LR) on the data of one of the bank's personal loan portfolio. Also, we demonstrated the use of 'textual data' available in the form of interaction with the borrowers and its value addition in predicting their payment behaviour.

Do Banks Pass Through Credit Expansions? The Marginal Profitability of Consumer Lending During the Great Recession

We examine the ability of policymakers to stimulate household borrowing and spending during the Great Recession by reducing banks’ cost of funds. Using panel data on 8.5 million U.S. credit card accounts and 743 credit limit regression discontinuities, we estimate the marginal propensity to borrow (MPB) for households with different FICO credit scores. We find substantial heterogeneity, with a $1 increase in credit limits raising total unsecured borrowing after 12 months by 59 cents for consumers with the lowest FICO scores ( 660) while having no effect on consumers with the highest FICO scores (> 740). We use the same credit limit regression discontinuities to estimate banks’ marginal propensity to lend (MPL) out of a decrease in their cost of funds. For the lowest FICO score households, higher credit limits quickly reduce marginal profits, limiting the pass-through of credit expansions to those households. We estimate that a 1 percentage point reduction in the cost of funds raises optimal credit limits by $127 for consumers with FICO scores below 660 versus $2,203 for consumers with FICO scores above 740. We conclude that banks’ MPL is lowest exactly for those households with the highest MPB, limiting the effectiveness of policies that aim to stimulate the economy by reducing banks’ cost of funds.

Strains on Money Market Makers and Money Market Tensions

We analyze the trading book of a key market maker in the European unsecured money market and study the extent to which liquidity risks accumulated by this market maker affect his pricing of liquidity and the bid-ask-spread he quotes on unsecured borrowing and lending. We find that the larger the funding liquidity risk assumed by the market maker the higher the market price for liquidity and the higher his term premium. Furthermore, his bid-ask-spread and the sensitivity of his bid-ask-spread to the maturity of transactions increases as his assumed liquidity risk rises. This suggests that also in the unsecured money market funding constraints and funding risks of the market maker affect market liquidity in line with Gromp and Vayanos (2004) and Brunnermeier and Pedersen (2009).

The Calculation of Prejudgment Interest

This Essay describes the proper method of calculating prejudgment interest based on sound financial principles. Using the paradigm that the claim plaintiff holds in litigation represents an involuntary loan from plaintiff to defendant and recognizing that in bankruptcy courts treat legal claims similarly to unsecured debt, we argue that prejudgment interest should be computed using the defendant's unsecured borrowing rate. Furthermore, we argue that courts should use a short-term, floating interest rate rather than a long-term rate in order to provide the proper incentive for the parties to settle. We criticize alternative bases for awarding prejudgment interest and address modifications to account for taxes, insurance, foreign currency conversion, asynchronous payments, and suits involving individual plaintiffs.

Credit and Self-Employment

Limited personal liability for debts has long been justified as a tool to promote entrepreneurial risk taking by providing insurance to the borrower in the event of low returns. Nonetheless, such limits erode repayment incentives, and so may increase unsecured borrowing costs. Our paper is the first to evaluate the tradeoff between credit costs and insurance against failure. We build a life-cycle model with risky, and repeated, occupational choice in the presence of defaultable debt contracts. We find that limits to liability can encourage self-employment, and alter the timing, size, and financing of self-employment projects. We also find that the positive relationship between wealth and self-employment rates may not be evidence for credit constraints: We show that such a relationship is present even when limited liability is eliminated.

Debt, donors, and the decision to give

Despite the enormous size of the nonprofit sector, there has been very little empirical research done on the capital structure of nonprofit organizations, and no one has examined the potential effects of borrowing on individual contributions. Using a representative sample of nonprofits, the empirical analysis first determines whether secured or unsecured borrowing by nonprofits influence future contributions. The results for the full sample support a “crowding-out” effect. When the analysis is repeated on a subsample of nonprofits that are older, larger, and more dependent upon donations, the results are more ambiguous: secured debt has little or no effect, while unsecured debt has a “crowd-in” effect. The empirical analysis is then expanded to test whether nonprofits with higher than average debt levels have different results than nonprofits with below average debt levels. The results suggest that donors do remove future donations when a nonprofit is more highly leveraged compared to similar organizations.

An analysis of secured and unsecured borrowing performance of the power corporations of Haryana: 2001-2010

Secured and unsecured borrowings shows the current status of the power sector whether the corporation is generating revenue or not the status shows it needs a lot of improvement on various points. For secured borrowings HPGCL & HVPNL needs lots of improvement and for unsecured borrowings DHBVNL needs to improve alot . Unsecured Borrowing Performance (USBP) of the four corporations is shaped by dividing unsecured loans over total assets one by one . Measuring this performance is quite important because of this a trend is came to know about loans of the four corporations individually. Unsecured Borrowing Performance (USBP) of the foru corporations is formed by dividing unsecured loans over total assets individually. Calculating this performance is quite essential because of this a trend is came to know about loans of the four corporations.The assessment of secured borrowing performance of the four corporations will advise whether there is significant change has been recorded in secured borrowing performance of the four corporations or not in relation to. For this the average secured borrowing performance of each corporation is compared with the average secured performance of power sector Haryana. If we compare secured and unsecured borrowing performances then secured borrowings are preferred because these are given on security and usually given for a long time. I. Interest on Loans The HVPNL estimate of interest of Rs. 1,737.35 million on loans included interest on new loans, other financial charges, interest on provident fund liability and excludes pension fund liability. The staff considered that all the loans contemplated for externally assisted projects would not materialise during the current year and therefore, proposed to disallow the interest on the same. The staff also noted that HVPNL did not submitted instrument-wise details of loans and details of the bonds issued to NTPC and NHPC. HVPNL, in their response submitted that the interest on loans is calculated in respect of loans raised in FY 1999-2000 and it has not included additional borrowing for 2000-01. The additional loans already raised include NTPC bonds of Rs. 250 crore, NHPC bonds of Rs. 300 crore, bonds of Rs. 131 crore raised through market subscription, and loans of Rs. 60 crore obtained from Commercial Banks, with a total annual interest burden of Rs. 91.88 crore Besides these, the licensee would receive Rs. 144.4 crore additional loan in 2000-01 from a number of other sources like PFC, IBRD, etc. with an annual interest of Rs. 9.39 crore. Thus the total interest based on the staff calculation after adding the additional loans and bonds comes to Rs. 213.02 crore 1 .

The determinants of unsecured borrowing: evidence from the BHPS

The British Household Panel Survey (BHPS) for 1995 and 2000 is used to examine the determinants of participation in the unsecured debt market and the amount borrowed. Age, income, positive financial prospects and housing tenure are found to be significant in probit models for participation. Income is the main variable explaining cross-sectional differences in unsecured debts.

The Costs and Benefits of Moral Suasion: Evidence from the Rescue of Long‐Term Capital Management*

This study examines the level of unsecured borrowing done by the firms that ultimately rescued Long‐Term Capital Management in the days leading up to the hedge fund’s rescue. Although these banks borrowed less at the height of the crisis, evidence suggests that this reduction in borrowing was demand‐driven and did not result from rationing by the market. Further, it is shown that large banks that were not involved with the LTCM rescue saw the rates they pay for unsecured funds decline following the hedge fund’s resolution. This finding is consistent with an increase in the strength of a too‐big‐to‐fail policy.

The Determinants of Unsecured Borrowing: Evidence from the British Household Panel Survey

Household indebtedness has risen sharply in recent years, with large increases in both secured and unsecured borrowing. In this paper, waves 5 and 10 of the British Household Panel Survey (BHPS) for 1995 and 2000 are used to examine the determinants of participation in the unsecured debt market and the amount borrowed. Probit models for participation are estimated and age, income, positive financial prospects and housing tenure are found to be very significant and have the expected sign according to a life-cycle model for consumption. Regressions to explain the level of borrowing by individuals suggest that income is the main variable explaining cross-sectional differences in unsecured debts. The increase in aggregate unsecured debt between 1995 and 2000 does not seem to be closely linked to changes in the determinants of debt market participation and has been mainly associated with the larger amounts borrowed by those with debts. Increases in income, better educational qualifications and improved prospects regarding the financial situation contributed to this result. The major part of the overall increase in unsecured debt is not explained by variables at the individual level, but is accounted for by common, unmodelled macroeconomic factors.

An Empirical Model of Household Arrears

Household arrears on payment obligations are one of the most direct measures of household sector financial stress. This paper uses a time series approach to model two of the key components of aggregate UK household arrears: those on mortgages and credit cards. Mortgages are the main component of secured borrowing by households and credit cards are a key element in unsecured borrowing. Recent data show that both secured and unsecured debt have risen substantially, both absolutely and as a proportion of income since 1997. Unsecured debt has increased more rapidly over this period and so has become more important in overall household debt. During this period of rapid debt accumulation, the proportion of mortgage loans in arrears has fallen but the value of credit card arrears relative to the value of active card balances has risen. The paper explains these differences in the behaviour of arrears by reference to the underlying driving forces identified in previous empirical work. In particular the level of housing equity appears to be more important in explaining mortgage arrears, and the role of supply factors is highlighted for credit card arrears. Although the estimated models confirm that both income and interest repayments (and therefore income gearing) are important factors in explaining both forms of arrears, unemployment only plays an additional role for mortgage arrears. Joint testing of the two models suggests a role for the ratio of the value of the mortgage loan to the value of housing equity for both kinds of arrears, but with opposing effects. In the case of mortgage arrears this might reflect the lenders' perceptions of the quality of the borrower. Credit card arrears appear to contain some information about future mortgage arrears although the reverse does not hold. Both equations adjust relatively quickly to any shocks, typically in around two years. The significance of the income-gearing term for both types of arrears underlines the importance of the path of interest rates for the financial position of the UK household sector.

The Costs and Benefits of Moral Suasion: Evidence from the Rescue of Long-Term Capital Management

This study examines the level of unsecured borrowing done by the firms that would ultimately rescue Long-Term Capital Management in the days leading up to the hedge fund's rescue. Although there is some evidence that these banks borrowed less at the height of the crisis, further examination reveals that this reduction in borrowing was demand-driven and did not result from rationing on the part of the market. This suggests that the market believed that the troubles at LTCM would not have solvency-threatening repercussions for the fund's major creditors. Further, it is shown that large banks that were not involved with the LTCM rescue saw the rates they pay for unsecured funds decline following the hedge fund's resolution. This finding is consistent with an increase in the perceived strength of a too-big-to-fail policy.