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The Liikanen Group proposes contingent convertible (CoCo) bonds as a potential mechanism to enhance financial stability in the banking industry. Especially life insurance companies could serve as CoCo bond holders as they are already the largest purchasers of bank bonds in Europe. We develop a stylized model with a direct financial connection between banking and insurance and study the effects of various types of bonds such as non-convertible bonds, write-down bonds and CoCos on banks' and insurers' risk situations. In addition, we compare insurers' capital requirements under the proposed Solvency II standard model as well as under an internal model that ex-ante anticipates additional risks due to possible conversion of the CoCo bond into bank shares. In order to check the robustness of our findings, we consider different CoCo designs (write-down factor, trigger value, holding time of bank shares) and compare the resulting capital requirements with those for holding non-convertible bonds. We identify situations in which insurers benefit from buying CoCo bonds due to lower capital requirements and higher coupon rates. Furthermore, our results highlight how the Solvency II standard model can mislead insurers in their CoCo investment decision due to economically irrational incentives.
Although banks are at the center of systemic risk, there are other institutions that contribute to it. With the publication of the leveraged lending guideline in March 2013, the U.S. regulators show that they are especially worried about the private equity firms with their high-risk deals. Given these risks and the interconnectedness of the banks through the LBO loan syndicates, I shed light on the impact of a bank’s LBO loan exposure on its systemic risk. By using 3,538 observations between 2000 and 2013 from 165 global banks, I show that banks with higher LBO exposure also have a higher level of systemic risk. Other loan purposes do not show this positive relationship. The main drivers influencing this relationship positively are the bank’s interconnectedness to other LBO financing banks and its size. Lending experience with a specific PE sponsor, experience with leading LBO syndicates or a bank’s credit rating, however, lead to a lower impact of the LBO loan exposure on systemic risk.
This Paper gives an overview of the German banking system and current challenges it is facing. It starts with an overview of the so-called ‘Three-Pillar-Banking-System’ and a detailed description of the current structure of the banking system in Germany. A brief comparison of the banking system in Germany with the ones in other European countries points out its uniqueness. The consequences of the financial crisis of 2007/2008 and further challenges for the German banking system are discussed, as well as the the ongoing debate around the question whether the strong government involvement should be sustained.
We investigate the determinants of firms’ implicit insurance to employees, using a difference-in-difference approach: we rely on differences between family and non-family firms to identify the supply of insurance, and exploit variation in unemployment insurance across and within countries to gauge workers’ demand for insurance. Using a firm-level panel from 41 countries, we find that family firms feature more stable employment, greater wage flexibility and lower labor cost than non-family ones. Employment stability in family firms is greater, and the wage discount larger, in countries with more generous public unemployment insurance: private and public provision of employment insurance are substitutes.
This paper investigates the effect of a change in informational environment of borrowers on the organizational design of bank lending. We use micro-data from a large multinational bank and exploit the sudden introduction of a credit registry, an information-sharing mechanism across banks, for a subset of borrowers. Using within borrower and loan officer variation in a difference-in-difference empirical design, we show that expansion of credit registry led to an improvement in allocation of credit to affected
borrowers. There was a concurrent change in the organizational structure of the bank that involved a dramatic increase in delegation of lending decisions of affected borrowers to loan officers. We also find a significant expansion in scope of activities of loan officers who deal primarily with affected borrowers, as well as of their superiors. There is suggestive evidence that larger banks in the economy were better able to implement similar changes as our bank. We argue that these patterns can be understood within the framework of incentive-based and information cost processing theories. Our findings could help rationalize why improvements in the information environment of borrowers may be altering the landscape of lending by moving decisions outside the boundaries of financial intermediaries.
We investigate the effect of the tone of news on investor stock price expectations and beliefs. In an experimental study we ask subjects to estimate a future stock price for twelve real listed companies. As additional information we provide them with historical stock prices and extracts from real newspaper articles. We propose a way to manipulate the tone of news extracts without distorting its content. Subjects in different treatment groups read news items that are written either in positive or negative tone for each stock. We find that subjects tend to predict a significantly higher (lower) return for stocks after reading positive (negative) tone news. The effect is especially pronounced for stocks with poor past performance. Subjects are more likely to be optimistic (pessimistic) about the economy and to buy (sell) stocks after reading positive (negative) than negative (positive) tone news. Our results show that the news media might affect not only how investors perceive information, but also what they do in response to it.
We study the life cycle of portfolio allocation following for 15 years a large random sample of Norwegian households using error-free data on all components of households’ investments drawn from the Tax Registry. Both, participation in the stock market and the portfolio share in stocks, have important life cycle patterns. Participation is limited at all ages but follows a hump-shaped profile which peaks around retirement; the share invested in stocks among the participants is high and flat for the young but investors start reducing it as retirement comes into sight. Our data suggest a double adjustment as people age: a rebalancing of the portfolio away from stocks as they approach retirement, and stock market exit after retirement. Existing calibrated life cycle models can account for the first behavior but not the second. We show that incorporating in these models a reasonable per period participation cost can generate limited participation among the young but not enough exit from the stock market among the elderly. Adding also a small probability of a large loss when investing in stocks, produces a joint pattern of participation and of the risky asset share that resembles the one observed in the data. A structural estimation of the relevant parameters that target simultaneously the portfolio, participation and asset accumulation age profiles of the model reveals that the parameter combination that fits the data best is one with a relatively large risk aversion, small participation cost and a yearly large loss probability in line with the frequency of stock market crashes in Norway.
We show that the size of collateralized household debt determines an economy’s vulnerability to crises of confidence. The house price feeds back on itself by contributing to a liquidity effect, which operates through the value of housing in a collateral constraint. Over a specific range of debt levels this liquidity feedback effect is strong enough to give rise to multiplicity of house prices. In a dynamic setup, we conceptualize confidence as a realization of rationally entertainable belief-weightings of multiple future prices. This delivers debt-level-dependent bounds on the extent to which confidence may drive house prices and aggregate consumption.
n this paper we analyze an economy with two heterogeneous investors who both exhibit misspecified filtering models for the unobservable expected growth rate of the aggregated dividend. A key result of our analysis with respect to long-run investor survival is that there are degrees of model misspecification on the part of one investor for which there is no compensation by the other investor's deficiency. The main finding with respect to the asset pricing properties of our model is that the two dimensions of asset pricing and survival are basically independent. In scenarios when the investors are more similar with respect to their expected consumption shares, return volatilities can nevertheless be higher than in cases when they are very different.
A theory of the boundaries of banks with implications for financial integration and regulation
(2015)
We offer a theory of the "boundary of the
rm" that is tailored to banking, as it builds on a single ine¢ ciency arising from risk-shifting and as it takes into account both interbank lending as an alternative to integration and the role of possibly insured deposit funding. Amongst others, it explains both why deeper economic integration should cause also greater financial integration through both bank mergers and interbank lending, albeit this typically remains ine¢ ciently incomplete, and why economic disintegration (or "desychronization"), as currently witnessed in the European Union, should cause less interbank exposure. It also suggests that recent policy measures such as the preferential treatment of retail deposits, the extension of deposit insurance, or penalties on "connectedness" could all lead to substantial welfare losses.