G21 Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
The dynamics of spillover effects during the european sovereign debt turmoil
- In this paper we develop empirical measures for the strength of spillover effects. Modifying and extending the framework by Diebold and Yilmaz (2011), we quantify spillovers between sovereign credit markets and banks in the euro area. Spillovers are estimated recursively from a vector autoregressive model of daily CDS spread changes, with exogenous common factors. We account for interdependencies between sovereign and bank CDS spreads and we derive generalised impulse response functions. Specifically, we assess the systemic effect of an unexpected shock to the creditworthiness of a particular sovereign or country-specific bank index to other sovereign or bank CDSs between October 2009 and July 2012. Channels of transmission from or to sovereigns and banks are aggregated as a Contagion index (CI). This index is disentangled into four components, the average potential spillover: i) amongst sovereigns, ii) amongst banks, iii) from sovereigns to banks, and iv) vice-versa. We highlight the impact of policy-related events along the different components of the contagion index. The systemic contribution of each sovereign or banking group is quantified as the net spillover weight in the total net-spillover measure. Finally, the captured time-varying interdependence between banks and sovereigns emphasises the evolution of their strong nexus.
Organizational choices of banks and the effective supervision of transnational financial institutions
- This paper outlines relatively easy to implement reforms for the supervision of
transnational banking-groups in the E.U. that should not be primarily based on legal form
but on the actual risk structures of the pertinent financial institutions. The proposal also
aims at paying close attention to the economics of public administration and international
relations in allocating competences among national and supranational supervisory bodies.
Before detailing the own proposition, this paper looks into the relationship between
sovereign debt and banking crises that drive regulatory reactions to the financial turmoil in
the Euro area. These initiatives inter alia affirm effective prudential supervision as a pivotal
element of crisis prevention.
In order to arrive at a more informed idea, which determinants apart from a perceived
appetite for regulatory arbitrage drive banks’ organizational choices, this paper scrutinizes
the merits of either a branch or subsidiary structure for the cross-border business of
financial institutions. In doing so, it also considers the policy-makers perspective. The analysis
shows that no one size fits all organizational structure is available and concludes that
banks’ choices should generally not be second-guessed, particularly because they are subject
to (some) market discipline.
The analysis proceeds with describing and evaluating how competences in prudential
supervision are currently allocated among national and supranational supervisory authorities.
In order to assess the findings the appraisal adopts insights form the economics of public
administration and international relations. It argues that the supervisory architecture has to
be more aligned with bureaucrats’ incentives and that inefficient requirements to cooperate
and share information should be reduced. Contrary to a widespread perception, shifting responsibility
to a supranational authority cannot solve all the problems identified.
Resting on these foundations, the last part of this paper finally sketches an alternative
solution that dwells on far-reaching mutual recognition of national supervisory regimes
and allocates competences in line with supervisors’ incentives and the risk inherent in crossborder
Basel III and CEO compensation in Banks : pay structures as a regulatory signal
- This paper proposes a new regulatory approach that implements capital requirements contingent on managerial compensation. We argue that excessive risk taking in the financial sector originates from the shareholder moral hazard created by government guarantees rather than from corporate governance failures within banks. The idea of the proposed regulation is to utilize the compensation scheme to drive a wedge between the interests of top management and shareholders to counteract shareholder risk-shifting incentives. The decisive advantage of this approach compared to existing regulation is that the regulator does not need to be able to properly measure the bank investment risk, which has been shown to be a difficult task during the 2008-2009 financial crisis.
Interbank network and bank bailouts : insurance mechanism for non-insured creditors?
- This paper presents a theory that explains why it is beneficial for banks to engage in circular lending activities on the interbank market. Using a simple network structure, it shows that if there is a non-zero bailout probability, banks can significantly increase the expected repayment of uninsured creditors by entering into cyclical liabilities on the interbank market before investing in loan portfolios. Therefore, banks are better able to attract funds from uninsured creditors. Our results show that implicit government guarantees incentivize banks to have large interbank exposures, to be highly interconnected, and to invest in highly correlated, risky portfolios. This can serve as an explanation for the observed high interconnectedness between banks and their investment behavior in the run-up to the subprime mortgage crisis.