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We model the impact of bank mergers on loan competition, reserve holdings and aggregate liquidity. A merger changes the distribution of liquidity shocks and creates an internal money market, leading to financial cost efficiencies and more precise estimates of liquidity needs. The merged banks may increase their reserve holdings through an internalization effect or decrease them because of a diversification effect. The merger also affects loan market competition, which in turn modifies the distribution of bank sizes and aggregate liquidity needs. Mergers among large banks tend to increase aggregate liquidity needs and thus the public provision of liquidity through monetary operations of the central bank. Klassifikation: D43, G21, G28, L13
Climate risk has become a major concern for financial institutions and financial markets. Yet, climate policy is still in its infancy and contributes to increased uncertainty. For example, the lack of a sufficiently high carbon price and the variety of definitions for green activities lower the value of existing and new capital, and complicate risk management. This column argues that it would be welfare-enhancing if policy changes were to follow a predictable longer-term path. Accordingly, the authors suggest a role for financial regulation in the transition.
With the second wave of the Covid-19 pandemic in full swing, banks face a challenging environment. They will need to address disappointing results and adverse balance sheet restatements, the intensity of which depends on the evolution of the euro area economies. At the same time, vulnerable banks reinforce real economy deficiencies. The contribution of this paper is to provide a comparative assessment of the various policy responses to address a looming banking crisis. Such a crisis will fully materialize when non-performing assets drag down banks simultaneously, raising the specter of a full-blown systemic crisis. The policy responses available range from forbearance, recapitalization (with public or private resources), asset separation (bad banks, at national or EU level), to debt conversion schemes. We evaluate these responses according to a set of five criteria that define the efficacy of each. These responses are not mutually exclusive, in practice, as they have never been. They may also go hand in hand with other restructuring initiatives, including potential consolidation in the banking sector. Although we do not make a specific recommendation, we provide a framework for policymakers to guide them in their decision making.
This policy letter adds to the current discussion on how to design a program of government assistance for firms hurt by the Coronavirus crisis. While not pretending to provide a cure-all proposal, the advocated scheme could help to bring funding to firms, even small firms, quickly, without increasing their leverage and default risk. The plan combines outright cash transfers to firms with a temporary, elevated corporate profit tax at the firm level as a form of conditional payback. The implied equity-like payment structure has positive risk-sharing features for firms, without impinging on ownership structures. The proposal has to be implemented at the pan-European level to strengthen Euro area resilience.
This Policy Letter presents a proposal for designing a program of government assistance for firms hurt by the Coronavirus crisis in the European Union (EU). In our recent Policy Letter 81, we introduced a new, equity-type instrument, a cash-against-tax surcharge scheme, bundled across firms and countries in a European Pandemic Equity Fund (EPEF). The present Policy Letter 84 focuses on the principles and conditions relevant for the operationalization of a EPEF. Our proposal has several desirable features. It: a) offers better risk sharing opportunities, augmenting the resilience of businesses and EU economies; b) is need-based, thereby contributing to an effective use of resources; c) builds on conditions and credible controls, addressing adverse selection and moral hazard; d) is accessible to smaller and medium-sized firms, the backbone of Europe’s economy; e) applies Europe-wide uniform eligibility criteria, strengthening support among member states; f) is a scheme of limited duration, reducing (perceived) government interference in businesses; g) creates a template for a growth-oriented public policy, aligning public and private sector interests; and h) builds on the existing institutional infrastructure and requires minimal legislative adjustments.
Market discipline for financial institutions can be imposed not only from the liability side, as has often been stressed in the literature on the use of subordinated debt, but also from the asset side. This will be particularly true if good lending opportunities are in short supply, so that banks have to compete for projects. In such a setting, borrowers may demand that banks commit to monitoring by requiring that they use some of their own capital in lending, thus creating an asset market-based incentive for banks to hold capital. Borrowers can also provide banks with incentives to monitor by allowing them to reap some of the benefits from the loans, which accrue only if the loans are in fact paid o.. Since borrowers do not fully internalize the cost of raising capital to the banks, the level of capital demanded by market participants may be above the one chosen by a regulator, even when capital is a relatively costly source of funds. This implies that capital requirements may not be binding, as recent evidence seems to indicate. JEL Classification: G21, G38
Some have argued that recent increases in credit risk transfer are desirable because they improve the diversification of risk. Others have suggested that they may be undesirable if they increase the risk of financial crises. Using a model with banking and insurance sectors, we show that credit risk transfer can be beneficial when banks face uniform demand for liquidity. However, when they face idiosyncratic liquidity risk and hedge this risk in an interbank market, credit risk transfer can be detrimental to welfare. It can lead to contagion between the two sectors and increase the risk of crises. Klassifikation: G21, G22
When liquidity plays an important role as in times of financial crisis, asset prices in some markets may reflect the amount of liquidity available in the market rather than the future earning power of the asset. Mark-to-market accounting is not a desirable way to assess the solvency of a financial institution in such circumstances. We show that a shock in the insurance sector can cause the current value of banks’ assets to be less than the current value of their liabilities so the banks are insolvent. In contrast, if historic cost accounting is used, banks are allowed to continue and can meet all their future liabilities. Mark-to-market accounting can thus lead to contagion where none would occur with historic cost accounting. Klassifizierung: G21, G22, M41
This paper analyzes banks' choice between lending to firms individually and sharing lending with other banks, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending is optimal whenever the benefit of greater diversification in terms of higher monitoring dominates the costs of free-riding and duplication of efforts. The model predicts a greater use of multiple-bank lending when banks are small relative to investment projects, firms are less profitable, and poor financial integration, regulation and inefficient judicial systems increase monitoring costs. These results are consistent with empirical observations concerning small business lending and loan syndication. JEL Klassifikation: D82; G21; G32.