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We investigate whether information sharing among banks has affected credit market performance in the transition countries of Eastern Europe and the former Soviet Union, using a large sample of firm-level data. Our estimates show that information sharing is associated with improved availability and lower cost of credit to firms. This correlation is stronger for opaque firms than transparent ones and stronger in countries with weak legal environments than in those with strong legal environments. In cross-sectional estimates, we control for variation in country-level aggregate variables that may affect credit, by examining the differential impact of information sharing across firm types. In panel estimates, we also control for the presence of unobserved heterogeneity at the firm level, as well as for changes in macroeconomic variables and the legal environment.
Risk transfer with CDOs
(2008)
Modern bank management comprises both classical lending business and transfer of asset risk to capital markets through securitization. Sound knowledge of the risks involved in securitization transactions is a prerequisite for solid risk management. This paper aims to resolve a part of the opaqueness surrounding credit-risk allocation to tranches that represent claims of different seniority on a reference portfolio. In particular, this paper analyzes the allocation of credit risk to different tranches of a CDO transaction when the underlying asset returns are driven by a common macro factor and an idiosyncratic component. Junior and senior tranches are found to be nearly orthogonal, motivating a search for the whereabout of systematic risk in CDO transactions. We propose a metric for capturing the allocation of systematic risk to tranches. First, in contrast to a widely-held claim, we show that (extreme) tail risk in standard CDO transactions is held by all tranches. While junior tranches take on all types of systematic risk, senior tranches take on almost no non-tail risk. This is in stark contrast to an untranched bond portfolio of the same rating quality, which on average suffers substantial losses for all realizations of the macro factor. Second, given tranching, a shock to the risk of the underlying asset portfolio (e.g. a rise in asset correlation or in mean portfolio loss) has the strongest impact, in relative terms, on the exposure of senior tranche CDO-investors. Our findings can be used to explain major stylized facts observed in credit markets.
Risk transfer with CDOs
(2008)
Modern bank management comprises both classical lending business and transfer of asset risk to capital markets through securitization. Sound knowledge of the risks involved in securitization transactions is a prerequisite for solid risk management. This paper aims to resolve a part of the opaqueness surrounding credit-risk allocation to tranches that represent claims of different seniority on a reference portfolio. In particular, this paper analyzes the allocation of credit risk to different tranches of a CDO transaction when the underlying asset returns are driven by a common macro factor and an idiosyncratic component. Junior and senior tranches are found to be nearly orthogonal, motivating a search for the where about of systematic risk in CDO transactions. We propose a metric for capturing the allocation of systematic risk to tranches. First, in contrast to a widely-held claim, we show that (extreme) tail risk in standard CDO transactions is held by all tranches. While junior tranches take on all types of systematic risk, senior tranches take on almost no non-tail risk. This is in stark contrast to an untranched bond portfolio of the same rating quality, which on average suffers substantial losses for all realizations of the macro factor. Second, given tranching, a shock to the risk of the underlying asset portfolio (e.g. a rise in asset correlation or in mean portfolio loss) has the strongest impact, in relative terms, on the exposure of senior tranche CDO-investors. Our findings can be used to explain major stylized facts observed in credit markets.
Based on a unique dataset of legislative changes in industrial countries, we identify events that strengthen the competition control of mergers and acquisitions, analyze their impact on banks and non-financial firms and explain the different reactions observed with specific regulatory characteristics of the banking sector. Covering nineteen countries for the period 1987 to 2004, we find that more competition-oriented merger control increases the stock prices of banks and decreases the stock prices of non-financial firms. Bank targets become more profitable and larger, while those of non-financial firms remain mostly unaffected. A major determinant of the positive bank returns is the degree of opaqueness that characterizes the institutional setup for supervisory bank merger reviews. The legal design of the supervisory control of bank mergers may therefore have important implications for real activity.
This paper analyses cross-border contagion in a sample of European banks from January 1994 to January 2003. We use a multinomial logit model to estimate the number of banks in a given country that experience a large shock on the same day (“coexceedances”) as a function of variables measuring common shocks and coexceedances in other countries. Large shocks are measured by the bottom 95th percentile of the distribution of the first difference in the daily distance to default of the bank. We find evidence in favour of significant cross-border contagion. We also find some evidence that since the introduction of the euro cross-border contagion may have increased. The results seem to be very robust to changes in the specification.
We examine the empirical predictions of a real option-pricing model using a large sample of data on mergers and acquisitions in the U.S. banking sector. We provide estimates for the option value that the target bank has in waiting for a higher bid instead of accepting an initial tender offer. We find empirical support for a model that estimates the value of an option to wait in accepting an initial tender offer. Market prices reflect a premium for the option to wait to accept an offer that has a mean value of almost 12.5% for a sample of 424 mergers and acquisitions between 1997 and 2005 in the U.S. banking industry. Regression analysis reveals that the option price is related to both the price to book market and the free cash flow of target banks. We conclude that it is certainly in the shareholders best interest if subsequent offers are awaited. JEL Classification: G34, C10
This paper investigates various theories explaining banks´ overbidding in the fixed rate tenders of the European Central Bank (ECB). Using auction data from both the Bundesbank and the ECB, we show that none of the theories can on its own explain the observed overbidding. This implies that the proposed new rules by the ECB, aimed at neutralizing interest rate expectations, would not eliminate overbidding if the rationing rule in the fixed rate tenders remains unchanged. JEL - Klassifikation: D44 , E32
Multiple lenders and corporate distress: evidence on debt restructuring : [Version Juni 2006]
(2006)
In the recent theoretical literature on lending risk, the coordination problem in multi-creditor relationships have been analyzed extensively. We address this topic empirically, relying on a unique panel data set that includes detailed credit-file information on distressed lending relationships in Germany. In particular, it includes information on creditor pools, a legal institution aiming at coordinating lender interests in borrower distress. We report three major findings. First, the existence of creditor pools increases the probability of workout success. Second, the results are consistent with coordination costs being positively related to pool size. Third, major determinants of pool formation are found to be the number of banks, the distribution of lending shares, and the severity of the distress shock.
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
Large banks often sell part of their loan portfolio in the form of collateralized debt obligations (CDO) to investors. In this paper we raise the question whether credit asset securitization affects the cyclicality (or commonality) of bank equity values. The commonality of bank equity values reflects a major component of systemic risks in the banking market, caused by correlated defaults of loans in the banks' loan books. Our simulations take into account the major stylized fact of CDO transactions, the non-proportional nature of risk sharing that goes along with tranching. We provide a theoretical framework for the risk transfer through securitization that builds on a macro risk factor and an idiosyncratic risk factor, allowing an identification of the types of risk that the individual tranche holders bear. This allows conclusions about the risk positions of issuing banks after risk transfer. Building on the strict subordination of tranches, we first evaluate the correlation properties both within and across risk classes. We then determine the effect of securitization on the systematic risk of all tranches, and derive its effect on the issuing bank's equity beta. The simulation results show that under plausible assumptions concerning bank reinvestment behaviour and capital structure choice, the issuing intermediary's systematic risk tends to rise. We discuss the implications of our findings for financial stability supervision. Klassifikation: G28
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
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
Under a new Basel capital accord, bank regulators might use quantitative measures when evaluating the eligibility of internal credit rating systems for the internal ratings based approach. Based on data from Deutsche Bundesbank and using a simulation approach, we find that it is possible to identify strongly inferior rating systems out-of time based on statistics that measure either the quality of ranking borrowers from good to bad, or the quality of individual default probability forecasts. Banks do not significantly improve system quality if they use credit scores instead of ratings, or logistic regression default probability estimates instead of historical data. Banks that are not able to discriminate between high- and low-risk borrowers increase their average capital requirements due to the concavity of the capital requirements function.
Empirical evidence suggests that even those firms presumably most in need of monitoringintensive financing (young, small, and innovative firms) have a multitude of bank lenders, where one may be special in the sense of relationship lending. However, theory does not tell us a lot about the economic rationale for relationship lending in the context of multiple bank financing. To fill this gap, we analyze the optimal debt structure in a model that allows for multiple but asymmetric bank financing. The optimal debt structure balances the risk of lender coordination failure from multiple lending and the bargaining power of a pivotal relationship bank. We show that firms with low expected cash-flows or low interim liquidation values of assets prefer asymmetric financing, while firms with high expected cash-flow or high interim liquidation values of assets tend to finance without a relationship bank. JEL - Klassifikation: G21 , G78 , G33
This paper suggests a motive for bank mergers that goes beyond alleged and typically unverifiable scale economies: preemtive resolution of banks´ financial distress. Such "distress mergers" can be a significant motivation for mergers because they can foster reorganizations, realize diversification gains, and avoid public attention. However, since none of these potential benefits comes without a cost, the overall assessment of distress mergers is unclear. We conduct an empirical analysis to provide evidence on consequences of distress mergers. The analysis is based on comprehensive data from Germany´s savings and cooperatives banks sectors over the period 1993 to 2001. During this period both sectors faced significant structural problems and superordinate institutions (associations) presumably have engaged in coordinated actions to manage distress mergers. The data comprise 3640 banks and 1484 mergers. Our results suggest that bank mergers as a means of preemtive distress resolution have moderate costs in terms of the economic impact on performance. We do find strong evidence consistent with diversification gains. Thus, distress mergers seem to have benefits without affecting systematic stability adversely.
The German corporate governance system has long been cited as the standard example of an insider-controlled and stakeholder-oriented system. We argue that despite important reforms and substantial changes of individual elements of the German corporate governance system the main characteristics of the traditional German system as a whole are still in place. However, in our opinion the changing role of the big universal banks in the governance undermines the stability of the corporate governance system in Germany. Therefore a breakdown of the traditional system leading to a control vacuum or a fundamental change to a capital market-based system could be in the offing.
Small and medium-sized firms typically obtain capital via bank financing. They often rely on a mixture of relationship and arm’s-length banking. This paper explores the reasons for the dominance of heterogeneous multiple banking systems. We show that the incidence of inefficient credit termination and subsequent firm liquidation is contingent on the borrower’s quality and on the relationship bank’s information precision. Generally, heterogeneous multiple banking leads to fewer inefficient credit decisions than monopoly relationship lending or homogeneous multiple banking, provided that the relationship bank’s fraction of total firm debt is not too large.
At least in the past, banking in continental Europe has been characterised by a number of features that are quite specific to the region. They include the following: (1) banks play a strong role in their respective financial systems; (2) universal banking is prevalent; (3) not strictly profit-oriented banks play a significant role; and (4) there are considerable differences between national banking systems. It can be safely assumed that the future of banking in Europe will be shaped by three major external developments: deregulation and liberalisation; advances in information technology; and economic, financial and monetary integration. The overall consequences of these developments would be much too vast a topic to be addressed in one short paper. Therefore the present paper concentrates on the following question: Are the traditional peculiarities of the banking and financial systems of continental Europe likely to disappear as a consequence of the aforementioned external developments or are they more likely to remain in spite of these developments? The external developments affect the features specific to banking in continental Europe only indirectly and only via the strategies selected and pursued by the various players in the financial systems, notably the banks themselves, and in ways which strongly depend on the structure of the banking industry and the level of competition between banks and other providers of financial services. The paper develops an informal model of the relationships between (1) external developments, (2) bank strategies and the structure of the banking industry, and (3) the peculiarities of banking in Europe, and derives a hypothesis predicting which of the traditional peculiarities are likely to disappear and which are likely to remain. It argues that, overall, the peculiarities are not likely to disappear in the short or the medium term. First version June 2000. This version March 2001.
We present an analysis of VaR forecasts and P&L-series of all 13 German banks that used internal models for regulatory purposes in the year 2001. To this end, we introduce the notion of well-behaved forecast systems. Furthermore, we provide a series of statistical tools to perform our analyses. The results shed light on the forecast quality of VaR models of the individual banks, the regulator's portfolio as a whole, and the main ingredients of the computation of the regulatory capital required by the Basel rules.
This paper is a draft for the chapter "German banks and banking structure" of the forthcoming book "The German financial system" edited by J.P. Krahnen and R.H. Schmidt (Oxford University Press). As such, the paper starts out with a description of past and present structural features of the German banking industry. Given the presented empirical evidence it then argues that great care has to be taken when generalising structural trends from one financial system to another. Whilst conventional commercial banking is clearly in decline in the US, it is far from clear whether the dominance of banks in the German financial system has been significantly eroded over the last decades. We interpret the immense stability in intermediation ratios and financing patterns of firms between 1970 and 2000 as strong evidence for our view that the way in which and the extent to which German banks fulfil the central functions for the financial system are still consistent with the overall logic of the German financial system. In spite of the current dire business environment for financial intermediaries we do not expect the German financial system and its banking industry as an integral part of this system to converge to the institutional arrangements typical for a market-oriented financial system.