Working Paper
Refine
Year of publication
Document Type
- Working Paper (41) (remove)
Has Fulltext
- yes (41)
Is part of the Bibliography
- no (41)
Keywords
- Bank (41) (remove)
Multiple lenders and corporate distress: evidence on debt restructuring : [Version Juli 2002]
(2002)
In the recent theoretical literature on lending risk, the common pool problem in multi-bank relationships has been analyzed extensively. In this paper we address this topic empirically, relying on a unique panel data set that includes detailed credit-fie information on distressed lending relationships in Germany. In particular, it includes information on bank pools, a legal institution aimed at coordinating lender interests in borrower distress. We find that the existence of small bank pools increases the probability of workout success and that coordination costs are positively related to pool size. We identify major determinants of pool formation, in particular the distribution of lending shares among banks, the number of banks, and the severity of the distress shock to the borrower.
The recent financial crisis has highlighted the limits of the “originate to distribute” model of banking, but its nexus with the macroeconomy and monetary policy remains unexplored. I build a DSGE model with banks (along the lines of Holmström and Tirole [28] and Parlour and Plantin [39] and examine its properties with and without active secondary markets for credit risk transfer. The possibility of transferring credit reduces the impact of liquidity shocks on bank balance sheets, but also reduces the bank incentive to monitor. As a result, secondary markets allow to release bank capital and exacerbate the effect of productivity and other macroeconomic shocks on output and inflation. By offering a possibility of capital recycling and by reducing bank monitoring, secondary credit markets in general equilibrium allow banks to take on more risk. Keywords: Credit Risk Transfer , Dual Moral Hazard , Monetary Policy , Liquidity , Welfare JEL Classification: E3, E5, G3 First Draft: December 2009, This Draft: September 2010
SUMMARY RECOMMENDATIONS 1. One of the major lessons from the current financial crisis refers to the systemic dimension of financial risk which had been almost completely neglected by bankers and supervisors in the pre-2007 years. 2. Accordingly, the most needed change in financial regulation, in order to avoid a repetition of such a crisis in the future, consists of influencing individual bank behaviour such that systemic risk is decreased. This objective is new and distinct from what Basle II was intended to achieve. 3. It is important, therefore, to evaluate proposed new regulatory instruments on the ground of whether or not they contribute to a reduction, or containment of systemic risk. We see two new regulatory measures of paramount importance: the introduction of a Systemic Risk Charge (SRC), and the implementation of a transparent bank resolution regime. Both measures complement each other, thus both have to be realized to be effective. 4. We propose a Systemic Risk Charge (SRC), a levy capturing the contribution of any individual bank to the overall systemic risk which is distinct from the institution’s own default risk. The SRC is set up such that the more systemic risk a bank contributes, the higher is the cost it has to bear. Therefore, the SRC serves to internalize the cost of systemic risk which, up to now, was borne by the taxpayer. 5. Major details of our SRC refer to the use of debt that may be converted into equity when systemic risk threatens the stability of the banking system. Also, the SRC raises some revenues for government. 6. The SRC has to be compared to several bank levies currently debated. The Financial Transaction Tax (FTT) does not directly address systemic risk and is therefore inferior to a SRC. Nevertheless, a FTT may offer the opportunity to subsidize on-exchange trading at the expense of off-exchange (over-the-counter, OTC) transactions, thereby enhancing financial market stability. The Financial Activity Tax (FAT) is similar to a VAT on financial services. It is the least adequate instrument among all instruments discussed above to limit systemic risk. 7. Bank resolution regime: No instrument to contain systemic risk can be effective unless the restructuring of bank debt, and the ensuing loss given default to creditors, is a real possibility. As the crisis has taught, bank restructuring is very difficult in light of contagion risk between major banks. We therefore need a regulatory procedure that allows winding down banks, even large banks, on short notice. Among other things, the procedure will require to distinguish systemically relevant exposures from those that are irrelevant. Only the former will be saved with government money, and it will then be the task of the supervisor to ensure a sufficient amount of nonsystemically relevant debt on the balance sheet of all banks. 8. Further issues discussed in this policy paper and its appendices refer to the necessity of a global level playing field, or the lack thereof, for these new regulatory measures; the convergence of our SRC proposal with what is expected to be long-term outcome of Basle III discussions; as well as the role of global imbalances.
This paper argues that banks must be sufficiently levered to have first-best incentives to make new risky loans. This result, which is at odds with the notion that leverage invariably leads to excessive risk taking, derives from two key premises that focus squarely on the role of banks as informed lenders. First, banks finance projects that they do not own, which implies that they cannot extract all the profits. Second, banks conduct a credit risk analysis before making new loans. Our model may help understand why banks take on additional unsecured debt, such as unsecured deposits and subordinated loans, over and above their existing deposit base. It may also help understand why banks and finance companies have similar leverage ratios, even though the latter are not deposit takers and hence not subject to the same regulatory capital requirements as banks.
Corporate borrowers care about the overall riskiness of a bank’s operations as their continued access to credit may rely on the bank’s ability to roll over loans or to expand existing credit facilities. As we show, a key implication of this observation is that increasing competition among banks should have an asymmetric impact on banks’ incentives to take on risk: Banks that are already riskier will take on yet more risk, while their safer rivals will become even more prudent. Our results offer new guidance for bank supervision in an increasingly competitive environment and may help to explain existing, ambiguous findings on the relationship between competition and risk-taking in banking. Furthermore, our results stress the beneficial role that competition can have for financial stability as it turns a bank’s "prudence" into an important competitive advantage.
This paper presents a novel model of the lending process that takes into account that loan officers must spend time and effort to originate new loans. Besides generating predictions on loan officers’ compensation and its interaction with the loan review process, the model sheds light on why competition could lead to excessively low lending standards. We also show how more intense competition may fasten the adoption of credit scoring. More generally, hard-information lending techniques such as credit scoring allow to give loan officers high-powered incentives without compromising the integrity and quality of the loan approval process. The model is finally applied to study the implications of loan sales on the adopted lending process and lending standard.
This paper analyzes the risk properties of typical asset-backed securities (ABS), like CDOs or MBS, relying on a model with both macroeconomic and idiosyncratic components. The examined properties include expected loss, loss given default, and macro factor dependencies. Using a two-dimensional loss decomposition as a new metric, the risk properties of individual ABS tranches can directly be compared to those of corporate bonds, within and across rating classes. By applying Monte Carlo Simulation, we find that the risk properties of ABS differ significantly and systematically from those of straight bonds with the same rating. In particular, loss given default, the sensitivities to macroeconomic risk, and model risk differ greatly between instruments. Our findings have implications for understanding the credit crisis and for policy making. On an economic level, our analysis suggests a new explanation for the observed rating inflation in structured finance markets during the pre-crisis period 2004-2007. On a policy level, our findings call for a termination of the 'one-size-fits-all' approach to the rating methodology for fixed income instruments, requiring an own rating methodology for structured finance instruments. JEL Classification: G21, G28 Keywords: credit risk, risk transfer, systematic risk
This paper analyzes the risk properties of typical asset-backed securities (ABS), like CDOs or MBS, relying on a model with both macroeconomic and idiosyncratic components. The examined properties include expected loss, loss given default, and macro factor dependencies. Using a two-dimensional loss decomposition as a new metric, the risk properties of individual ABS tranches can directly be compared to those of corporate bonds, within and across rating classes. By applying Monte Carlo Simulation, we find that the risk properties of ABS differ significantly and systematically from those of straight bonds with the same rating. In particular, loss given default, the sensitivities to macroeconomic risk, and model risk differ greatly between instruments. Our findings have implications for understanding the credit crisis and for policy making. On an economic level, our analysis suggests a new explanation for the observed rating inflation in structured finance markets during the pre-crisis period 2004-2007. On a policy level, our findings call for a termination of the 'one-size-fits-all' approach to the rating methodology for fixed income instruments, requiring an own rating methodology for structured finance instruments. JEL Classification: G21, G28
In this paper, we investigate how bank mergers affect bank revenues and present empirical evidence that mergers among banks have a substantial and persistent negative impact on merging banks’ revenues. We refer to merger related negative effects on banks’ revenues as dissynergies and suggest that they are a result of organizational diseconomies, the loss of customers and the temporary distraction of management from day-to-day operations by effecting the merger. For our analyses we draw on a proprietary data set with detailed financials of all 457 regional savings banks in Germany, which have been involved in 212 mergers between 1994 and 2006. We find that the negative impact of a merger on net operating revenues amounts to 3% of pro-forma consolidated banks’ operating profits and persists not only for the year of the merger but for up to four years post-merger. Only thereafter mergers exhibit a significantly superior performance compared to their respective pre-merger performance or the performance of their non-merging peers. The magnitude and persistence of merger related revenue dissynergies highlight their economic relevance. Previous research on post-merger performance mainly focuses on the effects from mergers on banks’ (cost) efficiency and profitability but fails to provide clear and consistent results. We are the first, to our knowledge, to examine the post-merger performance of banks’ net operating revenues and to empirically verify significant negative implications of mergers for banks’ net operating revenues. We propose that our finding of negative merger related effects on banks’ operating revenues is the reason why previous research fails to show merger related gains.
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