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Essays in Financial Intermediation and Credit Risk

Essays in Financial Intermediation and Credit Risk
Author: Javier M. Pereira
Publisher:
Total Pages: 113
Release: 2015
Genre:
ISBN:
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This dissertation focuses on issues in financial intermediation and sovereign credit risk. With the enactment of the Gramm-Leach-Bliley Act (GLBA) in 1999, the long-standing barriers between commercial and investment banking activities were formally removed. In chapter 1, I show that the increased competition, drastic reduction in underwriting fees and the increased issue complexity associated with the rapid entry of large commercial banks in securities underwriting lowered the screening incentives of top tier underwriters and led to deviations from the "underwriter certification hypothesis" (namely, that high-reputation underwriters should be associated with higher quality certification). Using data from the high-yield corporate bond market, I identify three patterns which are difficult to jointly reconcile within the standard reputation literature. First, evidence of increased credit rating variability reveals a structural change in the certification standards of prestigious underwriters after GLBA. This finding suggests that reputation concerns, a key source of discipline, did not prevent underwriters from lowering their screening standards. Second, the high yield bond market is dominated by high reputation underwriters. Hence, to account for such a behavior in a market dominated by prestigious institutions, a coordination device for poor certification would be necessary. Third, after accounting for issuer-underwriter matching, top tier underwriters still achieve lower at-issue yields post GLBA. Following poor certification, I show that market punishment through higher yields is confined to low reputation institutions. My findings suggest limitations of the reputation based disciplining mechanism. In chapter 2, I propose a theoretical framework to account for these patterns. In particular, I adopt the model of Ordonez (2013) to incorporate insights from the global game literature into the reputation mechanism to demonstrate that reputation equilibriums are fragile and can lead to a clustering of poor screening among high- and intermediate-reputation underwriters. My model suggests that the lack of a credible market-based punishment mechanism may indicate sticky priors about the reputation of prestigious underwriters. Finally, chapter 3 of my dissertation represents an exploratory work on the role of sovereign credit risk in the risk-adjusted uncovered interest parity condition (RA-UIP) and proposes the use of sovereign CDS spreads as a proxy for the time-varying risk premium necessary to explain the UIP puzzle. Recent literature suggests that sovereign risk contains a strong global component that is priced in currency markets. Using sovereign CDS spreads, I first corroborate whether changes in sovereign credit risk have a contemporaneous effect in currency prices for a set of 12 countries. In line with Della Corte et al. (2014), I find a strong contemporaneous relation between sovereign risk and currency prices. Then, I study whether sovereign credit risk contains a global credit risk component and whether the latter is priced in exchange rates. Using an equally weighted portfolio of sovereign CDS spreads as a proxy for global credit risk, I find that most of the information embedded in sovereign credit risk relevant for exchange rate returns seems to be global in nature. In light of these findings, I place my attention on the valuation channel proposed by Gourinchas and Rey (2007) and explore empirically the role of a country's net foreign asset position (NFA) for the dynamics of global credit risk exposure and exchange rate returns. I find that net creditor countries exhibit a strong positive relationship between global credit risk and exchange rate appreciation. Empirical findings demonstrate promising supportive evidence of an economic linkage between exchange rates, sovereign credit risk and macro fundamentals that warrants further exploration.

Essays on Bank Intermediation in Developing Countries

Essays on Bank Intermediation in Developing Countries
Author: Pierre Valere Nketcha Nana
Publisher:
Total Pages: 86
Release: 2014
Genre:
ISBN:
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This dissertation consists of three empirical essays on issues of bank intermediation in developing countries. The first essays seeks to improve our understanding of why banks in Africa are hoarding large volume of liquid assets. Prevailing explanations of this phenomenon have focused mostly on the role of credit risk. Yet, modern models of financial intermediation show that a high exposure to liquidity risk may also prompt banks to hoard large amounts of (precautionary) liquid reserves. We argue that this risk is important in Africa; and using data over the 1994-2008 period, we provide evidence indicating that it contributes significantly to the hoarding of bank liquid assets. This evidence suggests that liquidity risk reduces the share of deposits that African banks can channel into credits, which therefore, can adversely affect the availability of bank credit. The second and the third essays focus on the issue of the determinants of the availability of bank credit, or the lack thereof, in developing countries. In the second essay, we (re-)consider the role of credit risk, or more generally, of credit market institutions. Specifically, we use new data and improved measures from Doing Business, to reexamine the issue of the relationships between creditor rights protection and credit information sharing on one hand, and bank credit on the other hand. The data covers a large sample of 143 countries and are taken in averages over the period 2006-2010. Our results indicate the robustness of earlier evidence that both stronger creditor rights protection and better credit information sharing are associated with greater availability of bank credit. We find that these effects are significant even when the sample is restricted to include either developing countries only or poor countries only. In the third essay we consider the role of liquidity risk and monetary policy. These two factors have not received much attention in previous empirical studies on the determinants of bank credit in developing countries. Using a panel dataset which covers 97 lowand middle-income countries over the 2004-2010 period, we show that liquidity risk and monetary policy are actually important determinants of the availability of bank credit in developing countries. We find important heterogeneity in the results: both liquidity risk and monetary policy have greater effects on bank credit in economies with better credit market conditions, but much smaller and even not statistically significant effects in economies with poor credit market conditions. This result is important because it suggests that, at least in some developing countries, those with a relatively low level of credit risk, reducing the exposure of banks to liquidity risk, and/or implementing a less restrictive monetary policy, are effective channels through which the availability of bank credit could be enhanced. For countries with a relatively high level of credit risk, such channels would be ineffective; in these countries, reducing credit risk is of first order importance to stimulate bank lending.

Essays in Financial Intermediation and Banking

Essays in Financial Intermediation and Banking
Author: Elizabeth Ellen Foote
Publisher:
Total Pages:
Release: 2011
Genre:
ISBN:
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Banks' role as intermediaries between short term investors and long term borrow- ers has dominated the literature. Whilst this is an important feature, there are many other characteristics of banks. Each chapter in this PhD explores a different aspect of banking, from other forms of lending to banks' role in payment services. The first, and principal, chapter considers credit lines: `commitments' to lend if required. These remain off the bank's balance sheet until drawn upon. As off-balance sheet items, unused commitments face low capital charges under existing capital regulation. I ex- plore how this regulatory feature incentivises banks to build up exposure to these lines. This may lead to a suboptimal allocation of credit, ex post, following a market shock, as high drawdowns cause the balance sheet to balloon and the capital requirement to bind. In the second chapter, I consider banks as agents in large-value payment systems. In choosing the optimal time to settle a payment, banks trade off delay costs against the risk of having insuffcient liquidity to make future payments. With banks participating in multiple systems, I show how default in one system may spill over into another, through the strategic behaviour of multi-system participants. I explore how this risk varies with the degree of information asymmetry between agents in different systems. The third chapter focuses on retail banking. In joint work, we examine how the provision of consumer credit, either through current account overdrafts, or through credit card credit lines, affects the way in which debit and credit card networks com- pete. We find that, even when debit and credit cards compete, there are elements of complementarity between them. Banks providing debit cards and current accounts benefit when the consumer delays withdrawal of funds from her current account by using a credit card. This leads to surprisingly high debit merchant fees.

Three Essays on Financial Intermediation

Three Essays on Financial Intermediation
Author: Hon Sing Lee
Publisher:
Total Pages:
Release: 2004
Genre:
ISBN:
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This thesis is a collection of three essays, analyzing how banks intermediate credit flow over different friction.

Essays in Financial Intermediation

Essays in Financial Intermediation
Author: Jiakai Chen
Publisher:
Total Pages: 115
Release: 2015
Genre:
ISBN:
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This dissertation consists of two chapters that concern financial intermediation. Many shadow banks rely heavily on bank-sponsored private credit and liquidity support instead of government guarantees. Bank capital regulation cannot be effective without explicitly considering these facilities. In the first chapter of the dissertation, I use a continuous time model with maturity mismatch and bank moral hazard to study the impact of credit and liquidity guarantees on bank capital structure. I focus on a particular type of shadow banking called asset-backed commercial paper (ABCP). When banks provide credit guarantees to ABCP conduits, assuming that the validity of the guarantees is ensured by rating agencies, the commercial paper becomes risk free and is always priced at par. Rolling over the commercial paper is thus costless, so that frequently rolling over the short term ABCP to fund long term assets--a maturity mismatch--has no impact on bank value. Regulators can eliminate a bank's moral hazard by imposing a simple capital ratio requirement. However, the capital ratio requirement is no longer valid if banks use liquidity guarantees in their ABCP conduit funding because the funding maturity becomes important. Moreover, a liquidity guarantee becomes as costly as a credit guarantee when the maturity shortens. Using Moody's ABCP conduit data, I confirm that shorter ABCP maturity causes the bank's return to be more sensitive to the conduit credit loss. Thus, when banks have significant exposure to a liquidity guarantee, the search for a single appropriate risk weight is futile. More sophisticated tests, such as model-based tests are not only necessary but also have to be carried out under stressed scenarios. The second chapter studies the current London Interbank Offered Rate (LIBOR). Recent investigation reveals banks might have manipulated the London Interbank Offer Rate (LIBOR). With banks concern about derivative position, net interest income and signaling effect, the equilibrium reporting strategy is a monotonic non-linear function of borrowing cost. Current trimming mechanism cannot block tacit collusion: when banks benefit from lower LIBOR, tacit collusion leads to downward biased LIBOR quotes. Signaling effect causes further depressed LIBOR. Equilibrium submissions do cluster together, as people have observed from the data. Comparative statics suggest LIBOR bias spikes during the crisis, due to more dispersed borrowing costs and consumers' less confidence in banks. I propose a direct and \emph{ex ante} budget balanced LIBOR fixing mechanism. Finally, by calibrating the model to the ratio of dispersion among banks' LIBOR submissions to their CDS spreads, I come up with an initial estimation, which matches practitioner's opinions back in 2008, about LIBOR bias during the recent crisis.

Essays on Financial Intermediation in a Dynamic Setting

Essays on Financial Intermediation in a Dynamic Setting
Author: Ronaldo Carpio
Publisher:
Total Pages:
Release: 2012
Genre:
ISBN: 9781267967695
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The financial crisis of 2007-2009 demonstrated that financial intermediaries play a critical, if not yet well-understood, role in the economy. However, our theoretical understanding of what intermediaries do is currently incomplete. The papers in this dissertation seek to improve our theoretical knowledge by introducing models that explicitly capture the activities of a financial intermediary in a dynamic setting. The first paper tackles two fundamental theoretical questions about banks. The first question seems simple but is still unresolved: how should we model a banking firm? We develop a dynamic model of a banking firm based on the notion of banking as the inventory management of cash. A bank that makes loans and takes deposits is a dynamic, stochastic inventory management problem. The second question is an old issue that has again become relevant in the wake of the financial crisis: why do banks engage in maturity mismatch, the process of "borrowing short and lending long". We show how profit-maximizing behavior in an inventory management model can result in maturity mismatch. We present the dynamic model, solve it numerically, and use simulation to predict the bank's behavior in different environments. A limitation of this model is that interest rates and the supply of deposits are taken as exogenous. The second paper endogenizes these quantities for a simple model of an inventory-theoretic financial firm, a Ponzi scheme. As with an ordinary monopolistic firm, the "bank" faces a demand schedule and chooses the price it offers; here, the price is the interest rate, and demand is generated by an OLG population that chooses to borrow or lend using standard models of savings and portfolio choice. In this way we seek to endogenize interest rates, quantities of credit, and financial risk. An issue that arises in dynamic optimization models such as the ones above is that analytic solutions are rare and we must resort to numerical computation, Standard methods of solving dynamic programming problems are computationally expensive; the third paper presents two promising approaches that can potentially provide dramatic speedups in speed. The first method is based on pre-computing the inverse gradient and Lagrange multipliers of a known utility function; subsequent calls can simply look up the pre-computed maximizers, instead of having to call a numeric root-finding routine each time. The second method exploits the duality between concave functions and their Legendre-Fenchel transforms. The Bellman operator in primal space is isomorphic to a tractable scaling and addition operation in dual space. In special cases, we can obtain the value function of the solution in closed form; even when we cannot obtain a closed form solution, we can gain theoretical insight into the properties of the solution.

Essays on Financial Intermediation and Monetary Policy

Essays on Financial Intermediation and Monetary Policy
Author: Abolfazl Setayesh Valipour
Publisher:
Total Pages: 0
Release: 2022
Genre: Intermediation (Finance)
ISBN:
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My research revolves around financial institutions. In this essay, I aim to further our understandings of the internal workings of financial intermediaries, how they interact in financial networks, and how they affect monetary policy and the macroeconomy. In the first chapter, James Peck and I study a bank run model where the depositors can choose how much to deposit. In the many years and many published articles following the bank runs paper of Diamond and Dybvig (1983), only a few papers have modeled the decision of whether to deposit, much less the decision of how much to deposit. The questions we address here are, how does the opportunity for consumers to invest outside the banking system- in investments that do not provide liquidity insurance- (1) affect the nature of the final allocation, (2) affect the nature of the optimal deposit contract, and (3) affect the fragility of the banking system? We extend the Diamond and Dybvig (1983) model so to incorporate sequential service constraint and the opportunity of outside investments and show that under certain conditions the equilibrium entails partial deposits, thus arguing for the optimality of limited banking. One might think that when depositors are allowed to invest a fraction of their endowments outside the banking system, they would be hedging against the risk of a run occurring, but losing out on some of the services provided by banks. Thus, one might think that this would improve the stability of the financial system at the expense of lost efficiency. However, we show that the opposite could be true, with reduced stability (runs more likely) but higher efficiency! In the second chapter, I study the strategic behavior of heterogeneous banks in a network and its implications on the stability of the financial system. I construct a model alas Allen and Gale (2000) wherein banks differ in whether they are hit by an uninsurable excess liquidity demand. I show that in such a framework banks that are already facing a high liquidity demand are more likely to incur the burden of excess liquidity shocks even when that shock has not directly hit them, i.e. relatively healthier banks strategically pass liquidation costs to relatively less healthy banks. I also show that private bailouts arise endogenously in this framework. If the strategic behavior of a bank results in the other bank's failure, the first bank may choose to incur the burden of the liquidity shock by itself to let the other bank survive and, thus, to control the indirect costs of failure feeding back to its portfolio. I also show that for some economies the financial network becomes more stable as the level of cross-deposits is increased from the minimum level that fully insures banks against liquidity demand uncertainty up to a threshold level. In the third chapter, I study the role of financial intermediaries in the transmission of monetary policy in low interest rate environments. The global financial crisis not only proved our understanding of intermediaries were inaccurate and in many ways misleading but also provided an unprecedented opportunity to investigate the questions in ways that were not possible before. Among those, was the behavior of economic players in ultra-low and even negative market rates. I study the internal workings of intermediaries by exploiting geographical variation in market concentration and provide the first explanation for the gradual deterioration of monetary policy power in low market rates that does not rely on bank-specific characteristics and similarly applies to non-bank intermediaries. I show that- in stark contrast to the textbook view but consistent with my mechanism- in low market rates more concentrated banks respond to market rate falls by reducing their deposit supply as well as their loan supply by more than those of less concentrated banks. I argue this behavior is the response of banks to loan and deposit demand becoming less elastic to market rate changes in low market rates which itself is due to the shift of household assets from the ones that are fully responsive to market rate changes (e.g. money market funds) to those less responsive (e.g. deposits) or irresponsive (e.g. cash) in low market rates. As the market rate falls, The downward pressure of the increased market power and the upward pressure of the traditional channels, cause the non-monotonic response of banks to market rate changes. The results help explain the puzzling slow recovery of the economy as well as stable inflation after the global financial crisis. I also show that local house prices become less responsive to market rate changes in low market rates in the counties that are exposed to high-market-power banks.