Determinants of the Size of the Sovereign Credit Default Swap Market
Tobias Berg, Daniel Streitz
Journal of Fixed Income,
No. 3,
2016
Abstract
We analyze the sovereign credit default swap (CDS) market for 57 countries, using a novel dataset comprising weekly positions and turnover data. We document that CDS markets—measured relative to a country’s debt—are larger for smaller countries, countries with a rating just above the investment-grade cutoff, and countries with weaker creditor rights. Analyzing changes in credit risk, we find that rating changes matter but only for negative rating events (downgrades and negative outlooks). In particular, weeks with downgrades and negative outlooks are associated with a significantly higher turnover in the sovereign CDS market, even after controlling for changes in sovereign CDS spreads. We conclude that agencies’ ratings are a major determinant of the size of the sovereign CDS market.
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A Review of Empirical Research on the Design and Impact of Regulation in the Banking Sector
Sanja Jakovljević, Hans Degryse, Steven Ongena
Annual Review of Financial Economics,
2015
Abstract
We review existing empirical research on the design and impact of regulation in the banking sector. The impact of each individual piece of regulation may inexorably depend on the set of regulations already in place, the characteristics of the banks involved (from their size or ownership structure to operational idiosyncrasies in terms of capitalization levels or risk-taking behavior), and the institutional development of the country where the regulation is introduced. This complexity is challenging for the econometrician, who relies either on single-country data to identify challenges for regulation or on cross-country data to assess the overall effects of regulation. It is also troubling for the policy maker, who has to optimally design regulation to avoid any unintended consequences, especially those that vary over the credit cycle such as the currently developing macroprudential frameworks.
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The Impact of Securitization on Credit Rationing: Empirical Evidence
Santiago Carbo-Valverde, Hans Degryse, Francisco Rodríguez-Fernández
Journal of Financial Stability,
2015
Abstract
We study whether banks’ involvement into different types of securitization activity – asset backed securities (ABS) and covered bonds – in Spain influences credit supply before and during the financial crisis. While both ABS and covered bonds were hit by the crisis, the former were hit more severely. Employing a disequilibrium model to identify credit rationing, we find that firms with banks that were more involved in securitization see their credit constraints more relaxed in normal periods. In contrast, only greater covered bonds issuance reduces credit rationing during crisis periods whereas ABS aggravates these firms’ credit rationing in crisis periods. Our results are in line with the theoretical predictions that a securitization instrument that retains risk (covered bond) may induce a more prudent risk behavior of banks than an instrument that provides risk transferring (ABS).
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Financial Stability and Central Bank Governance
Michael Koetter, Kasper Roszbach, G. Spagnolo
International Journal of Central Banking,
No. 4,
2014
Abstract
The financial crisis has ignited a debate about the appropriate objectives and the governance structure of Central Banks. We use novel survey data to investigate the relation between these traits and banking system stability focusing in particular on their role in micro-prudential supervision. We find that the separation of powers between single and multiple bank supervisors cannot explain credit risk prior or during the financial crisis. Similarly, a large number of Central Bank governance traits do not correlate with system fragility. Only the objective of currency stability exhibits a significant relation with non-performing loan levels in the run-up to the crisis. This effect is amplified for those countries with most frequent exposure to IMF missions in the past. Our results suggest that the current policy discussion whether to centralize prudential supervision under the Central Bank and the ensuing institutional changes some countries are enacting may not produce the improvements authorities are aiming at. Whether other potential improvements in prudential supervision due to, for example, external disciplinary devices, such as IMF conditional lending schemes, are better suited to increase financial stability requires further research.
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Executive Compensation Structure and Credit Spreads
Stefano Colonnello, Giuliano Curatola, Ngoc Giang Hoang
Abstract
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about how inside debt features affect the relation between credit spreads and compensation components. First, inside debt reduces credit spreads only if it is unsecured. Second, inside debt exerts important indirect effects on the role of equity incentives: When inside debt is large and unsecured, equity incentives increase credit spreads; When inside debt is small or secured, this effect is weakened or reversed. We test our model on a sample of U.S. public firms with traded CDS contracts, finding evidence supportive of our predictions. To alleviate endogeneity concerns, we also show that our results are robust to using an instrumental variable approach.
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Taxing Banks: An Evaluation of the German Bank Levy
Claudia M. Buch, Björn Hilberg, Lena Tonzer
Abstract
Bank distress can have severe negative consequences for the stability of the financial system, the real economy, and public finances. Regimes for restructuring and restoring banks financed by bank levies and fiscal backstops seek to reduce these costs. Bank levies attempt to internalize systemic risk and increase the costs of leverage. This paper evaluates the effects of the German bank levy implemented in 2011 as part of the German bank restructuring law. Our analysis offers three main insights. First, revenues raised through the bank levy are minimal, because of low tax rates and high thresholds for tax exemptions. Second, the bulk of the payments were contributed by large commercial banks and the head institutes of savings banks and credit unions. Third, the levy had no effect on the volume of loans or interest rates for the average German bank. For the banks affected most by the levy, we find evidence of fewer loans, higher lending rates, and lower deposit rates.
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The Impact of Public Guarantees on Bank Risk-taking: Evidence from a Natural Experiment
Reint E. Gropp, C. Gruendl, Andre Guettler
Review of Finance,
No. 2,
2014
Abstract
In 2001, government guarantees for savings banks in Germany were removed following a lawsuit. We use this natural experiment to examine the effect of government guarantees on bank risk-taking. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. Using a difference-in-differences approach we show that none of these effects are present in a control group of German banks to whom the guarantee was not applicable. Furthermore, savings banks adjusted their liabilities away from risk-sensitive debt instruments after the removal of the guarantee, while we do not observe this for the control group. We also document that yield spreads of savings banks’ bonds increased significantly right after the announcement of the decision to remove guarantees, while the yield spread of a sample of bonds issued by the control group remained unchanged. The evidence implies that public guarantees may be associated with substantial moral hazard effects.
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Did Consumers Want Less Debt? Consumer Credit Demand versus Supply in the Wake of the 2008-2009 Financial Crisis
Reint E. Gropp, J. Krainer, E. Laderman
Abstract
We explore the sources of household balance sheet adjustment following the collapse of the housing market in 2006. First, we use microdata from the Federal Reserve Board’s Senior Loan Officer Opinion Survey to document that banks cumulatively tightened consumer lending standards more in counties that experienced a house price boom in the mid-2000s than in non-boom counties. We then use the idea that renters, unlike homeowners, did not experience an adverse wealth shock when the housing market collapsed to examine the relative importance of two explanations for the observed deleveraging and the sluggish pickup in consumption after 2008. First, households may have optimally adjusted to lower wealth by reducing their demand for debt and implicitly, their demand for consumption. Alternatively, banks may have been more reluctant to lend in areas with pronounced real estate declines. Our evidence is consistent with the second explanation. Renters with low risk scores, compared to homeowners in the same markets, reduced their levels of nonmortgage debt and credit card debt more in counties where house prices fell more. The contrast suggests that the observed reductions in aggregate borrowing were more driven by cutbacks in the provision of credit than by a demand-based response to lower housing wealth.
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Sovereign Credit Risk, Banks' Government Support, and Bank Stock Returns around the World: Discussion of Correa, Lee, Sapriza, and Suarez
Reint E. Gropp
Journal of Money, Credit and Banking,
s1
2014
Abstract
In the years leading up to the 2008–09 financial crisis, many banks around the world greatly expanded their balance sheets to take advantage of cheap and abundantly available funding. Access to international funding markets, in particular, made it possible for banks to reach a size that in some cases was a large multiple of their home countries’ gross domestic product (GDP). In Iceland, for example, assets of the banking system reached up to 900% of GDP in 2007. Similarly, by the end of 2008, assets in UK and Swiss banks exceeded 500% of their countries’ GDPs, respectively. Banks may also have grown rapidly because they may have wanted to reach too-big-to-fail status in their country, implying even lower funding cost (Penas and Unal 2004).
The depth and severity of the 2008–09 financial crisis and the subsequent debt crisis in Europe, however, have cast doubts on the ability of governments to bail out banks when they experience severe difficulties, in particular, in financially fragile environments and faced with large budget imbalances. This has resulted in as what some observers have dubbed a “doom loop”: the combination of weak public finances and weak banks results in a vicious cycle, in which the funding cost of banks increases, as the ability of governments to bail out banks is called into question, in turn increasing the funding cost of these banks and making the likelihood that the government will actually have to step in even higher, which in turn increases funding cost to the government and so forth.
Against this background, the paper by Correa et al. (2014) explores the link between sovereign rating changes and bank stock returns. They show large negative reactions of stock returns in response to sovereign ratings downgrades for banks that are expected to receive government support in case of failure. They find the strongest effects in developed economies, where the credibility of government bail outs is higher ex ante, while the effects are smaller in developing and emerging economies. In my view, the paper makes a number of important contributions to the extant literature.
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Modelling Macroeconomic Risk: The Genesis of the European Debt Crisis
Gregor von Schweinitz
Hochschulschrift, Juristische und Wirtschaftswissenschaftliche Fakultät der Martin-Luther-Universität Halle-Wittenberg,
2013
Abstract
Diverging European sovereign bond yields after 2008 are the most visible sign of the European debt crisis. This dissertation examines in a first step, to which extent the development of yields is driven by credit and liquidity risk, and how it is influenced by general uncertainty on financial markets. It can be shown that yields are driven to a significant degree by a flight towards bonds of high liquidity in times of high market uncertainty. In a second step, high yields are interpreted as a sign of an existing crisis in the respective country. Using the signals approach, the early-warning capabilities of four different proposals for the design of the scoreboard as part of the “Macroeconomic Imbalances Procedure” (introduced in December 2011 by the European Commission) are tested, advocating a scoreboard including a variety of many different indicators. In a third step, the methodology of the signals approach is extended to include also results on significance.
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