Essays on the impact of government policy, internationalization and financial innovation on financial stability

For better or worse, the global financial system went through remarkable change over the last decades. Cross-border banking giants emerged; many countries opened up their banking systems welcoming foreign ownership; government ownership in banking, which is deemed to be vicious, declined globally. The financial crisis of 2007-2009, however, changed our understanding of the global financial system and provided renewed impetus to some crucial debates, which may inform the policy-makers to avoid future crises. The chapters of this thesis contribute the ongoing discussions by providing empirical evidence on some crucial aspects. Chapter 2 analyzes the transmission of real estate price changes through multinational banks by investigating the credit supply of banks in response to national and foreign real estate price changes. In Chapter 3, we focus on the internationalization of banks and possible roles of financial safety nets and market discipline related to internationalization. Chapter 4 provides empirical evidence regarding countercyclical behavior of government owned banks, which may be useful during bad times. Finally, in Chapter 5 we focus on the macroeconomic effects of securitization at the aggregate level and show that securitization may have a negative impact on real economic outcomes by changing the credit composition towards consumption

The Transmission of Real Estate Shocks Through Multinational Banks

Abstract: This paper investigates the credit supply of banks in response to domestic and foreign real estate price changes. Using a large international dataset of multinational banks, we find evidence of a significant transmission of domestic real estate shocks into lending abroad. A 1% decrease in real estate prices in home country, in particular, leads to a 0.2-0.3% decrease in credit growth in the foreign subsidiary. This response, however, is asymmetric: only negative house price changes are transmitted. Stricter regulation of activities of parent banks can reduce this effect, indicating a role for regulation in alleviating the transmission of real estate shocks. Further, the analysis of the impact of real estate shocks on foreign subsidiary funding indicates that shocks are transmitted through changes in long-term debt funding and equity

Have European Banks Actually Changed Since the Start of the Crisis?

This paper documents trends in key bank variables over the 2003-2013 period for the set of banks that the ECB directly supervises as of January 30, 2015. This time period enables us to see how the crisis has affected the banks, and also how they have changed since the crisis. A range of variables is considered that together provide a picture to what extent banks have been moving in the direction of better performance and greater stability. These variables include indices of banks’ overall business model, size, off-balance sheet exposures, and internationalization. In addition, we consider several variables that inform about banks’ asset portfolios, funding strategies and capitalization. The identified trends provide a mixed picture of whether banks have been moving in the right direction since the start of the crisis

Do we need big banks? Evidence on performance, strategy and market discipline

For an international sample of banks, we construct measures of a bank’s absolute size and its systemic size defined as size relative to the national economy. We then examine how a bank’s risk and return on equity, its activity mix and funding strategy, and the extent to which it faces market discipline depend on both size measures. We show that bank returns increase with absolute size, yet decline with systemic size, while neither size measure is associated with bank risk as implicit in the Z-score. These results are consistent with the view that growing to a size that is systemic is not in the interest of bank shareholders. We also find that systemically large banks are subject to greater market discipline as evidenced by a higher sensitivity of their funding costs to risk proxies, consistent with the view that they can become too large to save. A bank’s interest costs, however, are estimated to decline with bank systemic size for all banks apart from those with very low capitalization levels. This suggests that market discipline, exercised through funding costs, does not prevent banks from attaining larger systemic size

Bank ownership and credit over the business cycle: Is lending by state banks less procyclical?

This paper finds that lending by state banks is less procyclical than lending by private banks, especially in countries with good governance. Lending by state banks in high income countries is even countercyclical. On the liability side, state banks expand their total liabilities and, in particular, their non-deposit liabilities relatively little during booms. Public banks also report loan non-performance more evenly over the business cycle. Overall our results suggest that state banks can play a useful role in stabilizing credit over the business cycle as well as during periods of financial instability. However, the track record of state banks in credit allocation remains quite poor, questioning the wisdom of using state banks as a short term countercyclical tool

Is the Financial Safety Net a Barrier to Cross-Border Banking?

A bank’s interest expenses are found to increase with its degree of internationalization as proxied by its share of foreign liabilities in total liabilities or a Herfindahl index of international liability concentration, especially if the bank is performing badly. Our benchmark estimation suggests that an international bank’s cost of funds raised through a foreign subsidiary is between 1.5% and 2.4% higher than the cost of funds for a purely domestic bank, which is a sizeable difference given an overall mean cost of funds of 3.3%. These results are consistent with limited incentives for national authorities to bail out an international bank, but also with an international bank recovery and resolution process that is inefficient. In any event, the operation of the financial safety net appears to be a barrier to cross-border banking

Bank Ownership and Credit over the Business Cycle: Is Lending by State Banks Less Procyclical?

Abstract: This paper finds that lending by state banks is less procyclical than lending by private banks, especially in countries with good governance. Lending by state banks in high income countries is even countercyclical. On the liability side, state banks expand potentially unstable non-deposit liabilities relatively little during booms, especially in countries with good governance. Public banks also report loan non-performance more evenly over the business cycle. Overall our results suggest that state banks can play a useful role in stabilizing credit over the business cycle as well as during periods of financial instability. However, the track record of state banks in credit allocation remains quite poor, questioning the wisdom of using state banks as a short term counter-cyclical tool