Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns

Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may be a channel allowing a bank default to spread to other banks. This paper analyzes how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures. Since information on bilateral exposures was not available in most previous studies, they assumed that banks spread their lending as evenly as possible among all the other banks by maximizing the entropy of interbank linkages. Based on the data available on actual bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims. The comparison indicates that, in line with the thesis prevailing in the literature, the maximum entropy method tends to underestimate the extent of contagion. However, this does not hold in general. Under certain circumstances, depending on the structure of the interbank linkages, the recovery rates of interbank exposures and banksÂ’ capitalization, the maximum entropy approach overestimates the scope for contagion.interbank market, financial contagion, systemic risk, maximum entropy

Bank Capital and Lending Behaviour: Empirical Evidence for Italy

This paper investigates the existence of cross-sectional differences in the response of lending to monetary policy and GDP shocks owing to a different degree of bank capitalization. The effects on lending of shocks to bank capital that are caused by a specific (higher than 8 per cent) solvency ratio for highly risky banks are also analyzed. The paper adds to the existing literature in three ways. First, it considers a measure of capitalization (the excess capital) that is better able to control for the riskiness of banksÂ’ portfolios than the well-known capital-to-asset ratio. Second, it disentangles the effects of the "bank lending channel" from those of the "bank capital channel" in the case of a monetary shock; it also provides an explanation for asymmetric effects of GDP shocks on lending based on the link between bank capital and risk aversion. Third, it uses a unique dataset of quarterly data for Italian banks over the period 1992-2001; the full coverage of banks and the long sample period helps to overcome some distributional bias detected for other available public datasets. The results indicate that well-capitalized banks can better shield their lending from monetary policy shocks as they have easier access to non-deposit fund-raising consistently with the "bank lending channel" hypothesis. A "bank capital channel" is also detected, with stronger effects for cooperative banks that have a larger maturity mismatch. Capitalization also influences the way banks react to GDP shocks. Again, the credit supply of well-capitalized banks is less pro-cyclical. The introduction of a specific solvency ratio for highly risky banks determines an overall reduction in lending.Basel standards; monetary transmission mechanisms; bank lending; bank capital

Bank heterogeneity and interest rate setting: what lessons have we learned since Lehman Brothers?

A substantial literature has investigated the role of relationship lending in shielding borrowers from idiosyncratic shocks. Much less is known about how lending relationships and bank-specific characteristics affect the functioning of the credit market in an economy-wide crisis, when banks may find it difficult to perform the role of shock absorbers. We investigate how bank-specific characteristics (size, liquidity, capitalization, funding structure) and the bank-firm relationship have influenced interest rate setting since the collapse of Lehman Brothers. Unlike the existing literature, which has focused chiefly on the amount of credit granted during the crisis, we look at its cost. The data on a large sample of loans from Italian banks to non-financial firms suggest that close lending relationships kept firms more insulated from the financial crisis. Further, spreads increased by less for the customers of well-capitalized, liquid banks and those engaged mainly in traditional lending business.bank interest rate setting, lending relationship, bank lending channel, financial crisis.

Do Women Pay More for Credit? Evidence from Italy

The answer is yes. By using a unique and large data set on overdraft contracts between banks and microfirms and self-employed individuals, we find robust evidence that women in Italy pay more for overdraft facilities than men. We could not find any evidence that women are riskier then men. The male/female differential remains even after controlling for a large number of characteristics of the type of business, the borrower and the market structure of the credit market. The result is not driven by women using a different type of bank than men, since the same bank charges different rates to male and female borrowers. Social capital does play a role: high levels of trust loosen credit conditions by lowering interest rates, but this benefit is not evenly distributed, as women benefit from increased social capital less than men.

The effects of mutual guarantee consortia on the quality of bank lending

In this paper we investigate whether or not mutual guarantee consortia (MGC), a financial institution well developed in Italy, alleviate the difficulties that Small and Medium Enterprises (SMEs) face when they ask for a bank loan. We find that the probability of a small firm affiliated to a MGC of going into default is lower than that of firms not affiliated to such a consortium. These results indicate that MGCs improve the ability of banks to screen and monitor small firms

Firms as monitor of other firms: mutual guarantee institutions and SME finance

A large body of literature has shown that small firms, due to their opaqueness, may find it difficult to access the credit market. Informational asymmetries may be mitigated by posting collateral or by building relationships with lenders (relationship lending). However, in some cases, due to a lack of collateral or of a long credit history, small enterprises may still find it very difficult to raise external finance unless alternative contracting schemes emerge. In particular, group lending or similarly micro-finance are examples of such alternative lending contracts. In this paper, we investigate the effect of mutual guarantee institutions (MGI) on loan interest rates. We argue that, similarly to group lending and micro-finance, firms affiliated to a MGI are linked by a joint responsibility for the loan providing MGI affiliates with peer monitoring incentives. Indeed, each MGI member contributes to the guarantee fund that is then posted as collateral to loans granted to MGI members. As a consequence, MGI willingness to post collateral signals firms creditworthiness to banks. The econometric analysis supports the hypothesis that these consortia improve lending conditions for small firms

The effects of mutual guarantee consortia on the quality of bank lending

In this paper we investigate whether or not mutual guarantee consortia (MGC), a financial institution well developed in Italy, alleviate the difficulties that Small and Medium Enterprises (SMEs) face when they ask for a bank loan. We find that the probability of a small firm affiliated to a MGC of going into default is lower than that of firms not affiliated to such a consortium. These results indicate that MGCs improve the ability of banks to screen and monitor small firms

Mutual Guarantee Institutions (MGIs) and small business credit during the crisis

The recent economic and financial crisis has drawn attention to how mutual guarantee institutions (MGIs) facilitate small and medium enterprises in accessing bank financing. The aim of this paper is twofold. First, we describe the structural features of the Italian market for mutual guarantees and its significance for small business credit. To this end, we use extensive databases (the Central Credit Register and the Central Balance Sheet Register) as well as specific surveys, which allow us to fill information gaps about this industry and to quantify regional diversity. Second, we investigate whether MGIs’ support to small firms continued to be effective in 2008-09, when credit constraints to Italian firms peaked. We find that MGIs played a role in avoiding a break-up in credit flows to affiliated firms, which also benefited from a lower cost of credit. However, this came at the cost of a deterioration in credit quality, which was more intense for customers with guarantees from MGIs.microfinance, peer monitoring, small business finance

Do Women Pay More for Credit? Evidence from Italy

Abstract The answer is yes. By using a unique and large data set on overdraft contracts between banks and microfirms and self-employed individuals, we find robust evidence that women in Italy pay more for overdraft facilities than men. We could not find any evidence that women are riskier then men. The male/female differential remains even after controlling for a large number of characteristics of the type of business, the borrower and the market structure of the credit market. The result is not driven by lack of credit history, nor by women using a different type of bank than men, since the same bank charges different rates to male and female borrowers. Social capital does play a role: high levels of trust loosen credit conditions by lowering interest rates, but this benefit is not evenly distributed, as women benefit from increased social capital less than men. * We than