The Introduction of the Euro and its Effects on Investment Decisions

In this paper we examine changes on investment decisions induced by the introduction of the Euro. There are two potential sources of portfolio reallocation. First, the introduction of the Euro diminished exchange rate risks within the EMU region, which relieved European investors from currency risk associated with intra-EMU investments. Second, monetary policy has been bundled within one single institution, which increased the correlation of different national stock and bond market returns. We test for structural breaks in the portfolio holdings of German investors and estimate a market model in the latter in order to account for the two described effects. We observe a significant decrease in national and an significant increase in intra-EMU as well as US investments. Therefore, the establishment of the EMU led to a decrease of investment home bias. --investment home bias,realized volatility,Euro introduction

How Law Affects Lending

A voluminous literature seeks to explore the relation between law and finance, but offers little insights into dynamic relation between legal change and behavioral outcomes or about the distributive effects of law on different market participants. The current paper disentangles the law-finance relation by using disaggregate data on banks’ lending patterns in 12 transition countries over a 8 year period. This allows us to control for country level heterogeneity and differentiate between different types of lenders. Employing a differences-in-differences methodology in an exclusive ”laboratory” setting as well as unique hand collected datasets on legal change as well as changes in bank ownership, we find that lending volume responds positively to legal change. However, not all legal change is equally effective. The introduction of a legal regime that enhances each lender’s individual prospects of enforcing her claims (collateral law) results in greater increases in lending volume than changes in bankruptcy law, the essence of which is to provide an orderly liquidation or reorganization process in the presence of multiple creditors. Finally, we find that banks that newly enter the market respond more strongly to legal change than do incumbents. In particular, foreign-owned banks extend their lending volume substantially more than domestic banks.creditor rights; credit market development; bankruptcy; collateral law; bank lending

Risk Taking by Banks in the Transition Countries

Although the performance and privatization of transition banks have been widely studied already, little is known about their risk taking and risk management activities. We use a new EBRD survey data set of banks to examine risk taking by banks in the transition countries. We find no indication of excessive risk taking by specific ownership or size categories of banks. Also, we find no connections between risk taking and the quality of the institutional environment although an unsound environment is associated with higher levels of capital

Institutions and Bank Behavior

This paper explores how the legal environment affects bank behavior in 20 transition economies. Based on a newly constructed data set we find that banks’ loan portfolio composition depends on the legal environment. If banks operate in a well-functioning legal environment they lend relatively more to SMEs and provide more mortgages. On the other hand, banks lend more to large enterprises and to the government if the legal system is unsound. As a transmission channel we identify the banks’ willingness to accept collateral which depends on the bankers’ perceptions of the prevailing laws regarding collateral

Sovereign Risk and Simple Debt Dynamics: The Case of Brazil and Argentina

In this paper we develop a simple neoclassical growth model with perfect internationalcapital mobility to analyze the international debt dynamics of developing countries ingeneral and Brazil and Argentina in particular. We show that three different regimes canbe distinguished: a stable steady state debtor regime, a stable steady state creditor regimeand an unstable regime. A switch from a stable debtor or a stable creditor position to anunstable creditor regime may be a sign of forthcoming trouble. We investigate this issueempirically for Brazil and Argentina over the period 1960-1999. Over the full sample, theevidence suggests that debt dynamics evolved according to the stable debtor case in bothcountries. Using a rolling regression technique, we find that indeed occasional switchesto the unstable regime occurred. In particular, Argentina was in the unstable regime formost of the 1990s way before the Argentine debt crisis erupted.economic development an growth ;

Pro-Cyclical Capital Regulation and Lending

We combine particular institutional features of the stepwise introduction of asset risk-specific capital charges by German banks with the event of the Lehman shock to test the theory of pro-cyclicality of capital regulation and to quantify the magnitude of this regulation on firms’ access to lending. The Lehman shock resulted in an increase of credit risk during the implementation period of the internal ratings-based (IRB) approach to capital regulation. At this point, banks introducing IRB had transferred only a portion of their loan portfolios to the new approach. Exploiting the variation of the regulatory approach within IRB banks and the fact that many firms borrow from several IRB banks at the same time allows us to systematically control for both bank-level and firm-level heterogeneity. Loans to the same firm decline by about 3.5 percent more when the loan is part of an IRB portfolio as compared with a portfolio using the traditional regulatory approach. Since banks tend to reduce especially large IRB credit exposures during the recession, firms relying on IRB loans experience an even stronger reduction in aggregate borrowing (5 to 10 percent larger) as compared with firms relying on loans under the traditional approach. Our findings have important implications for the design of capital regulation (i.e., Basel III)

Risk weights, lending, and financial stability: Limits to model-based capital regulation

Model-based capital regulation is considered to be one of the key innovations of Basel II. The objective of this innovation was to make capital charges more sensitive to risk. Using data from the German credit register, and employing a difference-indifference identification strategy, we empirically investigate how the introduction of this regulation affected the quantity and the composition of bank lending. We find that credit supplied by banks that introduced the model-based approach exhibits a higher sensitivity to model-based PDs as compared with credit supplied by banks that remained under the traditional approach. Interestingly, however, we find that risk models used for regulatory purposes tend to underpredict actual default rates. There is no such prediction error in PDs for loans under the traditional approach

Risk Taking by Banks in the Transition Countries

Although the performance and privatization of transition banks have been widely studied already, little is known about their risk taking and risk management activities. We use a new EBRD survey data set of banks to examine risk taking by banks in the transition countries. We find no indication of excessive risk taking by specific ownership or size categories of banks. Also, we find no connections between risk taking and the quality of the institutional environment although an unsound environment is associated with higher levels of capital