Estimating Switching Costs and Oligopolistic Behavior

We present an empirical model of firm behavior in the presence of switching costs. Customers' transition probabilities, embedded in firms' value maximization, are used in a multi-period model to derive estimable equations of a first order condition, market-share (demand), and supply equations. The novelty of the model is in its ability to extract information on both the magnitude and significance of switching costs, as well as on customers' transition probabilities, from conventionally available highly aggregated data which do not contain customer-specific information. As a matter of illustration, the model is applied to a panel data of banks, to assess the switching costs in the market for bank loans. The point estimate of the average switching cost is 4.1% which is about one third of the market average interest rate on loans. More than a quarter of the customer's added value is attributed to the lock-in phenomenon generated by these switching costs. About a third of the average bank's market share is due to its established bank-borrower relationship.

What determines banks’ market power? Akerlof versus Herfindahl

We introduce a model analyzing how asymmetric information problems in a bank-loan market may evolve over the age of a borrowing firm. The model predicts a life-cycle pattern for banks’interest rate markup. Young firms pay a low or negative markup, thereafter the markup increases until it falls for old firms. Furthermore, the pattern of the life-cycle depends on the informational advantage of the inside bank and when more dispersed borrower information yields fiercer bank competition. By applying a new measure of the informational advantage of inside banks and a large sample of small Nor-wegian firms, we find empirical support for the predicted markup pattern. We disentangle effects of asymmetric information (Akerlof effect)from effects of a concentrated banking market(Herfindahl effect). Our results indicate that the interest rate markups are not influenced by bank market concentration.Banking, risk-pricing, lock-in

Effects of Higher Equity Ratio on a Bank’s Total Funding Costs and Lending

Simply stating that because equity is much more expensive than debt funding, banks total funding costs will increase accordingly if their equity ratio is increased, biases the estimated increase upwards. As recently put forwards in the literature, one has to take into account that higher equity ratio lowers the volatility of equity and hence its required return. In addition, higher equity ratio makes a bank’s debt safer and lowers the required return on debt. Taking these two effects into account the Modigliani-Miller theorem implies that a bank’s total cost of funding should not be influenced by the bank’s equity ratio. However, the existence of explicit or implicit guarantees may reduce the latter effect and cause a bank’s total funding cost to increase somewhat when the equity ratio is raised. Miles, Yang, and Marcheggiano (2011) studying UK banks find a slight increase in their funding costs if the equity ratio is increased. Applying the estimates of Miles et.al. we find that a hypothetical doubling of DnB NOR Bank’s equity ratio from 5.5 to 11 per cent would increase its total funding costs in the range of 11 to 41 basis points. In steady state such an increase in Norwegian banks’ funding costs could reduce lending by 0.33 to 1.23 per cent. In the short run, an abrupt increase in banks’ required capital could however cause significantly larger reductions in lending due to frictions in the market for issuing equit

Global and Regional Initiatives to Strengthen Oversight and Regulation of the Financial Sector

A bird’s-eye view of recent reform proposals to banking regulation is presented. Emphasis is on the Basel Committee’s proposed capital and liquidity regulations, but also initiatives from other international organisations like the Financial Stability Board, G20, the International Monetary Fund and EU are presented. Besides capital and liquidity regulation, initiatives regarding resolution of failing systemically important financial institutions, cross border issues and taxation of the financial sector are briefly described

Lending Growth, Non-Performing Loans and Loan Losses

At macro level, large loan losses for banks have often been preceded by periods of high lending growth. We analyse at bank level whether high loan growth also leads to more problem loans later on. The analysis is carried out on a panel of Norwegian banks covering the period 1996 – 2016. The applied methodology is similar to the one found in similar studies on Spanish banks as well as on banks in several OECD countries. We find a statistically significant positive relationship between past excessive loan growth at a bank and its amount of problem loans 2 – 3 years ahead. Unlike in the studies of other countries, the effect is not economically significant. Results do not indicate that excessive loan growth will never have any adverse effect at Norwegian banks, as our sample covers a relatively calm period in the Norwegian banking sector. Nevertheless, with a non-linear technique, we do find some indication that banks with much higher lending growth also experience proportionally much higher loan losses.publishedVersio

Scale Economies, Bank Mergers, and Electronic Payments: A Spline Function Approach

This paper demonstrates the importance of using a flexible cost function specification when analyzing economies of scale and estimating the cost effect of banking mergers. The inflexibility of the translog cost function is illustrated and results are compared to more flexible spline and Fourier cost functions. Using these different approaches we predict the ex ante effect on average cost from mergers over 1987-1998 using a balanced panel of 130 Norwegian banks. On average mergers are predicted to lower costs. Predictions using the Fourier or spline approach are in overall agreement with computed actual average merger-cost changes ex post. Cost effects of electronic payments are also estimated and exceed cost reductions associated with mergers.publishedVersio

Innskyterpreferanse

Innskyterpreferanse innebærer at dersom kreditorene i en bank må ta tap, gis innskyterne fortrinnsrett, slik at innskuddene først blir nedskrevet etter at all øvrig gjeld er fullstendig nedskrevet. Artikkelen drøfter fordeler og problemer ved eventuelt å innføre innskyterpreferanse i Norge. Innskyterpreferanse vil redusere den subsidieringen av bankene som skyldes manglende risikoprising av innskuddsgarantien og den implisitte statsgarantien. Det vil også kunne gi større sikkerhet for ikke-finansielle foretak med tidvis store bankinnskudd. Innskyterpreferanse kan imidlertid gjøre eventuell markedsfinansiering vesentlig dyrere for banker som i liten grad benytter slik finansiering. Det vil i hovedsak gjelde mindre banker. Det kan også bidra til at flere små banker vil velge å foreta betalingsoppgjørene i Norges Bank fremfor hos de private oppgjørsbankene. Artikkelen drøfter videre problemer knyttet til gjeld som er utestående ved innføringstidspunktet for innskyterpreferanse. I en simulering illustreres hvordan et gitt tapsnivå kan slå ut for norske banker med og uten innskyterpreferanse

Why Regulate Banks?

In this note we seek to provide a first guide to how the economic literature explains the rationale for regulating banks. The guide is not exhaustive with respect to academic papers covered. Neither do we elaborate on how banks should be regulated; we only mention key measures in existing regulation