Bank Lending Policy, Credit Scoring and the Survival of Loans

To evaluate loan applicants, banks increasingly use credit scoring models. The objective of such models typically is to minimize default rates or the number of incorrectly classified loans. Thereby they fail to take into account that loans are multiperiod contracts for which reason it is important for banks not only to know if but also when a loan will default. In this paper a bivariate Tobit model with a variable censoring threshold and sample selection effects is estimated for (1) the decision to provide a loan or not and (2) the survival of granted loans. The model proves to be an effective tool to separate applicants with short survival times from those with long survivals. The banks loan provision process is shown to be ineffcient: loans are granted in a way that conflicts with both default risk minimization and survival time maximization. There is thus no trade-off between higher default risk and higher return in the lending policy

Credit ratings and bank monitoring ability

In this paper, the authors use credit rating data from two Swedish banks to elicit evidence on banks' loan monitoring ability. They test the banks' ability to forecast credit bureau ratings, and vice versa, and show that bank ratings are able to predict future credit bureau ratings. This is evidence that bank credit ratings, consistent with theory, contain valuable private information. However, the authors also find that public ratings have an ability to predict future bank ratings, implying that internal bank ratings do not fully or efficiently incorporate all publicly available information. This suggests that risk analyses by banks or regulators should be based on both internal bank ratings and public ratings. They also document that the credit bureau ratings add information to the bank ratings in predicting bankruptcy and loan default. The methods the authors use represent a new basket of straightforward techniques that enables both financial institutions and regulators to assess the performance of credit ratings systems.Credit ratings ; Risk assessment

Trade unions, employee share ownership and wage setting: A supply-side approach to the share economy

Employee share ownership is growing increasingly important. This paper studies employee share ownership in an economy with one monopoly union for each firm. We modify an implicit contra t model by adding dividend income to the usual wage income. Union members differ in exogenous stock endowments and choose wages under majority rule. As a result, wages are decreasing in stock endowments and a skewed distribution of stoc k-capital leads to higher wages and lower employment. Switching to a more equal distribution can increase employment and production. An optimal portfolio rule suggests that macroeconomic gains can be made from limiting the diversification of portfolios. Last, we show how the transfer of shares to employees can be made economically feasible.Trade unions; profit sharing; distribuion; voting; portfolio choice

Reaction Function Estimation when Central Banks Face Adjustment Costs

The main instrument of monetary policy in industrialized countries is currently a short-term interest rate. It typically remains unchanged during long spans of time. This paper tries to answer three questions. Why do Central Banks change targeted interest rates so seldom? How should we estimate Central banks' reaction functions? And what are the driving forces behind rate changes? This paper takes the point of view that Central Banks face a fixed cost when adjusting the targeted interest rate and therefore smoothe the targeted interest rate by using a discrete policy rule. In the estimation of the reaction function this discrete nature is taken into account by applying a grouped data model to a Swedish data set. It is found that the reaction function is best represented in terms of changes in growth rates of macro variables and changes in levels of financial variables. Probabilities of the target rate being raised, lowered or kept constant are computed and compared with actual interest rate behavior. The model has a prediction rate of 88% versus 78% for the best naive estimator.

Firm default and aggregate fluctuations

This paper studies the relation between macroeconomic fluctuations and corporate defaults while conditioning on industry affiliation and an extensive set of firm-specific factors. Using a logit approach on a panel data set for all incorporated Swedish businesses over 1990-2002, we find strong evidence for a substantial and stable impact of aggregate fluctuations. Macroeffects differ across industries in an economically intuitive way. Out-of-sample evaluations show our approach is superior to both models that exclude macro information and best fitting naive forecasting models. While firm-specific factors are useful in ranking firms’ relative riskiness, macroeconomic factors capture fluctuations in the absolute risk level.Business failures

Exploring Interactions between Real Activity and the Financial Stance

In this paper we empirically study interactions between real activity and the financial stance. Using aggregate data we examine a number of candidate measures of the financial stance of the economy. We find strong evidence for substantial spillover effects on aggregate activity from our preferred measure. Given this result, we use a large micro data-set for corporate firms to develop a macro-micro model of the interaction between the financial and real economy. This approach implies that the impulse responses of a given aggregate shock will depend on the portfolio structure of firms at any given point in time

Internal Ratings Systems, Implied Credit Risk and the Consistency of Banks Risk Classification Policies

Counterpart risk rating is at the heart of the banking business. In the new Basel II regulation, internal ratings have been given a central role. Although much research has been done on external ratings, much less is known about banks´ internal ratings. This paper presents new quantitative evidence on the consistency of internal ratings based on panel data from the complete business loan portfolios of two Swedish banks and a credit bureau over the period 1997-2000. We study rating class distributions, - transitions and default behavior and compute the credit loss distributions that each rating system implies by means of a semi-parametric Monte Carlo re-sampling method following Carey (1998). Our results reveal, for a portfolio with identical counterparts, substantial differences in the implied riskiness between banks. Such differences could translate into different amounts of required economic capital and create (new) incentives to securitize part of their loan portfolios or increase the riskiness of loans in certain rating classes. We also shed light on the quantitative importance of portfolio composition, portfolio size and the forecast horizon for loss distributions. For example, with common portfolio parameters, credit risk can be reduced by up to 40 percent by doubling the loan portfolio size. We also discuss the relation between loss distributions and the desirable level of insolvency risk

Governing the governors: A clinical study of central banks

Recent research on central bank governance has focused mainly on their monetary policy task. As the sub-prime loan market turmoil reminded us - central banks play a crucial role in financial markets not only in setting monetary policy, but also in ensuring their soundness and stability. In this paper we study the specific corporate governance structures of a number of central banks in light of their complex role of inflation guardians, bankers' banks, financial industry regulators/supervisors and, in some cases, competition authorities and deposit insurance agencies. We review their current institutional arrangements, e.g. formal objectives, ownership, board and governor appointment rules, term limits and compensation, using both existing surveys and newly collected information; and we contrast them with the structures suggested in the corporate and public governance literatures, where present. Our analysis highlights a striking variety in central bank governance structures and a number of specific issues that appear unsatisfactorily addressed by existing research, including the incentive structure for governor and board members, the balance between central banks' multiple objectives, and the need for term limits or post-employment restrictions