CREDIT AND BANKING
TABLE OF CONTENTS
Part 1 THEORY: WHy do banks exist? Are banks special? ...................................................4
1. WHat do banks do? What is special about banks?.................................................................. 4
1.1 definition ...................................................................................................................................................4
1.2 The functions/role of banks ......................................................................................................................4
1.3 link between Banks and economic growth ...............................................................................................5
2. Who wants to borrow from banks? ....................................................................................... 5
2.1 Basics of credit rationaing: fixed investment model .................................................................................5
2.2 Debt Overhang ..........................................................................................................................................8
3. Investor activism: active role of banks/other financial intermediaries .................................... 9
3.1 Introduciton .............................................................................................................................................10
3.2 Basics of investor activism.......................................................................................................................10
Part 1 empirics: WHy do banks exist? Are banks special? .................................................14
1. Some descriptives of Euro and belgian financial institutions ................................................ 14
2. Shadow banking ................................................................................................................. 16
2.1 definition .................................................................................................................................................16
2.2 Some descriptives....................................................................................................................................17
3. are bank loans special ? ...................................................................................................... 17
3.1 James: SOME EVIDENCE ON THE UNIQUENESS OF BANK LOANS (1987) ...............................................18
3.2 Refinements of james’ paper ..................................................................................................................20
3.3 Overview loan announcements studies ..................................................................................................20
3.4 other aspect: bank distress/merger ........................................................................................................20
3.5 other aspect: impact of bank distress on lt firm performance ...............................................................21
Part 2 theory : assymetric information ............................................................................21
1. Equilibrium credit rationing ................................................................................................ 21
1.1 definition .................................................................................................................................................21
1.2 Credit rationing due to adverse selection ...............................................................................................22
2. Collateral............................................................................................................................ 24
2.1 Ex-ante theories: Screening versus rationing (Bester (1985)) ................................................................24
2.2 Ex-post theories regarding COLLATERAL : solving ex-post frictions .......................................................26
part 2 Empirics: assymetric information ..........................................................................27
1. Luck and Santos “The valuation of collateral in bank lending” ............................................. 27
2. Berger, Frame and Ioannidou « offer an interesting setting to identify the importance of both
theories »............................................................................................................................... 31
part 3 theory: Information sharing in banking markets....................................................34
1
, 1. introduction ....................................................................................................................... 34
2. Modeling information SHARING: Padilla and pagano RFS 1997 ............................................ 35
2.1 The model ................................................................................................................................................35
2.2 Solve the game for given degree of moral hazard: p is fixed ..................................................................37
2.3 Issues with this model: ............................................................................................................................38
3. EXTENSIONS: padilla and pagano (eer 2000) ........................................................................ 38
3.1 the model ................................................................................................................................................39
3.2 Solve the game for given degree of moral hazard: p is given .................................................................39
3.3 effort choice ............................................................................................................................................45
4. Extenstions : Bouckaer and degryse (economic journal 2006)and castiglionesi et al (2020) ... 47
Part 3 Emirical work on information sharing in banking markets .....................................47
1. More generally ................................................................................................................... 47
2. Paper 1 by djankov, mcliesh and shleifer ............................................................................. 47
3. Paper 2 :data vs collateral ................................................................................................... 49
part 4 theory: Lender-Borrower Relationships .................................................................54
Goals ..............................................................................................................................................................54
1. Bank versus Arm’s Length Financing .................................................................................... 54
1.1 Outline .....................................................................................................................................................54
1.2 The project...............................................................................................................................................54
1.3 Financiers.................................................................................................................................................56
1.4 Different scenario’s (First-Best, Arm’s length, bank long term, bank short term)..................................57
1.5 Results .....................................................................................................................................................61
1.6 Comparison .............................................................................................................................................61
1.7 Further summary – effect bargaining power ..........................................................................................62
2. Creditor Concentration: Number of Relationships ................................................................ 63
2.1 DGG-Theoretical model ...........................................................................................................................64
part 4 Empirics: bank-firm relations ................................................................................65
1. Indicators of bank-firm relationship strength ....................................................................... 65
2. Impact of bank-firm relationships on firms .......................................................................... 68
3. Relationship banking and firms’ credit constraints ............................................................... 69
3.1 When Arm’s Length is Too Far. Relationship Banking over the Credit Cycle ..........................................69
Part 5 theory: individual bank runs and systemic risk.......................................................80
1. Individual bank runs ........................................................................................................... 81
1.1 Diamond-dybvig (1983) - model and variants .........................................................................................81
1.2 Runs .........................................................................................................................................................86
1.3 Anti-run policies ......................................................................................................................................87
2. Systemic Risk ...................................................................................................................... 87
3. Banking competition and stability ....................................................................................... 88
3.1 “Charter value hypothesis” (Traditional competition-fragility view)......................................................88
2
, 3.2 The optimal contracting hypothesis (competition stability view) ..........................................................88
Part 5 Empricis: individual bank runs and systematic risk.................................................89
Goals ..............................................................................................................................................................89
1. Introduction of topic ........................................................................................................... 89
1.1 Individual bank runs versus systemic risk................................................................................................90
1.2 Recent crisis: Laeven and Valencia (2018) IMF wp..................................................................................90
2. Evidence............................................................................................................................. 93
2.1 Determinants of banking crisis: banking competition and stability ........................................................93
2.2 Implications of banking crises .................................................................................................................95
2.3 Regulation and banking crisis ..................................................................................................................98
3. Liquidity risks ..................................................................................................................... 99
3.1 Kashyap, Rajan and Stein: Banks as liquidity providers: an explanation for the coexistence of lending
and deposit-taking .........................................................................................................................................99
3.2 Gatev, Schuermann and Strahan: Managing bank liquidity risk: How deposit-loan synergies vary with
market conditions .......................................................................................................................................101
3.3 Ippolito et al.: Double bank runs and liquidity risk management .........................................................102
Part 6 theory Banking Regulation: Micro-prudential and macro-prudential ................... 106
Objectives ....................................................................................................................................................106
1. Regulation of banks .......................................................................................................... 106
1.1 general setting..............................................................................................................................107
1.2 bank fragility ..........................................................................................................................................107
1.3 depositor protection and customer confidence ...................................................................................107
1.4 cost of bank failures ..............................................................................................................................108
2. Macro-prudential regulation ............................................................................................. 108
2.1 definition ...............................................................................................................................................108
2.2 Why macro-prudential regulation? .......................................................................................................109
2.3 Interaction with other policies and international dimensions .............................................................111
2.4 Macroprudential toolkit ........................................................................................................................112
Part 6 emperics: macro-prudential regulation ............................................................... 115
Lim et al. (2011) “Macroprudential Policy: What Instruments and How Are They Used? Lessons
from Country Experiences” ................................................................................................... 115
3
, CREDIT AND BANKING
PART 1 THEORY: WHY DO BANKS EXIST? ARE BANKS SPECIAL?
Goal:
- Aim to understand who benefits from borrowing from a bank
o Bank as a monitor – Bank as an advisor
- Aim to understand why impacts of banking crises may persist for a long time =debt overhang
1. WHAT DO BANKS DO? WHAT IS SPECIAL ABOUT BANKS ?
1.1 DEFINITION
Definition of a bank: an institution whose current operations consists in granting loans and receiving
deposits from the public
- Current <-> trade credit (delay of payment) granted by other firms
- Loans and deposits: fragility of banks
o All depositors may need liquidity at same time
E.g., the Belgian Government Savings Certificates led to a decrease in savings
account
o Lines of credit may be drawn at same time due to e.g., shock in economy
o If both sides withdraw at the same time: double bank run
- Public: justification for regulation
o Because banks provide unique services: liquidity and means of payment
o And small depositors are not armed to assess safety and soundness of banks =
consumers cannot protect themselves and do not know better
1.2 THE FUNCTIONS/ROLE OF BANKS
Liquidity and payment services
- “Money” exists as it reduces transaction costs
- People accept money as they expect to be able to use it again at a later stage
Role of banks in payment systems
- Often a loss-leader
= Component of a bank's operations that may not be highly profitable on its own, but is
there to attract clients
- New threats: Facebook, Apple (digital wallets), Fintech, cryptocurrencies,…
➔ These new players often leverage innovative technologies to provide payment services
more efficiently or at lower costs and they are able to gather a lot of information about their
users
- Info obtained through checking account helps in monitoring firms (e.g., Renault and Mester)
or Norden and Weber
Transforming assets
- Size transformation: deposits are typically small amounts whereas loans are large amounts
4
TABLE OF CONTENTS
Part 1 THEORY: WHy do banks exist? Are banks special? ...................................................4
1. WHat do banks do? What is special about banks?.................................................................. 4
1.1 definition ...................................................................................................................................................4
1.2 The functions/role of banks ......................................................................................................................4
1.3 link between Banks and economic growth ...............................................................................................5
2. Who wants to borrow from banks? ....................................................................................... 5
2.1 Basics of credit rationaing: fixed investment model .................................................................................5
2.2 Debt Overhang ..........................................................................................................................................8
3. Investor activism: active role of banks/other financial intermediaries .................................... 9
3.1 Introduciton .............................................................................................................................................10
3.2 Basics of investor activism.......................................................................................................................10
Part 1 empirics: WHy do banks exist? Are banks special? .................................................14
1. Some descriptives of Euro and belgian financial institutions ................................................ 14
2. Shadow banking ................................................................................................................. 16
2.1 definition .................................................................................................................................................16
2.2 Some descriptives....................................................................................................................................17
3. are bank loans special ? ...................................................................................................... 17
3.1 James: SOME EVIDENCE ON THE UNIQUENESS OF BANK LOANS (1987) ...............................................18
3.2 Refinements of james’ paper ..................................................................................................................20
3.3 Overview loan announcements studies ..................................................................................................20
3.4 other aspect: bank distress/merger ........................................................................................................20
3.5 other aspect: impact of bank distress on lt firm performance ...............................................................21
Part 2 theory : assymetric information ............................................................................21
1. Equilibrium credit rationing ................................................................................................ 21
1.1 definition .................................................................................................................................................21
1.2 Credit rationing due to adverse selection ...............................................................................................22
2. Collateral............................................................................................................................ 24
2.1 Ex-ante theories: Screening versus rationing (Bester (1985)) ................................................................24
2.2 Ex-post theories regarding COLLATERAL : solving ex-post frictions .......................................................26
part 2 Empirics: assymetric information ..........................................................................27
1. Luck and Santos “The valuation of collateral in bank lending” ............................................. 27
2. Berger, Frame and Ioannidou « offer an interesting setting to identify the importance of both
theories »............................................................................................................................... 31
part 3 theory: Information sharing in banking markets....................................................34
1
, 1. introduction ....................................................................................................................... 34
2. Modeling information SHARING: Padilla and pagano RFS 1997 ............................................ 35
2.1 The model ................................................................................................................................................35
2.2 Solve the game for given degree of moral hazard: p is fixed ..................................................................37
2.3 Issues with this model: ............................................................................................................................38
3. EXTENSIONS: padilla and pagano (eer 2000) ........................................................................ 38
3.1 the model ................................................................................................................................................39
3.2 Solve the game for given degree of moral hazard: p is given .................................................................39
3.3 effort choice ............................................................................................................................................45
4. Extenstions : Bouckaer and degryse (economic journal 2006)and castiglionesi et al (2020) ... 47
Part 3 Emirical work on information sharing in banking markets .....................................47
1. More generally ................................................................................................................... 47
2. Paper 1 by djankov, mcliesh and shleifer ............................................................................. 47
3. Paper 2 :data vs collateral ................................................................................................... 49
part 4 theory: Lender-Borrower Relationships .................................................................54
Goals ..............................................................................................................................................................54
1. Bank versus Arm’s Length Financing .................................................................................... 54
1.1 Outline .....................................................................................................................................................54
1.2 The project...............................................................................................................................................54
1.3 Financiers.................................................................................................................................................56
1.4 Different scenario’s (First-Best, Arm’s length, bank long term, bank short term)..................................57
1.5 Results .....................................................................................................................................................61
1.6 Comparison .............................................................................................................................................61
1.7 Further summary – effect bargaining power ..........................................................................................62
2. Creditor Concentration: Number of Relationships ................................................................ 63
2.1 DGG-Theoretical model ...........................................................................................................................64
part 4 Empirics: bank-firm relations ................................................................................65
1. Indicators of bank-firm relationship strength ....................................................................... 65
2. Impact of bank-firm relationships on firms .......................................................................... 68
3. Relationship banking and firms’ credit constraints ............................................................... 69
3.1 When Arm’s Length is Too Far. Relationship Banking over the Credit Cycle ..........................................69
Part 5 theory: individual bank runs and systemic risk.......................................................80
1. Individual bank runs ........................................................................................................... 81
1.1 Diamond-dybvig (1983) - model and variants .........................................................................................81
1.2 Runs .........................................................................................................................................................86
1.3 Anti-run policies ......................................................................................................................................87
2. Systemic Risk ...................................................................................................................... 87
3. Banking competition and stability ....................................................................................... 88
3.1 “Charter value hypothesis” (Traditional competition-fragility view)......................................................88
2
, 3.2 The optimal contracting hypothesis (competition stability view) ..........................................................88
Part 5 Empricis: individual bank runs and systematic risk.................................................89
Goals ..............................................................................................................................................................89
1. Introduction of topic ........................................................................................................... 89
1.1 Individual bank runs versus systemic risk................................................................................................90
1.2 Recent crisis: Laeven and Valencia (2018) IMF wp..................................................................................90
2. Evidence............................................................................................................................. 93
2.1 Determinants of banking crisis: banking competition and stability ........................................................93
2.2 Implications of banking crises .................................................................................................................95
2.3 Regulation and banking crisis ..................................................................................................................98
3. Liquidity risks ..................................................................................................................... 99
3.1 Kashyap, Rajan and Stein: Banks as liquidity providers: an explanation for the coexistence of lending
and deposit-taking .........................................................................................................................................99
3.2 Gatev, Schuermann and Strahan: Managing bank liquidity risk: How deposit-loan synergies vary with
market conditions .......................................................................................................................................101
3.3 Ippolito et al.: Double bank runs and liquidity risk management .........................................................102
Part 6 theory Banking Regulation: Micro-prudential and macro-prudential ................... 106
Objectives ....................................................................................................................................................106
1. Regulation of banks .......................................................................................................... 106
1.1 general setting..............................................................................................................................107
1.2 bank fragility ..........................................................................................................................................107
1.3 depositor protection and customer confidence ...................................................................................107
1.4 cost of bank failures ..............................................................................................................................108
2. Macro-prudential regulation ............................................................................................. 108
2.1 definition ...............................................................................................................................................108
2.2 Why macro-prudential regulation? .......................................................................................................109
2.3 Interaction with other policies and international dimensions .............................................................111
2.4 Macroprudential toolkit ........................................................................................................................112
Part 6 emperics: macro-prudential regulation ............................................................... 115
Lim et al. (2011) “Macroprudential Policy: What Instruments and How Are They Used? Lessons
from Country Experiences” ................................................................................................... 115
3
, CREDIT AND BANKING
PART 1 THEORY: WHY DO BANKS EXIST? ARE BANKS SPECIAL?
Goal:
- Aim to understand who benefits from borrowing from a bank
o Bank as a monitor – Bank as an advisor
- Aim to understand why impacts of banking crises may persist for a long time =debt overhang
1. WHAT DO BANKS DO? WHAT IS SPECIAL ABOUT BANKS ?
1.1 DEFINITION
Definition of a bank: an institution whose current operations consists in granting loans and receiving
deposits from the public
- Current <-> trade credit (delay of payment) granted by other firms
- Loans and deposits: fragility of banks
o All depositors may need liquidity at same time
E.g., the Belgian Government Savings Certificates led to a decrease in savings
account
o Lines of credit may be drawn at same time due to e.g., shock in economy
o If both sides withdraw at the same time: double bank run
- Public: justification for regulation
o Because banks provide unique services: liquidity and means of payment
o And small depositors are not armed to assess safety and soundness of banks =
consumers cannot protect themselves and do not know better
1.2 THE FUNCTIONS/ROLE OF BANKS
Liquidity and payment services
- “Money” exists as it reduces transaction costs
- People accept money as they expect to be able to use it again at a later stage
Role of banks in payment systems
- Often a loss-leader
= Component of a bank's operations that may not be highly profitable on its own, but is
there to attract clients
- New threats: Facebook, Apple (digital wallets), Fintech, cryptocurrencies,…
➔ These new players often leverage innovative technologies to provide payment services
more efficiently or at lower costs and they are able to gather a lot of information about their
users
- Info obtained through checking account helps in monitoring firms (e.g., Renault and Mester)
or Norden and Weber
Transforming assets
- Size transformation: deposits are typically small amounts whereas loans are large amounts
4
