The Economics of Banking

Description

The Economics of Banking provides an accessible overview of banking theory and practice. It introduces readers to the building blocks of fundamental theories and provides guidance on state-of-the-art research, reflecting the dramatic changes in the banking industry and banking research over the past two decades. This textbook explores market failure and financial frictions that motivate the role of financial intermediaries, explains the microeconomic incentives and behavior of participants in banking, examines microlevel market stress caused by economic recessions and financial crises, and looks at the role of monetary authorities and banking regulators to reduce systemic fragility as well as to improve macroeconomic stability. It delivers broad coverage of both the micro and macroeconomics of banking, central banking and banking regulation, striking a fine balance between rigorous theoretical foundations, sound empirical evidence for banking theories at work, and practical knowledge for banking and policymaking in the real world. The Economics of Banking is suitable for advanced undergraduate, master’s, or early PhD students of economics and finance, and will also be valuable reading for bankers and banking regulators. Cover Half Title Title Page Copyright Page Contents in Brief Table of Contents List of figures Preface Acknowledgments Acronyms PART I: INTRODUCTION CHAPTER 1 INTRODUCTION 1.1 What are banks and why are they special? 1.2 Structure of this book 1.3 Exercises PART II: THE MICROECONOMICS OF BANKING CHAPTER 2 FRAGILE BANKS 2.1 Introduction 2.2 Bank liquidity creation and bank run 2.2.1 Liquidity preferences and the need for liquidity insurance 2.2.2 Baseline result: the planner’s solution 2.2.3 Resource allocation in a decentralized economy 2.2.4 Bank run: fundamental-driven versus panic-driven 2.2.5 Fragile banks and policy implications 2.2.6 Equilibrium refinement and equilibrium selection 2.2.7 Summary 2.3 Optimal bank run 2.3.1 Modelling aggregate asset return risks 2.3.2 Optimal risk-sharing with zero liquidation cost 2.3.3 Optimal risk-sharing with positive liquidation cost 2.3.4 Summary 2.4 Fragility and bank liquidity 2.4.1 Model setup: the need for fragility 2.4.2 Constrained efficiency 2.4.3 Market liquidity and funding liquidity 2.4.4 Summary 2.5 Empirical evidence: drivers of bank runs and policy responses 2.6 Exercises CHAPTER 3 INFORMATION FRICTIONS IN BANKING 3.1 Introduction 3.2 Bank as delegated monitor 3.2.1 Asymmetric information and monitoring 3.2.2 Costly monitoring under direct lending 3.2.3 Bank and delegated monitoring 3.2.4 Summary 3.3 Monitoring and Capital 3.3.1 Model setup 3.3.2 Direct lending 3.3.3 Banking solution 3.3.4 Summary 3.4 Credit rationing 3.4.1 Model setup 3.4.2 Credit rationing in market equilibrium 3.4.3 Adverse selection and lending efficiency 3.4.4 Summary 3.5 Positive selection and excess lending 3.5.1 Market equilibrium under positive selection 3.5.2 Positive selection and excess lending 3.5.3 Summary 3.6 Empirical evidence 3.6.1 Relationship banking 3.6.2 Credit rationing 3.7 Exercises CHAPTER 4 INDUSTRIAL ORGANIZATION OF BANKING 4.1 Introduction 4.2 Price setting of competitive banks 4.3 Competition and stability: a static choice 4.3.1 Franchise value hypothesis 4.3.2 Moral hazard hypothesis 4.3.3 Summary 4.4 Competition and stability: a dynamic choice 4.4.1 Risk-taking as dynamic decision-making 4.4.2 Risk-taking: short-run gain versus long-run loss 4.4.3 Policy implication 4.5 Market entry under asymmetric information 4.5.1 Credit market with imperfect screening 4.5.2 Competition and market outcome 4.5.3 Winner’s curse on market entry 4.6 Empirical evidence 4.6.1 Measuring the intensity of competition 4.6.2 Identifying the competition effects on bank behavior 4.6.3 Real effects of banking competition 4.7 Exercises CHAPTER 5 SECURITIZED BANKING 5.1 Introduction 5.1.1 Risk appetite and securitization 5.1.2 Procedure of securitization 5.1.3 Repo and securitized banking 5.2 Loan sale and screening 5.2.1 Modelling loan sale and screening effort 5.2.2 Inefficient screening with loan sales 5.2.3 Summary 5.3 Securitized banking and financial instability 5.3.1 Originate-to-distribute and repo 5.3.2 Market equilibrium 5.3.3 Summary 5.4 Repo runs 5.4.1 Modelling dynamic collateralized lending 5.4.2 Non-run equilibrium 5.4.3 Run on the repos 5.4.4 Summary 5.5 Empirical evidence 5.5.1 Does securitization encourage banks’ risk-taking? 5.5.2 Securitization and bank performance 5.5.3 International evidence 5.6 Exercises CHAPTER 6 COMPLEXITY IN BANKING 6.1 Introduction 6.1.1 Organizational complexity 6.1.2 Complexity in products 6.1.3 Network complexity 6.1.4 Opacity 6.2 Strategic complexity in product 6.2.1 Model setup: agents, preferences, and technologies 6.2.2 Market power and product complexity 6.2.3 Summary 6.3 Network complexity 6.3.1 Banking network as a web of claims 6.3.2 Risk sharing through financial networks 6.3.3 Contagion over banking network 6.3.4 Summary 6.4 Opacity and banking 6.4.1 Model setup: agents, preferences, and technologies 6.4.2 Market funding, bank funding, and the role of opacity 6.4.3 Summary 6.5 Empirical evidence 6.5.1 Interbank network and contagion 6.5.2 Opacity measures and bank risk 6.6 Exercises PART III: THE MACROECONOMICS AND POLITICAL ECONOMY OF BANKING CHAPTER 7 CENTRAL BANKING 7.1 Introduction 7.2 Central banking in practice 7.2.1 Quantity tools and price tools 7.2.2 Conducting monetary policy in normal times 7.2.3 Conducting monetary policy in financial crises 7.3 Monetary policy, liquidity management, and bank lending 7.3.1 Bank lending and liquidity risk exposure 7.3.2 Liquidity management and bank lending channel 7.3.3 Summary 7.4 Monetary policy, maturity transformation, and liquidity risks 7.4.1 Maturity transformation in a monetary economy 7.4.2 Central banking and excess liquidity risk 7.4.3 Summary 7.5 Risk-taking channels of monetary policy 7.5.1 Modelling banks’ risk-shifting incentives 7.5.2 Risk-taking channels 7.5.3 Summary 7.6 Empirical Evidence 7.6.1 Identifying bank lending channel 7.6.2 Risk-taking channel of monetary policy 7.6.3 Bank lending under unconventional monetary policy 7.7 Exercises CHAPTER 8 THE BANKING-MACRO LINKAGES 8.1 Introduction 8.2 Costly state verification and the financial accelerator 8.2.1 Lending under costly state verification 8.2.2 Market equilibrium with no asymmetric information 8.2.3 Market equilibrium with asymmetric information 8.2.4 Summary 8.3 Moral hazard and bank lending 8.3.1 Aggregate deposit supply without financial friction 8.3.2 Aggregate deposit demand under financial friction 8.3.3 Summary 8.4 Overborrowing and excess volatility 8.4.1 Collateralized lending and borrowing constraint 8.4.2 Binding borrowing constraint and excess volatility 8.4.3 Summary 8.5 Risk management and the leverage cycle 8.5.1 Market equilibrium and asset price 8.5.2 VaR, asset price, and the leverage cycle 8.5.3 Summary 8.6 General equilibrium effect and the leverage cycle 8.6.1 Agents, time preferences, and technology 8.6.2 Market equilibrium without borrowing 8.6.3 Market equilibrium with borrowing 8.6.4 The business cycle and the leverage cycle 8.6.5 Summary 8.7 Exercises CHAPTER 9 INTERNATIONAL BANKING 9.1 Introduction 9.1.1 The ownership dimension of international banking 9.1.2 The location dimension of international banking 9.1.3 The currency dimension of international banking 9.2 International financial market and global risk-sharing: traditional view 9.2.1 Global risk-sharing in an endowment economy 9.2.2 Global risk-sharing in a production economy 9.2.3 Summary 9.3 Global banks and international transmission of monetary policy 9.3.1 Model setup: global bank and global balance sheet 9.3.2 International transmission of monetary policy through global banks 9.3.3 Summary 9.4 Empirical evidence 9.4.1 International banking and transmission of monetary policy 9.4.2 International risk-taking channel 9.5 Exercises CHAPTER 10 POLITICAL ECONOMY IN BANKING 10.1 Introduction 10.2 Government ownership and banking outcomes 10.2.1 Government ownership and banking: main hypotheses 10.2.2 Modelling government ownership and control rights 10.2.3 Political economy equilibrium 10.2.4 Summary 10.3 Political credit cycle 10.3.1 Reelection and credit supply to voters 10.3.2 Credit supply over election cycles 10.3.3 Summary 10.4 Empirical evidence 10.4.1 Government ownership and banking outcomes 10.4.2 Legal systems and banking 10.4.3 Political ties and banking outcomes 10.4.4 Political credit cycles 10.4.5 Moral suasion and home bias 10.4.6 Political economy and allocation efficiency 10.5 Exercises PART IV: THE ECONOMICS OF BANKING REGULATION CHAPTER 11 SYSTEMIC RISKS AND MACROPRUDENTIAL REGULATION 11.1 Introduction 11.1.1 Why is banking regulation special? 11.1.2 Bank-specific versus systemic risks 11.2 Maturity rat race and excess maturity mismatch 11.2.1 Maturity structure of debt contracts 11.2.2 Debt rollover and maturity rat race 11.2.3 Summary 11.3 Inefficient liquidity buffer and sellers’ strike 11.3.1 Model setup 11.3.2 Market equilibrium 11.3.3 Summary 11.4 Contagion in interbank market 11.4.1 Idiosyncratic liquidity shocks and interbank market 11.4.2 Equilibrium outcomes in the interbank market 11.4.3 Contagion through interbank market 11.4.4 Summary 11.5 Macroprudential versus microprudential perspectives 11.6 Empirical evidence: measuring systemic risks 11.6.1 CoVaR 11.6.2 Systemic expected shortfall 11.6.3 SRISK 11.7 Exercises CHAPTER 12 BANKING REGULATION IN PRACTICE 12.1 Introduction: banking regulation in principles 12.2 Liquidity regulation 12.2.1 Idiosyncratic and systemic liquidity risks 12.2.2 Lender-of-last-resort policy 12.2.3 Requirements on market liquidity and funding liquidity 12.2.4 Liquidity regulation and monetary policy implementation: a conceptual assessment 12.3 Capital regulation 12.3.1 Bank capital and resilience 12.3.2 Countercyclical capital requirement 12.3.3 Capital requirement and risk-taking: a conceptual assessment 12.3.4 Empirical evidence 12.4 Other issues 12.4.1 Interaction between banking regulation and monetary policy 12.4.2 Bail-in 12.5 Exercises PART V: APPENDIX SOLUTIONS TO SELECTED EXERCISES Bibliography Index