Banks' Capital, Securitization and Credit Risk: An Empirical Evidence for Canada
TL;DR: In this article, the authors investigated the relationship between banks' capital, securitization and risk in the context of the rapid growth of off-balance-sheet activities in the Canadian financial sector.
Abstract: This paper is the first attempt that empirically investigates the relationship between banks capital, securitization and risk in the context of the rapid growth of off-balance-sheet activities in the Canadian financial sector. The evidence over the 1988-1998 period indicates that a) securitization has negative effects on both Tier 1 and Total risk-based capital ratios, and b) there exists a positive statistical link between securitization and banks' risk. These results seem to accord with Kim and Santomero (1988) who concluded that banks might be induced to shift to more risky assets under the current capital requirements for credit risk.
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TL;DR: In this article, the authors use a database of securitisation activity and a large sample of European banks and find that the use of Securitization shelters banks' loan supply from the effects of monetary policy.
330 citations
TL;DR: This paper investigated the exante determinants of bank loan securitization by using different econometric methods on Italian individual bank data from 2000 to 2006 and found that banks that are less capitalized, less profitable, less liquid, and burdened with troubled loans are more likely to perform secURITization, for a larger amount and earlier.
Abstract: This paper investigates the ex-ante determinants of bank loan securitization by using different econometric methods on Italian individual bank data from 2000 to 2006. Our results show that bank loan securitization is a composite decision. Banks that are less capitalized, less profitable, less liquid and burdened with troubled loans are more likely to perform securitization, for a larger amount and earlier.
291 citations
Additional excerpts
...…items (Hall, 1993; Berger and Udell, 1994; Kim and Moreno, 1994; Hancock, Laing and Wilcox, 1995; Shrieves and Dahl, 1992; Thakor, 1996; Jacques and Nigro, 1997; Aggarwal and Jacques, 1998; Jackson et al., 1999; Rime, 2001; Aggarwal and Jacques, 2001; Dionne and Harchaoui, 2003; VanHoose, 2007)....
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TL;DR: In this article, the authors hypothesize and provide evidence that certain general characteristics of banks' loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans.
Abstract: We hypothesize and provide evidence that certain general characteristics of banks' loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans. We show that banks retain more risk when: (1) the types of loans have higher and/or less externally verifiable credit risk (specifically, commercial loans more than consumer loans more than mortgages), so banks must retain larger contractual or noncontractual first-loss interests in the loans; (2) the loans are closed-ended and banks retain larger contractual interests in the loans; and (3) the loans are closed-ended and banks retain types of contractual interests that more strongly concentrate the risk of the securitized loans (specifically, credit-enhancing interest-only strips more than other subordinated asset-backed securities). We also show that the magnitude and type of retained contractual interests are not risk-relevant in revolving loan securitizations, because banks have more incentive and ability to provide implicit recourse, a noncontractual interest. We infer that banks retain more of the risk of their securitized loans when their total equity risk as measured by future stock return volatility is more positively associated with the off-balance sheet securitized loans and the on-balance sheet contractual retained interests in those loans, all else being equal.
108 citations
TL;DR: This paper used data from 2001-2007 to assess the impact of mortgage and other forms of asset securitization on insolvency risk, profitability, and leverage ratios of US bank holding companies.
Abstract: We use data from 2001-2007 to assess the impact of mortgage and other forms of asset securitization on the insolvency risk, profitability, and leverage ratios of US bank holding companies. Using 3 different estimation techniques, we find that banks use mortgage securitization to reduce insolvency risk and increase leverage. We also find that securitization techniques increase bank profitability. Our results suggest that securitization techniques have played a positive role. This suggests that the current turmoil in mortgage credit and securitization markets is related to recent excesses in those markets, and that securitization activity will resume after those excesses are cleared up.
103 citations
TL;DR: In this paper, the authors compare the characteristics between banks that securitize and banks that do not and provide evidence of the capital arbitrage theory of Securitization, concluding that bank size is a significant determinant of whether a bank securitizes.
Abstract: Purpose – This paper aims to offer a comprehensive comparison of the characteristics between banks that securitize and banks that do not and to provide evidence of the capital arbitrage theory of securitization.Design/methodology/approach – First, the fundamental financial similarities and differences between banks that securitize assets and banks that do not participate in the securitization market are tested. Second, variables that help predict whether a bank securitizes assets are analyzed. Third, the determinants of securitization extent in banks that securitize assets are investigated – for general securitization extent and for specific type of asset securitized. Using a sample of 112 banks that securitize different assets, a matched sample of banks that do not securitize based on entity type and size is created. A quarterly panel data set of these banks dating back to 2001 is used.Findings – The results indicate that bank size is a significant determinant of whether a bank securitizes. Further, over...
101 citations
References
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TL;DR: In this paper, the role of bank capital regulation in risk control is investigated using the mean-variance model, and it is shown that the use of simple capital ratios in regulation is an ineffective means to bound the insolvency risk of banks.
Abstract: This paper investigates the role of bank capital regulation in risk control. It is known that banks choose portfolios of higher risk because of inefficiently priced deposit insurance. Bank capital regulation is a way to redress this bias toward risk. Utilizing the mean-variance model, the following results are shown: (a) the use of simple capital ratios in regulation is an ineffective means to bound the insolvency risk of banks; (b) as a solution to problems of the capital ratio regulation, the "theoretically correct" risk weights under the risk-based capital plan are explicitly derived; and (c) the "theoretically correct" risk weights are restrictions on asset composition, which alters the optimal portfolio choice of banking firms. THE RECENT INCREASE in bank failures, especially after the 1980 and 1982 Deregulatory Acts, has again ignited a controversy over the risk portfolio of the banking industry. Given the importance of this sector, there has been increased scrutiny of the industry's motives for risk taking and possible regulatory changes to improve its stability. These investigations have centered around two rather complementary areas. The first of these is the role of deposit insurance and how its current pricing procedure encourages risk taking and justifies current bank regulations. The works of Buser, Chen, and Kane [4], Kane [9], and Benston et al. [2] have made substantive contributions. The authors demonstrates the way in which our current fixed-rate insurance system rewards risk taking by the firm and insulates it through deposit insurance from the market discipline that needs to exist to ensure proper risk evaluation. This realization has led these authors to propose a series of regulatory changes to encourage proper portfolio choice within the industry. These include a shift to, market value accounting, risk-based deposit insurance premiums, and additional capital regulation. The last of these serves as a method of coinsurance whereby higher capital levels require the bank to absorb greater losses in the event of failure and encourage additional prudence in management. In essense it is one method of risk reduction that may offset the risk preference imposed on the industry due to the inappropriate insurance pricing. Because the amount of capital influences the probability of bank insolvency and thus the soundness of the entire banking system, the regulators, ceteris paribus, prefer more capital to
1,087 citations
"Banks' Capital, Securitization and ..." refers background or result in this paper
...Kim and Santomero (1988) show formally how a bank maximizing mean-variance preferences and facing uniform proportional capital requirements may substitute toward higher risky assets....
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...These results seem to accord with Kim and Santomero (1988) who concluded that banks might be induced to shift to more risky assets under the current capital requirements for credit risk....
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...…may react to capital requirements by complying with minimum solvency requirements by reducing the size of its risky portfolio (size effect) or by refusing to reduce (and maybe even increasing) the riskiness of the bank by choosing riskier projects (reshuffling effect) (Kim and Santomero, 1988)....
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...Depending on its shareholders’ risk/return appetite, the bank may react to capital requirements by complying with minimum solvency requirements by reducing the size of its risky portfolio (size effect) or by refusing to reduce (and maybe even increasing) the riskiness of the bank by choosing riskier projects (reshuffling effect) (Kim and Santomero, 1988)....
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TL;DR: In this article, the authors examine the effect of portfolio reaction to capital requirements by investigating the impact of capital ratio regulation on the portfolio behavior of commercial banks and conclude that the results of a higher required capital-asset ratio in terms of the average probability of failure are ambiguous, while the intra-industry dispersion of the probability for failure unambiguously increases.
Abstract: regulating bank capital, however, is a detailed consideration of the impact of such regulation on individual bank behavior and whether the regulation actually achieves its desired result.' Typically regulation is assumed to function in an essentially ceteris paribus environment, whereby the mere addition of capital to the bank's balance sheet reduces risk. The purpose of this paper is to examine explicitly the issue of portfolio reaction to capital requirements by investigating the effect of capital ratio regulation on the portfolio behavior of commercial banks.2 Implicit in the analysis is the view that bank regulators presently do not constrain portfolio risk so as to prevent such asset reshuffling. Given the lack of objective standards or guidelines on asset portfolio risk, this approach seems more appropriate than to assume no asset portfolio response. This paper examines the portfolio allocation that flows from the portfolio decision of the firm. Next it examines the effects on bank portfolio risk of a regulatory increase in the minimum capital asset ratio that is acceptable to the supervisory agency. For the system as a whole, the results of a higher required capital-asset ratio in terms of the average probability of failure are ambiguous,3 while the intra-industry dispersion of the probability of failure unambiguously increases. This result leads us to question the viability of regulating commercial banks in terms of a capital requirement. Thus, serious consideration should be given to the discontinuance of regulation of bank capital via ratio constraints. Alternatively, regulation should be imposed on both asset composition and capital in a way that has heretofore not been considered.
1,027 citations
TL;DR: In this paper, the authors investigated the relationship between changes in risk and capital in a large sample of banks and found that changes in bank capital over the period studied have been risk-based.
Abstract: This study investigates the relationship between changes in risk and capital in a large sample of banks. A positive association between changes in risk and capital is found. The fact that this finding holds in banks with capital ratios in excess of regulatory minimum levels supports the conclusion that, for most banks, bank owners' and/or managers' private incentives work to limit total risk exposure. Results for banks which were undercapitalized by regulatory standards indicate that regulation was at least partially effective during the period covered. Overall, the findings support a conclusion that changes in bank capital over the period studied have been ‘risk-based’.
811 citations
"Banks' Capital, Securitization and ..." refers background in this paper
...See, for example, Shrieves and Dahl (1992), Haubrich and Wachtel (1993), Jacques and Nigro (1997), and Aggarwal and Jacques (2001)....
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...In recent years, a number of studies, including those of Shrieves and Dahl (1992) and Aggarwal and Jacques (2001), have modeled the response of banks to regulatory capital standards by using simultaneous equation models that allow bank-risk levels to be influenced both directly and indirectly by…...
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TL;DR: In this paper, the consequences of capital regulations on the portfolio choices of commercial banks are investigated. But the authors focus on the risk-based insurance premia and do not consider the effect of the risk on the investment decisions of the banks.
690 citations
"Banks' Capital, Securitization and ..." refers background in this paper
...Theoretical contributions by Keeley and Furlong (1989, 1990) and Rochet (1992) obtain, however, that such substitution effects are sensitive to assumptions about banks’ objective functions and to whether or not asset markets are complete....
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...In recent years, a number of studies, including those of Shrieves and Dahl (1992) and Aggarwal and Jacques (2001), have modeled the response of banks to regulatory capital standards by using simultaneous equation models that allow bank-risk levels to be influenced both directly and indirectly by regulatory capital requirements....
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...In a perfect-information scenario, market discipline would ensure that a bank engaging in riskier behavior would have to compensate its stockholders and depositors with a higher rate of return (Rochet, 1992)....
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TL;DR: In this paper, the authors examined the impact of risk-based capital requirements on aggregate bank lending and showed that increasing the money supply can either raise or lower lending when capital requirements are linked only to credit risk.
Abstract: Capital requirements linked solely to credit risk are shown to increase equilibrium credit rationing and lower aggregate lending. The model predicts that the bank's decision to lend will cause an abnormal runup in the borrower's stock price and that this reaction will be greater the more capital-constrained the bank. I provide empirical support for this prediction. The model explains the recent inability of the Federal Reserve to stimulate bank lending by increasing the money supply. I show that increasing the money supply can either raise or lower lending when capital requirements are linked only to credit risk. THE MOTIVATION OF THIS article is first to examine the impact of "risk-based" capital requirements-namely those that link mandatory capital-to-asset ratios for banks to their loans- on aggregate bank lending. These requirements, called the Basle capital rules (or BIS guidelines), went into effect in March 1989 for banks in the leading industrialized nations. These rules initially required banks to maintain capital equal to 7.25 percent of business and most consumer loans, with the requirement increasing to 8 percent by the end of 1992. Secondly, I wish to understand the link between monetary policy and aggregate bank credit in the presence of risk-based capital requirements. My curiosity is sparked in part by two recent phenomena. One is the experience of the U.S. economy, which displayed sluggish growth during 1989-93 despite a monetary policy that attempted to spur bank lending and economic activity.' And the other is the striking decline in loans relative to security holdings (mostly government bonds) in the asset portfolios of U.S.
616 citations
"Banks' Capital, Securitization and ..." refers background in this paper
...While papers such as those by Hall (1993), Haubrich and Wachtel (1993), and by Calem and Rob (1996), and Thakor (1996) made a persuasive case for the role played by capital requirements in this switch, this conclusion has been challenged....
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