Each depositor insured to at least $250,000 per insured bank

Working Paper Series:    2012     2011     2010     2009     2008     2007     2006     2005     2004    

Financial Stability and Basel II - PDF 148k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-10
Paul H. Kupiec
September 2006

Abstract


The Basel II Advanced Internal Ratings (AIRB) approach is compared to capital requirements set using an equilibrium structural credit risk model. Analysis shows the AIRB approach undercapitalizes credit risk relative to regulatory targets and allows wide variation in capital requirements for a given exposure owing to ambiguity in the definitions of loss given default and exposure at default. In contrast, the Foundation Internal Ratings Based (FIRB) approach may over-capitalize credit risk relative to supervisory objectives. It is unclear how Basel II will buttress financial sector stability as it specifies the weakest risk regulatory capital standard for large complex AIRB banks.

Key Words: credit risk measurement, credit risk capital allocation, Basel II

JEL Classification: G12, G20, G21, G28

On the Market Discipline of Informationally-Opaque Firms: Evidence from Bank Borrowers in the Federal Funds Market - PDF 1023k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-09
Adam B. Ashcraft
Hoyt Bleakley
September 2006

Abstract


Using plausibly exogenous variation in demand for federal funds created by daily shocks to reserve balances, we identify the supply curve facing a bank borrower in the inter-bank market, and study how access to overnight credit is affected by changes in public and private measures of borrower creditworthiness. While there is evidence that lenders respond to adverse changes in public information about credit quality by restricting access to the market in a fashion consistent with market discipline, there is also evidence that borrowers are able to respond to adverse changes in private information about credit quality by increasing leverage as if to offset the future impact on earnings. While the responsiveness of investors to public information is comforting, we document evidence which suggests that banks are able to manage the real information content of these disclosures. In particular, public measures of loan portfolio performance have information about future loan charge-offs, but only in quarters when the bank is examined by supervisors. However, the loan supply curve is not any more sensitive to public disclosures about non-performing loans in an exam quarter, suggesting that investors are unaware of this information management.

Key words: Earnings management, market discipline, opaqueness

JEL Classification: G14, G18, G21

Capital Allocation for Portfolio Credit Risk - PDF 805k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-08 (revision of CFRWP 2005-04)
Paul Kupiec
August 2006

Abstract


Capital allocation rules are derived that maximize leverage while maintaining a target solvency rate for credit portfolios where risk is driven by a single common factor and idiosyncratic risk is fully diversified. Equilibrium conditions ensure that capital allocations depend on interest earnings as well as credits’ probability of default, endogenous loss given default, and asset correlation. Capitalization rates exceed those estimated using Gaussian credit loss models. Results demonstrate that credit risk is undercapitalized by the Basel II AIRB approach in part because of ambiguities regarding the definition of loss given default. An alternative proposed capital rule removes this bias.

Key words: economic capital, credit risk internal models, Basel II Internal Ratings Approach

JEL Classification: G12, G20, G21, G28

Did the Introduction of Fixed-Rate Federal Deposit Insurance Increase Bank Risk? - PDF 728k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-07
Gayle DeLong, Anthony Saunders
August 2006

Abstract
We investigate whether the introduction of fixed-price U.S. federal deposit insurance increased the risk-taking of banks. We examine 70 financial institutions and find that banks in general became more risky after the introduction of deposit insurance. However, a subset of well-performing banks reduced their risk. Deposit insurance helped to bring about stability in that depositors did not discriminate between weaker and stronger banks. Although investors did not see deposit insurance as a net subsidy to the banking industry, investors believed deposit insurance would allow smaller banks to compete better against bigger banks. While deposit insurance allowed greater risk-taking among some banks, it also brought more stability and competition within the banking industry.

Keywords: Government Policy and Regulation; Banks; Deposit Insurance

JEL Classification: G18 and G21

Understanding the Role of Recovery in Default Risk Models:Empirical Comparisons and Implied Recovery Rates 842k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-06
Gurdip Bakshi, Dilip Madan, Frank Zhangc
August 2006

Abstract
This article presents a framework for studying the role of recovery on defaultable debt prices (for a wide class of processes describing recovery rates and default probability). These debt models have the ability to differentiate the impact of recovery rates and default probability, and can be employed to infer the market expectation of recovery rates implicit in bond prices. Empirical implementation of these models suggests two central findings. First, the recovery concept that specifies recovery as a fraction of the discounted par value has broader empirical support. Second, parametric debt valuation models can provide a useful assessment of recovery rates embedded in bond prices.

Keywords: Recovery; default risk; defaultable coupon bonds, corporate bond pricing, recovery payout as a fraction of face, recovery as a fraction of pre-default debt values, recovery as a fraction of the present value of face, implied recovery.

JEL Classification: G0, G10, G11, G12, G13, C5.

Multi-Period Corporate Default Prediction With Stochastic Covariates - PDF 970k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-05
Darrell Duffie, Leandro Saita, and Ke Wang
September 2005

Abstract
We provide maximum likelihood estimators of term structures of conditional probabilities of corporate default, incorporating the dynamics of firm-specific and macroeconomic covariates. For U.S. Industrial firms, based on over 390,000 firm-months of data spanning 1980 to 2004, the level and shape of the estimated term structure of conditional future default probabilities depends on a firm’s distance to default (a volatility-adjusted measure of leverage), on the firm’s trailing stock return, on trailing S& P 500 returns, and on U.S. interest rates, among other covariates. Variation in a firm’s distance to default has a substantially greater effect on the term structure of future default hazard rates than does a comparatively significant change in any of the other covariates. Default intensities are estimated to be lower with higher short-term interest rates. The out-of-sample predictive performance of the model is an improvement over that of other available models.

Keywords: default, bankruptcy, duration analysis, doubly stochastic, distance to default

JEL Codes: C41, G33, E44

Borrower-Lender Distance, Credit Scoring, and the Performance of Small Business Loans - PDF 901k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-04
Robert DeYoung, Dennis Glennon, Peter Nigro
March 2006

Abstract
We develop a theoretical model of decision-making under risk and uncertainty in which bank lenders have both imperfect information about loan applications and imperfect ability to make decisions based on that information. We test the loan-default implications of the model for a large random sample of small business loans made by U.S. banks between 1984 and 2001 under the SBA 7(a) loan program. As predicted by our model, both borrower-lender distance and credit-scoring contribute to greater loan defaults; the former finding suggests that distance interferes with information collection and monitoring, while the latter finding implies production efficiencies that encourage credit-scoring lenders to make riskier loans at the margin. However, we also find that credit-scoring dampens the harmful effects of distance, consistent with the conjecture that information generated by credit scoring models improves the ability of lenders to assess and price default risk.

JEL Codes: D81, G21, G28.

Key words: borrower-lender distance, credit scoring, small business loans.

Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary With Market Conditions - PDF 817k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-03
Evan Gatev, Til Schuermann, Philip E. Strahan
December 2005

Abstract
Unused loan commitments expose banks to systematic liquidity risk, but this exposure can be reduced by combining loan commitments with transactions deposits. We show that bank equity volatility increases with unused loan commitments, but this increase is reduced for banks with high levels of transaction deposits. This deposit-lending synergy becomes even more powerful during periods of tight liquidity, when nervous investors move funds into their banks. Thus, the simultaneous taking of deposits and lending may be thought of as a liquidity hedge.

JEL Codes: G18; G21

Key Words: Liquidity; banking; financial crisis.

Interest Rate Risk Management at Commercial Banks: An Empirical Investigation - PDF 366k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-02
Amiyatosh Purnanandam
May 2005

Abstract
I analyze the effects of bank characteristics and macroeconomic shocks on interest rate riskmanagement behavior of commercial banks. My findings are consistent with hedging theories based on cost of financial distress and costly external financing. As compared to the derivative users, the derivative non-user banks adopt conservative asset-liability management policies in tighter monetary policy regimes. Finally, I show that the derivative non-user bank’s lending volume decline significantly with the contraction in the money-supply. Derivative users, on the other hand, remain immune to the monetary policy shocks. My findings suggest that a potential benefit of derivatives usage is to minimize the effect of external shocks on a firm’s operating policies.

JEL Codes: G21, G32, G33 and E5

Keywords: Hedging, Derivatives, Bankruptcy, Credit-Channel.

Bank Lines of Credit in Corporate Finance: An Empirical Analysis - PDF 193k (PDF Help)

FDIC Center for Financial Research Working Paper No. 2006-01
Amir Sufi
December 2005

Abstract
I use novel data collected from annual 10-K SEC filings to examine the role of bank lines of credit in the liquidity management of public corporations. I find that bank lines of credit account for a large share of liquidity only for firms with a historical record of profitability. Firms with low profitability that are unable to obtain a line of credit more heavily use cash in their corporate liquidity management; they hold higher balances of cash and save more cash out of cash flow than firms that are able to obtain a line of credit. Even among firms that obtain lines of credit, banks use financial covenants on profitability to restrict access when firms experience drops in performance. The credit restriction is temporary and firms eventually regain full access to their line of credit.

JEL Codes: G20, G21, G32, G31

Keywords: Bank Debt, Lines of Credit, Revolving Credit Facilities, Flexibility, Leverage, Liquidity, Cash-flow sensitivity of cash.