- Email: [email protected]
The future of universal banking
Journal of Banking & Finance 35 (2011) 765–767
Contents lists available at ScienceDirect
Journal of Banking & Finance journal homepage: www.elsevier.com/locate/jbf
Editorial
The future of universal banking
The Department of Economics of the University of Crete organizes annually since 1997 an international conference on Macroeconomic Analysis and International Finance. The articles included in this special issue are refereed versions of papers presented at the 14th International Conference on Macroeconomic Analysis and International Finance held at the University Campus, Rethymno 27–29 May 2010 and submitted to the JBF in an open call for papers. The central theme of this conference was The Future of Universal Banking. The topics discussed in this issue deal with the issue of monetary divisia and the liquidity puzzle; the new directions in banking in the aftermath of the 2007–2009 financial crisis; the role of foreign banks; and the causes of bank risk-taking and fragility of the financial intermediaries. We begin the Special Issue with an overview of these papers. ‘‘Rethinking the liquidity puzzle: Application of a measure of the economic money stock,’’ Kelly, Barnett and Keating (2011) provides a reconsideration of the potential solutions to the liquidity puzzle. They argue that historically attempts to solve this puzzle have focused on narrowly defined monetary aggregates, such as non-borrowed reserves, the monetary base, or M1. Many of these efforts have failed to find a short-term negative correlation between interest rates and monetary policy innovations. More recent research uses sophisticated macroeconomic and econometric modeling. However, little research has investigated the role measurement error plays in the liquidity puzzle, since in nearly every case, work investigating the liquidity puzzle has used one of the official monetary aggregates, which have been shown to exhibit significant measurement error. In this paper the authors examine the role that measurement error plays in the liquidity puzzle by (i) providing a theoretical framework explaining how the official simple-sum methodology can lead to a liquidity puzzle and (ii) testing for the liquidity effect by estimating an unrestricted VAR. The authors conclude that when measured using a reputable index number, the broadest monetary aggregate exhibits stronger liquidity effects than the more narrow measures and they argue that this is contrary to the current literature. They also find, based on the variance decompositions analysis, that the properlyweighted broader aggregates typically contain more explanatory information than the narrow aggregates about the movements of the FEDF. Demiroglu and James (2011) in ‘‘The use of bank lines of credit in corporate liquidity management: A review of the empirical evidence,’’ provide a detailed review of the empirical evidence on the use of bank lines of credit as a source of corporate liquidity. The traditional explanation for lines of credit is that they provide insurance against liquidity shocks, in much the same as way hoarding 0378-4266/$ - see front matter Ó 2010 Elsevier B.V. All rights reserved. doi:10.1016/j.jbankfin.2010.10.025
cash does. However, recent empirical research suggests that access to lines of credit is contingent on the credit quality of the borrower as well as the financial condition of the lender. These findings suggest that lines of credit are an imperfect substitute for cash as a source of corporate liquidity. In ‘‘Can pure-play internet banking survive the credit crisis?’’ Arnold and van Ewijk (2011) argue that the credit crisis has exposed flaws in the workings of the banking industry. Many banks using the so-called transaction-oriented business model have fallen victim to the simultaneous collapse in market and funding liquidity. In contrast, relationship banks have remained relatively shielded from the turmoil in the financial markets. In this paper the authors consider the pure-play internet banking model (PPI) as a hybrid business model that, on the surface, combines features of both relationship and transaction banking. Although, in terms of customer orientation, PPI banks may partly resemble relationship banks, they lack their comparative advantage in generating borrower-specific information. Instead, the characteristic features of PPI banks are low costs and easy scalability. While the latter may enable PPI banks to quickly capture market share, it may also generate overexposure in risky markets. The analysis provides a case study on ING Direct, one of the leading global PPI banks and addresses the sustainability of the PPI business model by comparing the ING Direct foreign operations. The findings for ING Direct are validated using data for E-Trade Bank. The authors conclude that the managing growth appears to be the prime challenge to PPI banks. In ‘‘Financial Euroization: The role of foreign-owned banks and interest rates’’ Basso, Calvo-Gonzalez and Jurgilas (2011) address the question why in many economies households and firms borrow and make deposits in a foreign currency? They provide an extension of the existing literature, with the development of a framework that allows for interest rate differentials and access to foreign funds to play a role in explaining this process of asset substitution or financial dollarization. The authors use a newly compiled data set on transition economies and employ a standard panel as well as a panel-VAR methodology in their empirical analysis. They find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits. Bernoth and Pick (2011) in ‘‘Forecasting the fragility of the banking and insurance sector’’ argue that linkages between banks and insurance companies are important when forecasting the fragility of the banking and insurance sectors. To study the importance of such relationship they propose a novel empirical
766
Editorial / Journal of Banking & Finance 35 (2011) 765–767
framework that allows one to estimate unobserved linkages in panel data sets that contain observed regressors. They find that taking unobserved common factors into account reduces the root mean square forecasts error of firm specific forecasts by up to 12%, of system forecasts by up to 21%, and by up to 34% for systemic forecasts of more distressed firms relative to a model based on observed variables only. Furthermore, based on the estimates of the factor loadings it is shown that the correlation of financial institutions has been relatively stable over the forecast period. In ‘‘Are foreign banks more profitable than domestic banks? Home- and host- country effects of banking market structure, governance, and supervision,’’ Chen and Liao (2011) empirically investigate whether foreign banks are more profitable than domestic banks. The paper also investigates the impact of banking market structure on bank profitability using structural and static measures of bank competition. In addition, joint home- and host-country effects of banking market structure, macroeconomic condition, governance, and changes in bank supervision on foreign bank margins are identified. The sample uses both bank- and country-level data on banking sectors from 70 countries over the period 1992–2006. The authors find that foreign banks are more profitable than domestic banks when they operate in a host country whose banking sector is less competitive and when the parent bank in the home country is highly profitable. Moreover, when foreign banks operate in a host country with lower growth rates of GDP, higher interest and inflation rates, and more stringent regulatory compliance with Basel risk weights, their margins increase. In contrast, when the parent bank is located in a country that experiences high economic risk, implements restrictive capital requirements, and has less competitive banking market structures, its foreign subsidiary is likely to experience a significant decrease in net interest margin vis-à-vis domestic banks. Specifically, changes in bank supervision of a parent bank’s ownership restrictiveness in the home country significantly increases foreign bank margins, while supervisory changes in regulatory compliance with Basel risk weights in the host country enhances foreign bank margins. Delis and Kouretas (2011) in ‘‘Interest rates and bank risk-taking’’ analyse the argument that the low interest-rate environment of the early to mid 2000s is considered as an element that triggered increased risk-taking appetite of banks in search for yield. This paper uses approximately 18,000 annual observations on euro area banks over the period 2001–2008 and presents strong empirical evidence that low interest rates indeed increase bank risk-taking substantially. This result is robust across a number of different specifications that account, inter alia, for the potential endogeneity of interest rates and/or the dynamics of bank risk. Notably, among the banks of the large euro area countries this effect is less pronounced for French institutions, which held on average a relatively low level of risk assets. Finally, the distributional effects of interest rates on bank risk-taking due to individual bank characteristics reveal that the impact of interest rates on risk assets is diminished for banks with higher equity capital and is amplified for banks with higher off-balance sheet items. Jeon, Olivero and Wu (2011) in ‘‘Do foreign banks increase competition? Evidence from emerging Asian and Latin American banking markets,’’ examine the impact of foreign bank penetration on the competitive structure of domestic banking sectors in host emerging economies. The authors focus their analysis on Asia and Latin America during the period 1997–2008. Using bank-level panel data to identify foreign banks and to estimate measures of banking competition, they provide robust empirical evidence that an increase in foreign bank penetration enhances competition in these host countries’ banking sectors. In addition, they find that this positive penetration–competition link is associated with a spillover effect from foreign banks to their domestic counterparts.
This spillover becomes stronger when more efficient and less risky foreign banks enter into less concentrated host country markets. A final results of the analysis is that the spillover effect is greater when foreign banks enter in the form of ’’e novo penetration’’ than through mergers or acquisitions of domestic banks (‘‘M&A penetration’’). Karmann, Eichler and Maltritz (2011) in ‘‘The term structure of the banking crisis risk in the United States: A market data based compound option approach’’ use a compound option-based structural credit risk model to estimate banking crisis risk for the United States based on market data on bank stocks on a daily frequency. They contribute to the relevant literature by providing separate information on short-term, long-term and total crisis risk instead of a single-maturity risk measure usually inferred by Merton-type models or barrier models. The estimation of the model is conducted by the application of the appropriate maximum likelihood approach. The main finding of the empirical analysis is that strongly increasing total crisis risk estimated from early July 2007 onwards is driven mainly by short-term crisis risk. Banks that defaulted or were overtaken during the crisis have a considerably higher crisis risk (especially higher long-term risk) than banks that survived the crisis. The final paper ‘‘Towards a more accurate measure of foreign entry and its impact on domestic banking performance: a case of China’’ by Xu (2011) investigates the issue on the measurement of impact of foreign bank entry in a host country lies in the measurement of foreign bank presence. Conventional measures are aggregate measures that fail to capture micro-level foreign presence in a host country. Moreover, in an empirical setting where bank data are used, it is difficult to separate their effects from those of macroeconomic variables, resulting in unreliable estimates. To overcome the weaknesses of these aggregate measures, the author contructs a spatially disaggregated measure of foreign presence for local Chinese banks, employing location data on foreign bank branches. Using these new measures, the paper reexamines the relationship between foreign presence and banking performance in China. The estimation results show that the spatially disaggregated measures not only improve the measurement of foreign bank presence but are also vital in resolving the unexplained discrepancies found in existing empirical studies contingent on aggregate measures. Importantly, the study provides strong empirical evidence that foreign entry is supportive of a more competitive and efficient banking industry in China. Acknowledgements The authors thank the discussants, referees and all participants at the Conference whose comments have improved substantially the papers presented in this issue. We are also grateful to the University of Crete, Bank of Greece, and EFG Eurobank for their generous financial support. Last but not least we would like to thank Ms. Ioanna Yotopoulou for her superb secretarial assistance as well as Mr. Pericles Drakos and Mr. Kostis Pigounakis for their technical support. References Arnold, I., van Ewijk, S., 2011. Can pure play internet banking survive the credit crisis? Journal of Banking and Finance 35, 783–793. Basso, H.S., Calvo-Gonzalez, O., Jurgilas, M., 2011. Financial Euroization: the role of foreign-owned banks and interest rates. Journal of Banking and Finance 35, 794–806. Bernoth, K., Pick, A., 2011. Forecasting the fragility of the banking and insurance sector. Journal of Banking and Finance 35, 807–818. Chen, S.-H., Liao, C.-C., 2011. Are foreign banks more profitable than domestic banks? Home- and host-country effects of banking market structure, governance, and supervision. Journal of Banking and Finance 35, 819–839.
Editorial / Journal of Banking & Finance 35 (2011) 765–767 Delis, M.D., Kouretas, G.P., 2011. Interest rates and bank risk-taking. Journal of Banking and Finance 35, 840–855. Demiroglu, C., James, C., 2011. The use of bank lines of credit in corporate liquidity management: a review of the empirical evidence. Journal of Banking and Finance 35, 775–782. Jeon, B.N., Olivero, M.P., Wu, J., 2011. Do foreign banks increase competition? Evidence from emerging Asian and Latin American banking markets. Journal of Banking and Finance 35, 856–875. Karmann, A., Eichler, S., Maltritz, D., 2011. The term structure of the banking crisis risk in the United States: a market data based compound option approach. Journal of Banking and Finance 35, 876–885. Kelly, L.J., Barnett, W.A., Keating, J.W., 2011. Rethinking the liquidity puzzle: application of a measure of the economic money stock. Journal of Banking and Finance 35, 768–774. Xu, Y., 2011. Towards a more accurate measure of foreign entry and its impact on domestic banking performance: a case of China. Journal of Banking and Finance 35, 886–901.
767
Georgios P. Kouretas Department of Business Administration, Athens University of Economics and Business, GR-14304 Athens, Greece E-mail address: [email protected] Athanasios P. Papadopoulos Department of Economics, University of Crete, GR-74100 Rethymno, Greece E-mail address: [email protected] Available online 3 November 2010
Contents lists available at ScienceDirect
Journal of Banking & Finance journal homepage: www.elsevier.com/locate/jbf
Editorial
The future of universal banking
The Department of Economics of the University of Crete organizes annually since 1997 an international conference on Macroeconomic Analysis and International Finance. The articles included in this special issue are refereed versions of papers presented at the 14th International Conference on Macroeconomic Analysis and International Finance held at the University Campus, Rethymno 27–29 May 2010 and submitted to the JBF in an open call for papers. The central theme of this conference was The Future of Universal Banking. The topics discussed in this issue deal with the issue of monetary divisia and the liquidity puzzle; the new directions in banking in the aftermath of the 2007–2009 financial crisis; the role of foreign banks; and the causes of bank risk-taking and fragility of the financial intermediaries. We begin the Special Issue with an overview of these papers. ‘‘Rethinking the liquidity puzzle: Application of a measure of the economic money stock,’’ Kelly, Barnett and Keating (2011) provides a reconsideration of the potential solutions to the liquidity puzzle. They argue that historically attempts to solve this puzzle have focused on narrowly defined monetary aggregates, such as non-borrowed reserves, the monetary base, or M1. Many of these efforts have failed to find a short-term negative correlation between interest rates and monetary policy innovations. More recent research uses sophisticated macroeconomic and econometric modeling. However, little research has investigated the role measurement error plays in the liquidity puzzle, since in nearly every case, work investigating the liquidity puzzle has used one of the official monetary aggregates, which have been shown to exhibit significant measurement error. In this paper the authors examine the role that measurement error plays in the liquidity puzzle by (i) providing a theoretical framework explaining how the official simple-sum methodology can lead to a liquidity puzzle and (ii) testing for the liquidity effect by estimating an unrestricted VAR. The authors conclude that when measured using a reputable index number, the broadest monetary aggregate exhibits stronger liquidity effects than the more narrow measures and they argue that this is contrary to the current literature. They also find, based on the variance decompositions analysis, that the properlyweighted broader aggregates typically contain more explanatory information than the narrow aggregates about the movements of the FEDF. Demiroglu and James (2011) in ‘‘The use of bank lines of credit in corporate liquidity management: A review of the empirical evidence,’’ provide a detailed review of the empirical evidence on the use of bank lines of credit as a source of corporate liquidity. The traditional explanation for lines of credit is that they provide insurance against liquidity shocks, in much the same as way hoarding 0378-4266/$ - see front matter Ó 2010 Elsevier B.V. All rights reserved. doi:10.1016/j.jbankfin.2010.10.025
cash does. However, recent empirical research suggests that access to lines of credit is contingent on the credit quality of the borrower as well as the financial condition of the lender. These findings suggest that lines of credit are an imperfect substitute for cash as a source of corporate liquidity. In ‘‘Can pure-play internet banking survive the credit crisis?’’ Arnold and van Ewijk (2011) argue that the credit crisis has exposed flaws in the workings of the banking industry. Many banks using the so-called transaction-oriented business model have fallen victim to the simultaneous collapse in market and funding liquidity. In contrast, relationship banks have remained relatively shielded from the turmoil in the financial markets. In this paper the authors consider the pure-play internet banking model (PPI) as a hybrid business model that, on the surface, combines features of both relationship and transaction banking. Although, in terms of customer orientation, PPI banks may partly resemble relationship banks, they lack their comparative advantage in generating borrower-specific information. Instead, the characteristic features of PPI banks are low costs and easy scalability. While the latter may enable PPI banks to quickly capture market share, it may also generate overexposure in risky markets. The analysis provides a case study on ING Direct, one of the leading global PPI banks and addresses the sustainability of the PPI business model by comparing the ING Direct foreign operations. The findings for ING Direct are validated using data for E-Trade Bank. The authors conclude that the managing growth appears to be the prime challenge to PPI banks. In ‘‘Financial Euroization: The role of foreign-owned banks and interest rates’’ Basso, Calvo-Gonzalez and Jurgilas (2011) address the question why in many economies households and firms borrow and make deposits in a foreign currency? They provide an extension of the existing literature, with the development of a framework that allows for interest rate differentials and access to foreign funds to play a role in explaining this process of asset substitution or financial dollarization. The authors use a newly compiled data set on transition economies and employ a standard panel as well as a panel-VAR methodology in their empirical analysis. They find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits. Bernoth and Pick (2011) in ‘‘Forecasting the fragility of the banking and insurance sector’’ argue that linkages between banks and insurance companies are important when forecasting the fragility of the banking and insurance sectors. To study the importance of such relationship they propose a novel empirical
766
Editorial / Journal of Banking & Finance 35 (2011) 765–767
framework that allows one to estimate unobserved linkages in panel data sets that contain observed regressors. They find that taking unobserved common factors into account reduces the root mean square forecasts error of firm specific forecasts by up to 12%, of system forecasts by up to 21%, and by up to 34% for systemic forecasts of more distressed firms relative to a model based on observed variables only. Furthermore, based on the estimates of the factor loadings it is shown that the correlation of financial institutions has been relatively stable over the forecast period. In ‘‘Are foreign banks more profitable than domestic banks? Home- and host- country effects of banking market structure, governance, and supervision,’’ Chen and Liao (2011) empirically investigate whether foreign banks are more profitable than domestic banks. The paper also investigates the impact of banking market structure on bank profitability using structural and static measures of bank competition. In addition, joint home- and host-country effects of banking market structure, macroeconomic condition, governance, and changes in bank supervision on foreign bank margins are identified. The sample uses both bank- and country-level data on banking sectors from 70 countries over the period 1992–2006. The authors find that foreign banks are more profitable than domestic banks when they operate in a host country whose banking sector is less competitive and when the parent bank in the home country is highly profitable. Moreover, when foreign banks operate in a host country with lower growth rates of GDP, higher interest and inflation rates, and more stringent regulatory compliance with Basel risk weights, their margins increase. In contrast, when the parent bank is located in a country that experiences high economic risk, implements restrictive capital requirements, and has less competitive banking market structures, its foreign subsidiary is likely to experience a significant decrease in net interest margin vis-à-vis domestic banks. Specifically, changes in bank supervision of a parent bank’s ownership restrictiveness in the home country significantly increases foreign bank margins, while supervisory changes in regulatory compliance with Basel risk weights in the host country enhances foreign bank margins. Delis and Kouretas (2011) in ‘‘Interest rates and bank risk-taking’’ analyse the argument that the low interest-rate environment of the early to mid 2000s is considered as an element that triggered increased risk-taking appetite of banks in search for yield. This paper uses approximately 18,000 annual observations on euro area banks over the period 2001–2008 and presents strong empirical evidence that low interest rates indeed increase bank risk-taking substantially. This result is robust across a number of different specifications that account, inter alia, for the potential endogeneity of interest rates and/or the dynamics of bank risk. Notably, among the banks of the large euro area countries this effect is less pronounced for French institutions, which held on average a relatively low level of risk assets. Finally, the distributional effects of interest rates on bank risk-taking due to individual bank characteristics reveal that the impact of interest rates on risk assets is diminished for banks with higher equity capital and is amplified for banks with higher off-balance sheet items. Jeon, Olivero and Wu (2011) in ‘‘Do foreign banks increase competition? Evidence from emerging Asian and Latin American banking markets,’’ examine the impact of foreign bank penetration on the competitive structure of domestic banking sectors in host emerging economies. The authors focus their analysis on Asia and Latin America during the period 1997–2008. Using bank-level panel data to identify foreign banks and to estimate measures of banking competition, they provide robust empirical evidence that an increase in foreign bank penetration enhances competition in these host countries’ banking sectors. In addition, they find that this positive penetration–competition link is associated with a spillover effect from foreign banks to their domestic counterparts.
This spillover becomes stronger when more efficient and less risky foreign banks enter into less concentrated host country markets. A final results of the analysis is that the spillover effect is greater when foreign banks enter in the form of ’’e novo penetration’’ than through mergers or acquisitions of domestic banks (‘‘M&A penetration’’). Karmann, Eichler and Maltritz (2011) in ‘‘The term structure of the banking crisis risk in the United States: A market data based compound option approach’’ use a compound option-based structural credit risk model to estimate banking crisis risk for the United States based on market data on bank stocks on a daily frequency. They contribute to the relevant literature by providing separate information on short-term, long-term and total crisis risk instead of a single-maturity risk measure usually inferred by Merton-type models or barrier models. The estimation of the model is conducted by the application of the appropriate maximum likelihood approach. The main finding of the empirical analysis is that strongly increasing total crisis risk estimated from early July 2007 onwards is driven mainly by short-term crisis risk. Banks that defaulted or were overtaken during the crisis have a considerably higher crisis risk (especially higher long-term risk) than banks that survived the crisis. The final paper ‘‘Towards a more accurate measure of foreign entry and its impact on domestic banking performance: a case of China’’ by Xu (2011) investigates the issue on the measurement of impact of foreign bank entry in a host country lies in the measurement of foreign bank presence. Conventional measures are aggregate measures that fail to capture micro-level foreign presence in a host country. Moreover, in an empirical setting where bank data are used, it is difficult to separate their effects from those of macroeconomic variables, resulting in unreliable estimates. To overcome the weaknesses of these aggregate measures, the author contructs a spatially disaggregated measure of foreign presence for local Chinese banks, employing location data on foreign bank branches. Using these new measures, the paper reexamines the relationship between foreign presence and banking performance in China. The estimation results show that the spatially disaggregated measures not only improve the measurement of foreign bank presence but are also vital in resolving the unexplained discrepancies found in existing empirical studies contingent on aggregate measures. Importantly, the study provides strong empirical evidence that foreign entry is supportive of a more competitive and efficient banking industry in China. Acknowledgements The authors thank the discussants, referees and all participants at the Conference whose comments have improved substantially the papers presented in this issue. We are also grateful to the University of Crete, Bank of Greece, and EFG Eurobank for their generous financial support. Last but not least we would like to thank Ms. Ioanna Yotopoulou for her superb secretarial assistance as well as Mr. Pericles Drakos and Mr. Kostis Pigounakis for their technical support. References Arnold, I., van Ewijk, S., 2011. Can pure play internet banking survive the credit crisis? Journal of Banking and Finance 35, 783–793. Basso, H.S., Calvo-Gonzalez, O., Jurgilas, M., 2011. Financial Euroization: the role of foreign-owned banks and interest rates. Journal of Banking and Finance 35, 794–806. Bernoth, K., Pick, A., 2011. Forecasting the fragility of the banking and insurance sector. Journal of Banking and Finance 35, 807–818. Chen, S.-H., Liao, C.-C., 2011. Are foreign banks more profitable than domestic banks? Home- and host-country effects of banking market structure, governance, and supervision. Journal of Banking and Finance 35, 819–839.
Editorial / Journal of Banking & Finance 35 (2011) 765–767 Delis, M.D., Kouretas, G.P., 2011. Interest rates and bank risk-taking. Journal of Banking and Finance 35, 840–855. Demiroglu, C., James, C., 2011. The use of bank lines of credit in corporate liquidity management: a review of the empirical evidence. Journal of Banking and Finance 35, 775–782. Jeon, B.N., Olivero, M.P., Wu, J., 2011. Do foreign banks increase competition? Evidence from emerging Asian and Latin American banking markets. Journal of Banking and Finance 35, 856–875. Karmann, A., Eichler, S., Maltritz, D., 2011. The term structure of the banking crisis risk in the United States: a market data based compound option approach. Journal of Banking and Finance 35, 876–885. Kelly, L.J., Barnett, W.A., Keating, J.W., 2011. Rethinking the liquidity puzzle: application of a measure of the economic money stock. Journal of Banking and Finance 35, 768–774. Xu, Y., 2011. Towards a more accurate measure of foreign entry and its impact on domestic banking performance: a case of China. Journal of Banking and Finance 35, 886–901.
767
Georgios P. Kouretas Department of Business Administration, Athens University of Economics and Business, GR-14304 Athens, Greece E-mail address: [email protected] Athanasios P. Papadopoulos Department of Economics, University of Crete, GR-74100 Rethymno, Greece E-mail address: [email protected] Available online 3 November 2010