Skip to main content
main-content
Top

About this book

The traditional role of a bank was to transfer funds from savers to investors, engaging in maturity transformation, screening for borrower risk and monitoring for borrower effort in doing so. A typical loan contract was set up along six simple dimensions: the amount, the interest rate, the expected credit risk (determining both the probability of default for the loan and the expected loss given default), the required collateral, the currency, and the lending technology. However, the modern banking industry today has a broad scope, offering a range of sophisticated financial products, a wider geography -- including exposure to countries with various currencies, regulation and monetary policy regimes -- and an increased reliance on financial innovation and technology. These new bank business models have had repercussions on the loan contract. In particular, the main components and risks of a loan contract can now be hedged on the market, by means of interest rate swaps, foreign exchange transactions, credit default swaps and securitization. Securitized loans can often be pledged as collateral, thus facilitating new lending. And the lending technology is evolving from one-to-one meetings between a loan officer and a borrower, at a bank branch, towards potentially disruptive technologies such as peer-to-peer lending, crowd funding or digital wallet services.
This book studies the interaction between traditional and modern banking and the economic benefits and costs of this new financial ecosystem, by relying on recent empirical research in banking and finance and exploring the effects of increased financial sophistication on a particular dimension of the loan contract.

Table of Contents

Frontmatter

Chapter 1. Introduction

Abstract
The traditional role of a bank is to transfer funds from savers to investors, engaging in maturity transformation, screening for borrower risk, and monitoring for borrower effort in doing so. Until not so long ago, a traditional loan contract included as salient dimensions its amount, the interest rate, its expected credit risk, the required collateral, and the currency in which the loan was granted, all “wrapped” up in a singular way of the bank-firm engagement that occurred mainly through the loan officer. However, the scope of the modern banking industry today is much broader, offering a range of sophisticated financial products, a wider geography-including exposure to countries with various currencies, regulation, and monetary policy regimes-and an increased reliance on financial innovation and technology. This book offers a review of how new financial products and technologies have changed the traditional lending contract.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 2. Securitization and Lending

Abstract
In this chapter, we address the impact on the loan amount that the phenomenon of loan securitization has had. Securitization implies that financial intermediaries that grant illiquid loans subsequently pool them together, diversifying risks and converting them into liquid assets or asset-backed securities (ABSs). These assets are then sold to outside investors, in exchange for wholesale funding. A liquid market for securitized assets has recognized benefits for the banking industry, such as improving risk-sharing and reducing banks’ cost of capital. But securitization can also spur risk-taking. We review the theories and estimates put forward in the recent banking literature to quantify these benefits and costs of securitization on the volume and the quality of credit.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 3. Interest Rate Risk

Abstract
We study how modern finance has affected banks interest rate risk management and how the decision hedge interest rate risk affects the transmission of monetary policy, the value of its equity, its lending behaviour, and, hence, the investment decisions of the firms to which they lend. Financial intermediation often exposes banks to interest rate risks by creating mismatches in the maturity structure and repricing terms of their assets and liabilities. Unlike credit risk which a bank can be more or less exposed to but requires credit derivatives to completely remove, it is possible for a bank to completely insulate itself from interest rate risk without trading derivatives. While banks may use interest rate derivatives to manage their interest rate risk exposure, they may also use on-balance sheet techniques, that is, managing the difference in maturity and repricing terms of their assets and liabilities. Before reviewing the literature that focuses on the effects of this decision, we begin with a discussion of the papers that seek to uncover the methods and motives for managing interest rate risk.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 4. Credit Risk

Abstract
These days banks can trade away credit risk (i.e., the risk that the loan amount will not be returned due to borrower financial distress), by using the credit default swaps (CDS) market. In this chapter, we begin by describing credit default swaps and key events in the CDS market. We then study how modern finance has affected banks credit rate risk management through the use of credit default swaps (CDS). Next we discuss the literature that seeks to uncover the externalities of the decision to hedge credit risk using CDS. In particular, we focus on how this affects other credit markets and the CDS references firms, how these referenced firms respond to having CDS traded on their debt, and, finally, how CDS trading affects non-reference firms.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 5. Collateral and Lending

Abstract
In this chapter, we review the different forms of collateral pledged by borrowers’ bank loans and the role of collateral in reducing transaction costs. We start with contributions that study how fluctuations in real estate prices affect economic growth because they change the value of the collateral stock individuals and firms hold. We then review recent evidence on the role that movable and patent collateral play in easing lending frictions. Finally, we discuss the importance of legal frameworks that enforce creditor rights and, in consequence, enhance the use and benefits of pleadgeable assets.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 6. Global Banking

Abstract
In this chapter, we review the literature that seeks to uncover the consequences of the integration of the global banking system. We begin by proving a detailed description of the main concepts in the global banking literature and the different channels through which economic shocks are transmitted. Next, we review how the integration of the banking system affects borrowing constraints, loan rates, and economic output. Further, we review the literature that seeks to uncover why and how banks establish branches and subsidiaries in foreign countries. We then review the literature on the effects of the assets of a local bank’s foreign affiliates on their sensitivity to local funding shocks? We continue by discussing how monetary policy is transmitted across boarders, both inward and outward transmission. Finally, we discuss how global banking interacts with macroprudential policy.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 7. FinTech and the Future of Banking

Abstract
A recent technological wave resulting from both technological advances and increasing bank regulation, known as FinTech, has the potential to revamp bank business models. In this chapter, we review the very recent academic literature that has developed to understand and explain the benefits and the pitfalls of FinTech lending. We analyse the interplay between technology and recent bank regulations in driving the rise of FinTech firms, whether these newcomers act as competitors or complements to traditional bank lending, as well as the liability side of the FinTech lenders and the behaviour of their investors.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Chapter 8. Conclusion

Abstract
The goal of this book was to review the data sets, empirical methodologies, and findings regarding the role of banks and financial technology in current financial markets. It should be clear by now that the modern banking industry goes much further than its initial purpose of transferring funds from savers to investors, and, in this way, screen and monitor borrowers, provide liquidity, and perform maturity transformation.
Andrada Bilan, Hans Degryse, Kuchulain O’Flynn, Steven Ongena

Backmatter

Additional information

Premium Partner

    Image Credits