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This book provides insight into current research topics in finance and banking in the aftermath of the financial crisis. In this volume, authors present empirical research on liquidity risk discussed in the context of Basel III and its implications. Chapters also investigate topics such as bank efficiency and new bank business models from a business diversification perspective, the effects on financial exclusion and how liquidity mismatches are related with the bank business model. This book will be of value to those with an interest in how Basel III has had a tangible impact upon banking processes, particularly with regard to maintaining liquidity, and the latest research in financial business models.



1. Introduction

The aim of this volume is to enrich the banking and finance literature by providing some insights into research being undertaken in the aftermath of the global financial crisis, including a variety of topics covering all the major research fields in finance and banking.
Santiago Carbó Valverde, Pedro J. Cuadros Solas, Francisco Rodríguez Fernández

2. A Note on Regulatory Arbitrage: Bank Risk, Capital Risk, Interest Rate Risk and ALM in European Banking

Interest rate risk and its management are one of the classic activities of banking operations, classified as asset and liability management (ALM). This chapter considers ALM as a possible avenue for regulatory arbitrage under regulatory capital constraints. The theoretical purpose is to present a theory of regulatory arbitrage as a regulatory response to capital requirements in banking depending on capitalisation mechanisms. The empirical purpose is to analyse capital risk and bank risk in European banking in terms of ALM. The theoretical and empirical results presented support observations of a possible loophole in today’s capital regulations via ALM and of regulatory arbitrage as a regulatory response. In addition, it is more likely that low-capitalised banks utilise ALM as a way to counter higher levels of capital regulation.
Magnus Willesson

3. Basel III, Liquidity Risk and Regulatory Arbitrage

This chapter discusses and analyses the incentives for banks to behave opportunistically in order to bypass liquidity constraints and even benefit from regulatory arbitrage. The chapter specifically focuses on the new liquidity constraints introduced by Basel III and provides a number of examples from both on- and off-balance sheet perspectives of how banks are transferring risk to other parts of the economy that might be less well equipped to handle these risks. The chapter concludes by discussing the potential implications of such behaviours for the role banks will play in a liquidity-constrained economy.
Viktor Elliot, Ted Lindblom

4. OTC Derivatives and Counterparty Credit Risk Mitigation: The OIS Discounting Framework

In recent years, a complex regulatory framework has been developed, aimed at improving the functioning of the OTC derivatives market, reducing counterparty risk and enhancing transparency and mitigation for investors. We refer, in particular, to regulation of the financial markets (European Market Infrastructure Regulation), prudential supervision (Basel II and III) and the IFRS 13 Fair Value Measurement accounting regulations. These regulatory frameworks impact on financial intermediaries at organisational, procedural, measurement and collateralisation levels and, as will be seen throughout this chapter, on their pricing frameworks (or, better, on how cash flows should be discounted to define the mark to market of the financial asset). This chapter thus focuses on: (1) the regulatory framework related to counterparty risk (EMIR framework, Basel III, IAS/IFRS); and (2) methodologies to move from Libor/Euribor to OIS discounting in derivatives pricing.
Paola Leone, Massimo Proietti, Pasqualina Porretta, Gianfranco A. Vento

5. Diversification and Connections in Banking: First Findings

Literature on the diversification of banks usually refers to revenue mix, geographical markets and M&A deals. This chapter aims to fill a gap by investigating diversification in terms of different business combinations (carrying out activities in different client front-end businesses). We built a proprietary dataset of 92,747 half-year observations from data at both divisional and corporate levels. Retail banking, corporate banking, private banking and investment banking are the main business combinations in which banks operate. We discovered that the four business combinations are poorly correlated, as is evident from the low correlation coefficients between variables pertaining to them. This finding supports the diversification efforts carried out by banks’ managers in the first decade of this century.
Claudio Zara, Luca Cerrato

6. Banking System and Financial Exclusion: Towards a More Comprehensive Approach

The aim of this chapter is to analyse financial exclusion far beyond the classical approach of branch disappearance by including a new dimension: use difficulties. Our main hypothesis states that branch closures have been inconsistent and depended on the vulnerability of particular communities. We empirically analyse the main drivers of branch abandonment (physical access) and branch saturation (difficulties of use) in the city of Madrid and the surrounding municipalities and we find that the main socio-economic determinants of an area’s vulnerability appear statistically significant. We apply quantile regressions to better capture the more extreme cases of financial exclusion and we test our hypothesis at municipality and district levels which adds new evidence to previous studies. We conclude by discussing the main challenges of financial exclusion.
Marta de la Cuesta González, Cristina Ruzay Paz-Curbera, Beatriz Fernández Olit

7. Small and Medium-Sized Banks in Central and Eastern European Countries

The aim of this paper is to analyse the impact of bank size on the behaviour and performance of banks in Central and Eastern European countries, both before and after the recent financial crisis. To exploit this cross-country dimension, the current study measures bank size in two ways: in relation to absolute size and to market share. The analysis, which was carried out on bank-level data, employed the traditional ratio analysis of bank investment strategy, safety and profitability, supplemented by efficiency scores, estimated in data envelopment analysis models. The main research questions are whether medium-sized and small banks in CEE countries have experienced comparative advantages, and to what extent these advantages have been dependent on economic conditions.
Katarzyna Mikołajczyk

8. Stock Returns and Bank Ratings in the PIIGS

This paper analyses the effect of rating signals on banks’ stock market returns in European peripheral countries during the period 2002–2012. The results obtained show that investors do respond to rating announcements, and that before the financial crisis such announcements had the opposite effect to what would be expected according to the financial situation of the entities evaluated due to the investors’ appetite for risk. On the other hand, since the financial crisis investors’ risk aversion has increased, as banks’ rating signals have the expected effect on the stock market return given the financial situation of the entities evaluated. Analysis of the causal relationship between rating signals and financial markets indicates that the rating agencies do not strictly follow a “through-the-cycle” strategy.
Carlos Salvador Muñoz

9. Value Creation Drivers in European Banks: Does the Capital Structure Matter?

The aim of this chapter is to investigate the main value creation drivers in European banks. We start by identifying three business models using balance-sheet characteristics of a large sample of European banks. We then seek to analyse the most important accounting profit and capital absorption drivers. In particular for retail- funded banks we try to assess the impact of loan-loss provisioning (LLP) together with a wide array of credit-risk exposure on value creation measured by EVA. We also endogenise the effect of growth opportunities. Our results suggest that provisioning policies are positively and significantly related to EVA through the impact on asset returns volatility and equity betas. We also account for a relation between betas and growth opportunities.
Josanco Floreani, Maurizio Polato, Andrea Paltrinieri, Flavio Pichler

10. Liquidity Mismatch, Bank Borrowing Decision and Distress: Empirical Evidence from Italian Credit Co-Operative Banks

Since the 2007–2008 financial crisis liquidity risk has become one of the top priorities for regulators and new liquidity requirements have been introduced. Despite the importance of liquidity risk and the progress in addressing it there is no consensus about how to measure it and how to do so in a such a way as to provide information about (endogenous) systemic liquidity risk. This work aims to implement the “Liquidity Mismatch Index” proposed by Brunnermeier et al. (2011) to measure the mismatch between market liquidity of assets and the funding liabilities, using a sample of Italian co-operative banks. It investigates the main determinants of this mismatch, how it correlates with other bank characteristics and whether it provides useful information about borrowing decisions and distress of banks.
Gianfranco Vento, Andrea Pezzotta, Stefano Di Colli


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