Andrew Powell

TRADING FORWARD IN AN IMPERFECT MARKET: THE CASE OF ELECTRICITY IN BRITAIN*

The thrust of government policy in the British electricity industry has been to create a competitive and transparen t commodity market. To this end there has been a separation of supply from distribution and an independent company operates a transparent spot market, known as the pool. However, there is also a set of futu res and options-style contracts which lie over the pool that are not transparent. This paper considers the effects of the contract market on the pool. The model is an application of the theory of futures-style trading when the spot market is imperfect. However, the model is somewhat non-standard as there is no secondary trading in the contra cts and the generators may capture rents in the contract market. The results suggest several externalities due to the strategic use of th ese contracts by both the generators and the RECs which may limit the number of contracts traded. It is argued that the Office for Electricity Regulation (Offer) should intervene to help the creation of a transparent and standardized contract market. This may ensure the success of the contract market, ease entry to generation and foster competition. Copyright 1993 by Royal Economic Society.

Improving Credit Information, Bank Regulation, and Supervision: On the Role and Design of Public Credit Registries

The authors analyze how data in public credit registries can be used both to strengthen bank supervision and to improve the quality of credit analysis by financial institutions. Empirical tests using public credit registry (PCR) data were performed in collaboration with the central banks in Argentina, Brazil, and Mexico. The results of the empirical tests confirm the value of the data for credit risk evaluation and provide insights regarding its use in supervision, including in calculations of credit risk for capital and provisioning requirements, or as a check on a banks internal ratings for the Basel IIs internal rating-based approach. The authors also define a set of critical design parameters and use the results to comment on appropriate public registry design. Finally, they discuss the relationship between the different objectives of a PCR and how they influence the registrys design.

On Emerging Economy Sovereign Spreads and Ratings

This paper analyzes alternative models for emerging sovereign ratings. Although a small number of economic fundamentals explain ratings reasonably well, variations in those economic fundamentals are themselves explained by a small number of world factors. On the other hand, global financial variables associated with risk aversion are additionally required in order to explain the significant spread compression at the end of 2006. To determine whether ratings matter for spreads, the paper compares results across different methodologies, in particular exploiting differences in opinion between rating agencies. The evidence from this and previous methodologies is that ratings do matter. Finally, the paper finds that global indicators of risk aversion have become less important for emerging market spreads and that the effect of sub-prime news is less than the effect of “average news” on emerging economy credit default swap (CDS) spreads.

Loyal Lenders or Fickle Financiers: Foreign Banks in Latin America

We suggest that foreign banks may represent a trade-off for their developing country hosts. A portfolio model is developed to show that a more diversified international bank may be one of lower overall risk and less susceptible to funding shocks but may react more to shocks that affect expected returns in a particular host country. Foreign banks have become particularly important in Latin America where we find strong support for these theoretical predictions using a dataset of individual Latin American banks in eleven countries. Moreover, we find no significant difference between the size of the response of foreign banks to a negative liquidity shock and a positive opportunity shock: in both cases the market share of foreign banks in credit increases.

The Importance of an Effective Legal System for Credit Markets: The Case of Argentina

Argentina is a federal country and hence, although laws are national and the central bank has national jurisdiction as a regulator of the financial system, the 24 Argentine provinces have independent judicial authority. In this paper we analyze how variations in the effectiveness of the legal system across the different provinces have affected the development of credit markets. We find strong results. Provinces with poor legal enforcement have less credit available to borrowers and banks’ non-performing loans are higher. We conclude that the effectiveness of the legal system remains a highly significant variable in determining the development of the Argentine credit market and that improvements in the legal system would result in a significant increase in the availability of credit.

Prudential Responses to De Facto Dollarization

Abstract We present a model that encompasses three distinct motives for dollarization (price volatility, credit risk, and moral hazard) and discuss when risk‐based prudential policy responses are called for and the form they should take. We argue that the overall policy response must be tailored to the nature of the dollarization the economy is facing. However, prudential policies should be formulated irrespective of the roots of dollarization. Their aim should be to enhance financial stability by ensuring that banks internalize credit risk within acceptable risk tolerance levels, taking dollarization and the current monetary policy environment as given.

Basel II and Developing Countries: Sailing Through the Sea of Standards

Despite recently announced delays, Basel II - the new standard for bank capital - is due to be completed this year for implementation in the 13 Basel Committee member countries by the end of 2006. Should the other 170 plus member countries of the World Bank also adopt Basel II? Basel II was not written with developing countries in mind, but that does not necessarily mean that there is nothing in it for developing countries or that it can be ignored. Basels I and II represent a wide Sea of Standards. This paper suggests five alternative island-standards and five navigational tools to help countries choose their preferred island within the sea. It is suggested that for some developing countries the standardized approach will yield little in terms of linking regulatory capital to risk, but that countries may need many years of work to adopt the more advanced internal rating-based approach. The paper then proposes a centralized rating-based approach as a transition measure. The paper also makes proposals regarding a set of largely unresolved cross-border issues.

Reforming Bank Capital Requirements: Implications of Basel II for Latin American Countries

The controversial proposal to overhaul the international accord regarding the regulation of bank capital was completed in 2004, and the thirteen Basel Committee member countries are set to implement the new accord, known as Basel II, by 2007. We develop a Basel II decision tree to guide policymakers facing the issue of whether to adopt the new accord. We also estimate credit risk in banks across three Latin American countries using a homogeneous methodology. Our findings suggest that Latin America falls between the two main Basel II alternatives. Non-G10 countries may thus wish to recalibrate Basel IIs internal ratings-based (IRB) approach. Alternatively, we propose an intermediate centralized ratings-based (CRB) approach. We argue that the CRB approach may be made compatible with Basel II by developing an integrated policy for provisions and capital. We perceive a danger that Basel II may be adopted too quickly or inappropriately and may then represent the end of a standard rather than the establishment of a new one. We suggest that a Basel II-compatible CRB approach with homogeneous definitions would enhance true comparability.

Do Credit Rating Agencies Add Value? Evidence from the Sovereign Rating Business Institutions

If rating agencies add no new information to markets, their actions are not a public policy concern. But as rating changes may be anticipated, testing whether ratings add value is not straightforward. This paper argues that ratings and spreads are both noisy signals of fundamentals and suggest ratings add value if, controlling for spreads, they help explain other variables. The paper additionally analyzes the different actions (ratings and outlooks) of the three leading agencies for sovereign debt, considering the differing effects of more or less anticipated events. The results are consistent across a wide range of tests. Ratings do matter and hence how the market for ratings functions may be a public policy concern.

The Quality of Life in Latin American Cities: Markets and Perception

This book suggests how that exploration should be undertaken, and how a monitoring system that has a solid conceptual basis and is both easy to operate and reasonable in cost can then be put into practice. Long the ideal of many scholars and observers of urban problems, such a system may now be close to realization. In this book, examples of Latin American cities are used as case studies. As argued in the first chapter, there are good reasons to concentrate on Latin America: it is the world region with the most rapid urban development and is the most urbanized region in the developing world. In contrast to residents of cities in poorer regions, Latin Americans have managed to democratize homeownership and to extend basic services to the majority of households. That means that improving the Quality of Life (QoL) in Latin American cities is no longer primarily a matter of bricks and mortar. But the challenges are as large as they are diverse. Chapter two introduces the reader to the hedonic price and the life satisfaction approaches and presents a comparative summary of the conclusions of the six case studies. This chapter, like the first, is essential for the policy maker or activist in urban affairs who wants to understand the possibilities of the new systems for monitoring the quality of urban life. Chapter three is a concise and self-contained introduction to the economic theory on which the hedonic pricing and life satisfaction approaches are based and which forms the backbone of this book. Chapters four-eight then summarize the most notable findings of the case studies, each emphasizing a different topic and focus.