Christoffer Kok

Impact of bank competition on the interest rate pass-through in the euro area

This article analyses the impact of loan market competition on the interest rates applied by euro area banks to loans during the period 1994–2004, using a novel measure of competition called the Boone indicator. We find evidence that stronger competition implies significantly lower spreads between bank and market interest rates for most loan market products, in line with expectations. This result implies that stronger competition causes both lower bank interest rates and a stronger pass-through of market rate changes into bank rates. Evidence of the latter is also presented by our Error Correction Model (ECM) for bank rates. Further, banks compensate income losses from increased loan market competition by offering lower deposit rates. Our findings with respect to the loan market rates have important monetary policy implications, as they suggest that measures to promote competition in the European banking sector are likely to render the monetary policy transmission mechanism more effective.

The Dynamics of Bank Spreads and Financial Structure

This paper investigates the effect of within banking sector competition and competition from financial markets on the dynamics of the transmission from monetary policy rates to retail bank interest rates in the euro area. We use a new dataset that permits analysis for disaggregated bank products. Using a difference-in-difference approach, we test whether development of financial markets and financial innovation speed up the pass through. We find that more developed markets for equity and corporate bonds result in a faster pass-through for those retail bank products directly competing with these markets. More developed markets for securitized assets and for interest rate derivatives also speed up the transmission. Further, we find relatively strong effects of competition within the banking sector across two different measures of competition. Overall, the evidence supports the idea that developed financial markets and competitive banking systems increase the effectiveness of monetary policy.

Assessing interbank contagion using simulated networks

This paper presents a new approach to randomly generate interbank networks while overcoming shortcomings in the availability of bank-by-bank bilateral exposures. Our model can be used to simulate and assess interbank contagion effects on banking sector soundness and resilience. We find a strongly non-linear pattern across the distribution of simulated networks, whereby only for a small percentage of networks the impact of interbank contagion will substantially reducoe average solvency of the system. In the vast majority of the simulated networks the system-wide contagion effects are largely negligible. The approach furthermore enables to form a view about the most systemic banks in the system in terms of the banks whose failure would have the most detrimental contagion effects on the system as a whole. Finally, as the simulation of the network structures is computationally very costly, we also propose a simplified measure—a so-called Systemic Probability Index—that also captures the likelihood of contagion from the failure of a given bank to honour its interbank payment obligations but at the same time is less costly to compute. We find that the SPI is broadly consistent with the results from the simulated network structures.

Modelling Loans to Non-Financial Corporations in the Euro Area

We model the determinants of loans to non-financial corporations in the euro area. Using the Johansen (1992) methodology, we identify three cointegrating relationships. These relationships are interpreted as the long-run loan demand, investment and loan supply equations. The short-run dynamics of loan demand for the euro area are subsequently modelled using a Vector Error Correction Model (VECM). We perform a number of specification tests, which suggest that developments in loans to non-financial corporations in the euro area can be reasonably explained by the model. We then use the estimated model to analyse the impact of permanent and temporary shocks to the policy rate on bank lending to non-financial corporations.

Bank Reactions After Capital Shortfalls

This paper investigates whether European banks have capital targets and how deviations from the target impact their equity composition and activity mix. Using quarterly data for a sample of large European banks between 2004 and 2011, we show that there are notable asymmetries in banks’ reactions to deviations from optimal capital levels. Banks prefer to reshuffle risk-weighted assets or increase asset holdings when being above their optimal Tier 1 ratio, whereas they rather try to increase equity levels or reshuffle risk-weighted assets without changing asset holdings when being below target. At the same time, focusing instead on a unweighted equity ratio target, we find evidence of deleveraging and lower loan growth for undercapitalized banks during the recent financial crisis, whereas in the pre-crisis periods banks primarily reacted to deviations from their optimal target by adjusting equity levels.

Modelling the emergence of the interbank networks

Interbank contagion has become a buzzword in the aftermath of the financial crisis that led to a series of shocks to the interbank market and to periods of pronounced market disruptions. However, little is known about how interbank networks are formed and about their sensitivity to changes in key bank parameters (for example, induced by common exogenous shocks or by regulatory initiatives). This paper aims to shed light on these issues by modelling endogenously the formation of interbank networks, which in turn allows for checking the sensitivity of interbank network structures and hence, their underlying contagion risk to changes in market-driven parameters as well as to changes in regulatory measures such as large exposures limits. The sequential network formation mechanism presented in the paper is based on a portfolio optimization model, whereby banks allocate their interbank exposures while balancing the return and risk of counterparty default risk and the placements are accepted taking into account funding diversification benefits. The model offers some interesting insights into how key parameters may affect interbank network structures and can be a valuable tool for analysing the impact of various regulatory policy measures relating to banks’ incentives to operate in the interbank market.

Exploring the Nexus Between Macro-Prudential Policies and Monetary Policy Measures: Evidence from an Estimated DSGE Model for the Euro Area

The financial crisis highlighted the importance of systemic risks and of policies that can be employed to prevent and mitigate them. Several recent initiatives aim at establishing institutional frameworks for macro-prudential policy. As this process advances further, substantial uncertainties remain regarding the transmission channels of macro-prudential instruments as well as the interactions with other policy functions, and monetary policy in particular. This paper provides an overview and some illustrative model simulations using an estimated DSGE model for the euro area of the macroeconomic interdependence between macro-prudential instruments and monetary policy.

Emergence of the EU Corporate Lending Network

DISCLAIMER: This presentation should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB

Competition and contestability in bank retail markets

In this chapter the authors build on earlier work by Corvoisier and Gropp (2009) and examine the role of internet banking in retail banking competition. They focus on European banks for the period 2002–15. Building on the idea of contestable markets, they show that internet banking has overall increased competition through contestability of markets. The effect is stronger for retail deposits, but recently consumer loans have shown an effect. The authors attribute this finding to the advent of FinTechs. The findings support the use of non-concentration-based measures in banking in research.

A stochastic forward-looking model to assess the profitability and solvency of European insurers

In this paper, we develop an analytical framework for conducting forward-looking assessments of profitability and solvency of the main euro area insurance sectors. We model the balance sheet of an insurance company encompassing both life and non-life business and we calibrate it using country level data to make it representative of the major euro area insurance markets. Then, we project this representative balance sheet forward under stochastic capital markets, stochastic mortality developments and stochastic claims. The model highlights the potential threats to insurers solvency and profitability stemming from a sustained period of low interest rates particularly in those markets which are largely exposed to reinvestment risks due to the relatively high guarantees and generous profit participation schemes. The model also proves how the resilience of insurers to adverse financial developments heavily depends on the diversification of their business mix. Finally, the model identifies potential negative spillovers between life and non-life business through the redistribution of capital within groups.