Janet Mitchell

SMES and Bank Lending Relationships: The Impact of Mergers

This paper studies the impact of bank mergers on firm-bank lending relationships using information from individual loan contracts in Belgium. We analyse the effects of bank mergers on the probability of borrowers maintaining their lending relationships and on their ability to continue tapping bank credit. The Belgian financial environment reflects a number of interesting features: high banking sector concentration; ‘in-market’ mergers with large target banks; importance of large banks in providing external finance to SMEs; and low numbers of bank lending relationships maintained by SMEs. We find that bank mergers generate short-term and longer-term effects on borrowers probability of losing a lending relationship and on credit availability. Mergers also have heterogeneous impacts across borrower types, including borrowers of acquiring and target banks, borrowers of differing size, borrowers with single versus multiple relationships, and borrowers with differing relationship intensities. Firms borrowing from acquiring banks are less likely to lose their lending relationship, while target bank borrowers are more likely to lose their relationship or see their credit availability harmed. Overlap borrowers – borrowing from two of the merging banks – are less likely to lose their relationship than firms borrowing from only one of the merging banks or firms borrowing from non-merging banks.

Banking Crises and Bank Rescues: The Role of Reputation

This paper focuses on bank rescue packages and on the behaviour of troubled banks in light of rescue offers. A puzzling feature of experience with banking crises is that in many cases policy authorities make offers of bank rescue, and banks are reluctant to accept these offers. We study situations in which regulators have decided to offer bank rescue plans, and we show that a combination of factors, including bankers reputational concerns, can explain banks potential reluctance to accept offers of recapitalization.

Incentives and Tranche Retention in Securitisation: A Screening Model

This paper examines the power of different contractual mechanisms to influence an originators choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a vertical slice, or share of the portfolio; the originator holds the equity tranche of a structured finance transaction; the originator holds the mezzanine tranche, rather than the equity tranche. These mechanisms will result in differing levels of screening, and the differences arise from varying sensitivities to a systematic risk factor. Equity tranche retention is not always the most effective mechanism, and the equity tranche can be dominated by either a vertical slice or a mezzanine tranche if the probability of a downturn is likely and if the equity tranche is likely to be depleted in a downturn. If the choice of how much and what form to retain is left up to the originator, the retention mechanism may lead to low screening effort, suggesting a potential rationale for government intervention.

Financial Intermediation Theory and Implications for the Sources of Value in Structured Finance Markets

Structured finance instruments represent a form of securitization technology which can be defined by the characteristics of pooling of financial assets, delinking of the credit risk of the asset pool from the credit risk of the originating intermediary, and issuance of tranched liabilities backed by the asset pool. Tranching effectively accomplishes a slicing of the loss distribution of the underlying asset pool. This paper reviews the finance literature relating to security design and securitization, in order to identify the economic forces underlying the creation of SF instruments. A question addressed is under what circumstances one would expect to observe pooling alone (as with traditional securitization) versus pooling and tranching combined (as with structured finance). It is argued that asymmetric information problems between an originator and investors can lead to pooling of assets and tranching of associated liabilities, as opposed to pooling alone. The more acute the problem of adverse selection, the more likely is value to be created through issuance of tranched assetbacked securities. Structured finance instruments also help to complete incomplete financial markets, and they may also appear in response to market segmentation.

Failure Prediction Models: Performance, Disagreements, and Internal Rating Systems

We address a number of comparative issues relating to the performance of failure prediction models for small, private firms. We use two models provided by vendors, a model developed by the National Bank of Belgium, and the Altman Z-score model to investigate model power, the extent of disagreement between models in the ranking of firms, and the design of internal rating systems. We also examine the potential gains from combining the output of multiple models. We find that the power of all four models in predicting bankruptcies is very good at the one-year horizon, even though not all of the models were developed using bankruptcy data and the models use different statistical methodologies. Disagreements in firm rankings are nevertheless significant across models, and model choice will have an impact on loan pricing and origination decisions. We find that it is possible to realize important gains from combining models with similar power. In addition, we show that it can also be beneficial to combine a weaker model with a stronger one if disagreements across models with respect to failing firms are high enough. Finally, the number of classes in an internal rating system appears to be more important than the distribution of borrowers across classes.

Markets and Growth

This paper studies key markets (financial, labor, natural resource, and product) to assess how they are facilitating or constraining growth. First, we draw on the body of existing theoretical and empirical literature to discuss the links between markets and growth. Second, we present four stylized scenarios of the process of growth, which summarize differences across six regions of the developing world. Financial market infrastructure and efficient factor reallocation in response to shocks appear to be among the most important growth determinants. We highlight the relative lack of research on the relationship between labor markets and growth, as opposed to the relationship between human capital production and growth. Finally, we combine suggestions of Topel (1999) and Pritchett (2000) to argue that country-specific markets should be a principal focus of future research on growth. This paper provides a framework for such studies.

Liquidity risk in securities settlement

Abstract This paper studies the potential impact on securities settlement systems (SSSs) of a major market disruption, caused by the default of the largest player. A multi-period, multi-security model with intraday credit is used to simulate direct and second-round settlement failures triggered by the default, as well as the dynamics of settlement failures, arising from a lag in settlement relative to the date of trades. The effects of the defaulter’s net trade position, the numbers of securities and participants in the market, and participants’ trading behavior are also analyzed. We show that in SSSs – contrary to payment systems – large and persistent settlement failures are possible even when ample liquidity is provided. Central bank liquidity support to SSSs thus cannot eliminate settlement failures due to major market disruptions. This is due to the fact that securities transactions involve a cash leg and a securities leg, and liquidity can affect only the cash side of a transaction. Whereas a broad program of securities borrowing and lending might help, it is precisely during periods of market disruption that participants will be least willing to lend securities. Settlement failures can continue to occur beyond the period corresponding to the lag in settlement. This is due to the fact that, upon observation of a default, market participants must form expectations about the impact of the default, and these expectations affect current trading behavior. If, ex post, fewer of the previous trades settle than expected, new settlement failures will occur. This result has interesting implications for financial stability. On the one hand, conservative reactions by market participants to a default – for example by limiting the volume of trades – can result in a more rapid return of the settlement system to a normal level of efficiency. On the other hand, limitation of trading by market participants can reduce market liquidity, which may have a negative impact on financial stability.

Staying, Dropping, or Switching: The Impacts of Bank Mergers on SMEs

This paper studies the impact of bank mergers on firm-bank lending relationships using detailed loan contract data from Belgium. We argue that in order to accurately gauge the heterogeneous impacts of mergers, the analysis must distinguish borrowers not only by their relationship with the acquiring versus the target bank in a merger and by firm size, but also by whether they have single versus multiple-bank relationships. For single-relationship borrowers, it is necessary to go beyond the usual comparison of relationship continuation and discontinuation to analyze the three alternatives of staying, dropping, and switching. For multiple-relationship borrowers, relationship intensity also plays a role.

Ten years after the financial crisis: Regulatory reforms and the Belgian Banking Sector

This article reviews the experience of the 2007-2008 financial crisis and the principal regulatory reforms that followed, at the international, European and Belgian levels. These reforms have included increases in minimum regulatory capital requirements for banks, improvement of the quality of capital held by banks, broadening of the risks for which bank capital requirements are imposed, introduction of liquidity regulation for banks, introduction of macroprudential policies, and development of frameworks to facilitate the resolution of failed banks without the use of taxpayer funds.Changes in the Belgian banking sector in the ten years following the crisis are examined, and the following outcomes are observed: the size of banks has diminished; leverage has decreased; banks have returned to their core businesses, concentrating on domestic lending; banks’ trading activities have been reduced; holdings of government debt as a proportion of total assets have increased; dependence on wholesale funding has fallen. Most of these developments reflect an enhanced resilience of the banking sector.