Expanding the reach of formal financial services to excluded individuals and businesses is a policy aim in many countries. Research to date has focused on the effect of financial inclusion on the well-being of consumers and overall development and growth. There is much less international evidence on the effect of financial inclusion on financial stability, in particular the banking system, which is the main provider of formal finance. We contend that access to financial services defined too broadly is an imprecise measure for evaluating the influence of inclusion on financial stability. We hypothesize that inclusion through access to payments and savings accounts has a neutral or positive effect on financial stability, while access to credit can weaken financial stability if credit growth occurs without due regard to borrower ability-to-repay. Using comparable cross-country data available since 2011 surveying the demand for different financial services, we find support for adverse effects on bank soundness from credit inclusion only. We also contribute new evidence on the role of the bank market structure in affecting risk-taking incentives by banks. We find that a more competitive structure intensifies the adverse impact of credit inclusion on stability. (c) 2021 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.

The current financial crisis affecting all sectors of the Lebanese economy became visible in a dollar liquidity shortage in the summer of 2019 that has since become acute with a political crisis since 17 October 2019. However, while the crystallization of the crisis is recent, the fragile funding scheme of the economy has developed over a long period of time. In common with previous countries and crises, the balance sheets of each of the government, the banking system, the central bank and the private sector are overextended and mismatched — currency and maturity mismatch. Also in common with many previous crises, a fixed exchange rate regime is vulnerable to speculative attack, especially in light of the overvaluation of the real exchange rate that has developed over more than a decade. What is unique to the Lebanon case is that the balance sheets of all 4 sectors of the economy are so exposed to each other through claims and cross-claims. Other countries relied on foreign investors for funding (such as dispersed foreign banks) and were therefore prone to volatile inflows and reversals. In contrast, dedicated non-volatile depositors supported most of Lebanon’s funding for many years until their sudden stop. In this sense, Lebanon has been a victim of its own luck in having a dedicated resident, expatriate, and regional depositor base. This: i) allowed the debt and the imbalances in the balance sheets to build up even further than in previous crises and ii) now complicates the recovery. It complicates the recovery because a sudden stop in the source domestic depositor funding has quickly spread through all balance sheets, contributing to the systemic liquidity freeze and now causing second-round adverse feedback loops to the economy. There is no easy solution. But to arrest this downward spiral, I propose that a key first step in any effective policy response is to separate the government debt problem from the liquidity problem affecting the banking system and real economy. Borrowing from the lessons of the global financial crisis successfully applied by the Federal Reserve and the European Central Bank, external liquidity support (such as collateralized dollar credit lines) should be targeted directly to the banking system to restore depositor confidence and unfreeze the economy. Then the government debt problem, via restructuring and reform should be addressed separately in a democratic political process with citizen (meaning depositor) agreement.

One key risk to the banking system is how funding costs will change as monetary policy is normalized and interest rates rise after almost a decade of near-zero rates. Our contribution is to develop a model that jointly estimates banks’ balance sheets and retail interest rates to arrive at a consistent estimate of the change in bank funding costs as market rates change. Our estimates imply a 100 basis-point shock to the Federal Funds rate would increase overall deposit funding costs by about $40 billion, which is roughly equal to 25% of aggregate annual net income for commercial banks and savings institutions. We also find that deposit rate responses are largely symmetric, in contrast to some previous research showing deposit rates are less responsive to upward movements in reference rates. We introduce unique and confidential data on bank deposit betas to anchor our results.

This paper reconciles the state of the economy with industry conditions in driving asset liquidation values and, therefore, recovery rates on defaulted debt securities. Evidence to date downplays the economywide effect in favor of industry and debt characteristic explanations. This paper shows that macroeconomic effects are important but operate differentially at the industry level. Industries whose sales growth is more correlated with GDP growth recover less during recessions. And industries that are more dependent on external finance recover less when the stock market falls. These findings expose how economywide shocks are transmitted to industry downturns, providing a framework for the role of aggregate risk in recovery risk and for macroeconomic stress testing. (C) 2015 Elsevier B.V. All rights reserved.

Can banks maintain their advantage as liquidity providers when exposed to a financial crisis? While banks honored credit lines drawn by firms during the 2007 to 2009 crisis, this liquidity provision was only possible because of explicit, large support from the government and government-sponsored agencies. At the onset of the crisis, aggregate deposit inflows into banks weakened and their loan-to-deposit shortfalls widened. These patterns were pronounced at banks with greater undrawn commitments. Such banks sought to attract deposits by offering higher rates, but the resulting private funding was insufficient to cover shortfalls and they reduced new credit.

This paper considers the impact of a regulatory policy action on bank credit and traces its incidence across banks. I make use of a reserve requirement increase in Lebanon that was considerably greater on foreign currency deposits than on domestic currency deposits. All banks cut lending as they scrambled to adjust portfolios. But the policy shock disproportionately affected banks with a greater reliance on dollar funding and with low buffers of dollar liquid assets. Exposed domestic‐owned banks also adjusted more slowly than similar foreign‐owned banks that obtained outside funding. Descriptive firm–bank matching evidence reveals a disproportionate impact on small firms.

The economic recovery following the financial crisis and Great Recession of 2007-09 has been slow. Research has shown that recessions following banking crises are typically accompanied by large and persistent declines in output. Contributing factors include sharp declines in asset prices, such as housing prices, that damage the balance sheets of both households and financial institutions. These factors, combined often with a buildup of debt during the bubble years prior to a crisis, cause debt deleveraging to be drawn out. Demand for new credit by households is therefore depressed by the effects of reduced income and wealth, and by the debt overhang. Likewise, the supply of new credit from banks is limited by past liquidity and solvency shocks and by banks' perceptions of higher risk in future lending.The Federal Reserve has taken steps since the financial crisis to push both short- and long-term interest rates to historically low levels. These steps have aimed to reduce financing costs generally and, more specifically, to lower the interest rates charged to finance consumer spending, which accounts for about 70 percent of all spending in the economy.However, interest rates charged by lenders to consumers do not change automatically when the Federal Reserve alters the stance of monetary policy. The extent to which policy actions pass through to consumer interest rates determines, in part, the effectiveness of monetary policy. Typically, when the Federal Reserve wants to provide policy stimulus to the economy, it lowers its target for the federal funds rate-its main policy interest rate. But when the short-term rate hits the zero bound as it did in the financial crisis, there are fewer options, and the effects are less certain. Thus, it is particularly important to evaluate this pass-through from monetary policy to consumer loan rates when central banks ease policy through unconventional tools such as purchases of longer-term securities and communication to the public about the future path of policy.This article examines the extent of pass-through to bank-reported lending rates. The data show that, since unconventional monetary policy was introduced at the end of 2008, this pass-through has weakened. The weaker response is not limited to one group of banks but characterizes both large banks and community banks. This means the effect of monetary policy on consumer spending may have declined.Section I reviews recent Federal Reserve policy actions and trends in interest rates on Treasuries and other securities. Section II describes banks' role in monetary policy transmission and introduces disaggregated data on consumer rates, which can be used to assess banks' ratesetting behavior. Section III examines the effectiveness of the banking channel of monetary policy transmission by estimating the response of consumer rates to market rates before and after the financial crisis.I. MONETARY POLICY ACTIONSIn normal times, the policy instrument the Federal Reserve targets to influence economic activity is the federal funds rate, the overnight rate at which banks lend to and borrow from each other. Conventionally, the Federal Reserve eases monetary policy by lowering its target for the federal funds rate. Because markets are integrated, other interest rates-including long-term borrowing costs-also move down. By driving down borrowing rates and increasing interest-sensitive consumption and investment, the Federal Reserve stimulates economic activity.But recent times have not been normal. The onset of the financial crisis in August 2007 led to disruptions in the normal functioning of credit markets in which financial institutions obtain and provide funding to each other. These disruptions later affected bank borrowers, visible in the sharp plunge in credit to the overall economy (Chart 1). Bank credit contracted more sharply and for longer than during previous recessions in the early 1990s and early 2000s. …

Can banks maintain their advantage as liquidity providers when they are exposed to a financial crisis? While banks honored their promised credit lines drawn by firms during the 2007-09 crisis, this provision of liquidity by banks was only possible because of explicit, large support from the government and government-sponsored agencies. At the onset of the crisis, aggregate deposit inflows into banks weakened and their loan-todeposit shortfalls widened. These patterns were more pronounced at banks exposed to greater undrawn commitments. Such banks sought to attract deposits by offering higher rates, but the resulting private funding was insufficient to cover loan-to-deposit shortfalls and they reduced new credit. JEL Codes: E4, G01, G11, G21, G28.

Can banks maintain their advantage as liquidity providers when exposed to a financial crisis? While banks honored their credit lines drawn by firms during the 2007-09 crisis, this provision of liquidity by banks was only possible because of explicit, large support from the government and government-sponsored agencies. At the onset of the crisis, aggregate deposit inflows into banks weakened and their loan-to-deposit shortfalls widened. These patterns were pronounced at banks exposed to greater undrawn commitments. Such banks sought to attract deposits by offering higher rates, but the resulting private funding was insufficient to cover loan-to-deposit shortfalls and they reduced new credit. JEL Codes: E4, G01, G11, G21, G28.

This paper studies the transmission of monetary policy through the bank-lending channel in a partially dollarized banking system. Taking advantage of the cross-sectional and time- series variation in individual Mexican bank balance sheets, I find that the deposits and loans of banks that have a larger share of foreign currency deposits are less sensitive to domestic monetary shocks, particularly for small banks. The results also suggest that banks with a larger foreign deposit share are more sensitive to foreign (U.S.) monetary shocks and Mexican country risk. The results indicate a novel way in which monetary policy has real effects in a partially dollarized economy: Not only are banks unable to easily replace insured deposits with other sources of funds because of information frictions (the conventional bank lending channel), but they are also unable to fully offset a loss of domestic currency deposits with foreign currency deposits.

The 2007-09 financial crisis illustrated the importance of healthy banks for the overall stability of the financial system and economy. Because banking is inherently risky, the health of banks depends importantly on their ability to manage risk and the associated exposure to losses. The crisis revealed that risk management at banks and other financial institutions had shortcomings. As a result, the riskiness of their loans and other investments resulted in large losses that arguably contributed to the severity of the recession.An important component of a strong risk management system is a bank's ability to assess the potential losses on its investments. One factor that determines the extent of losses is the recovery rate on loans and bonds that are in default. The recovery rate measures the extent to which the creditor recovers the principal and accrued interest due on a defaulted debt. While financial companies, their regulators, and researchers commonly assume that the recovery rate is constant, in practice, actual recovery rates vary significantly. Moreover, recovery rates are systematically related to default rates. For example, recovery rates on corporate bonds are inversely related to the aggregate corporate default rate. As a result, assuming constant recovery rates can lead to an incorrect assessment of potential losses, which in turn, would reduce the effectiveness of risk management programs.One reason why recovery and default rates may be inversely related is that they are both likely to be strongly influenced by the economy. For example, the same adverse economic conditions that cause defaults to rise-such as a recession-can cause recoveries to fall. Drawing on more than 30 years of recovery data on defaulted debt instruments, this article shows that the state of the economy does indeed help determine creditor recovery rates. Industry distress also drives recovery rates, and evidence suggests that industry distress can be triggered by an overall weak economy.Section I examines why the recovery rate is an important input to credit risk models. Section II analyzes recovery rates on U.S. corporate debt securities. It shows that recoveries vary considerably across time, sectors, seniority, and security type of the defaulted debt instrument. The variation in the recovery rate across time is also related to the aggregate default rate and to the business cycle. Section III examines in detail the different potential factors that explain recoveries, including bond market conditions, the macroeconomy, industry distress, and their interrelationships.I. THE RECOVERY RATEThe goal of risk management is to reduce the risk of large losses and to increase a financial firm's resilience to large losses. One key assumption in risk management is how the recovery rate is determined. This assumption is important because additional risk is introduced when the recovery rate is not constant. Weaknesses in modeling this risk may cause common measures of credit risk to be understated.The recovery rate in credit riskCredit risk is the dominant source of risk for banks (Pesaran, Schuermann, Treutler, and Weiner). Credit risk is the risk of changes in value from unexpected changes in credit quality (Duffie and Singleton). 1 Unexpected changes in credit quality can come from changes to the likelihood of default, the exposure at default, and the loss given default (where loss given default is 1 minus the recovery rate). Credit risk therefore comprises both default risk and recovery risk, where recovery risk is the chance of recovering less than the full amount of principal and accrued interest due, given a default event.2 Recovery is uncertain and often less than the full amount due, meaning that the recovery rate varies between zero and 100 percent.A common assumption in analyzing credit risk, however, is that the recovery rate is known with certainty, so that the analysis focuses on modeling the likelihood of default. …

This paper investigates what induces small firms in an emerging market economy to borrow dollar credit from domestic banks. Our data are from a unique survey of firms in Lebanon. The findings complement studies of large firms with foreign currency loans from foreign lenders. Exporters, naturally hedged against currency risk, are more likely to incur dollar debt. Firms also partly hedge themselves by passing currency risk to customers and suppliers. Less opaque firms with easily verifiable collateral and higher net worth are more likely to access dollar credit. Firms reliant on formal financing (banks and supplier credit) are more likely to contract dollar debt than firms reliant on informal financing (family, friends and moneylenders). Bank relationships, however, do not increase the dollar debt likelihood. And finally, profitable firms are less likely to have dollar debt. Information frictions and limited collateral, therefore, constrain dollar credit even when it is intermediated domestically. (C) 2012 Elsevier B.V. All rights reserved.

Can banks maintain their advantage as liquidity providers when they are heavily exposed to a financial crisis? The standard argument - that banks can - hinges on deposit inflows that are seeking a safe haven and provide banks with a natural hedge to fund drawn credit lines and other commitments. We shed new light on this issue by studying the behavior of bank deposit rates and inflows during the 2007-09 crisis. Our results indicate that the role of the banking system as a stabilizing liquidity insurer is not one of the passive recipient, but of an active seeker, of deposits. We find that banks facing a funding squeeze sought to attract deposits by offering higher rates. Banks offering higher rates were also those most exposed to liquidity demand shocks (as measured by their unused commitments, wholesale funding dependence, and limited liquid assets), as well as with fundamentally weak balance-sheets (as measured by their non-performing loans or by subsequent failure). Such rate increases have a competitive effect in that they lead other banks to offer higher rates as well. Overall, the results present a nuanced view of deposit rates and flows to banks in a crisis, one that reflects banks not just as safety havens but also as stressed entities scrambling for deposits.

(ProQuest: ... denotes formula omitted.)In financial crises of the recent past, investors often withdrew from securities markets and placed their funds into safer assets, such as U.S. Treasuries and bank deposits. During such episodes, a wide range of businesses shut out of securities markets sought to fund their operations by drawing down credit lines established with banks during normal times. Awash with funds from depositors seeking a safe haven, banks had no difficulty meeting these increased credit demands. Thus, banks helped avoid financial disruptions and business liquidations that would have occurred in the absence of a liquidity backstop.In 2007-09, however, banks were at the center of the financial crisis. While significant risks were present in some other financial institutions, this crisis was special in that commercial banks were much more exposed to losses than in recent past crises. This key feature of the crisis casts doubt on the notion that banks are a natural source of liquidity during financial crises. Were bank deposits still viewed as a safe haven, and if not, how compromised was their ability to meet the demand for liquidity? This article examines how commercial bank deposits and lending evolved during the recent crisis compared with past episodes of financial stress.The article concludes that the bank-centered nature of the crisis made it harder than in the past for banks to attract deposits and provide liquidity to borrowers shut out of securities markets. The first section of the article explores the main similarity and the key difference of the 2007-09 financial crisis with previous financial market disruptions. The second section reviews the theory that banks can provide liquidity when financial markets and other financial institutions cannot-and why the theory might break down in a bank-centered crisis. The third section presents new evidence, both from aggregate and individual bank data, that funds did not flow into bank deposits as robustly as in past times of stress and bank lending did not increase as much. To determine if these differences were due to the bank-centered nature of the crisis, the section also investigates whether deposits and loans increased less at banks where deposits were more likely to be viewed as unsafe.I. COMPARING THE 2007-09 CRISIS WITH PREVIOUS FINANCIAL CRISESThe financial crisis of 2007-09 was similar to previous crises in that the need for liquidity by businesses and households was unmet by market-based sources of funding. There was also a key difference: The banking system was arguably more adversely affected by credit losses and uncertainty surrounding these losses than in recent previous crises.The similarity of the 2007-09 and past crisesOne common feature of past financial crises was a need for liquidity. Businesses, households, and other economic entities needed funds to cover day-to-day operations and investments, but found it difficult or even impossible to borrow in securities markets. The investors that supplied market funds may have suffered a major loss in one market or may have changed their beliefs about risks or uncertainty in the economy. As a result, these investors shifted funds to low-risk assets, such as U.S. Treasury bonds, in what is known as a flight to safety. Thus, borrowers from a range of sectors became vulnerable to financing disruptions at the same time-that is, to a systemic liquidity shortage.In such crises, the demand for liquidity usually came from nonfinancial businesses. Even large, creditworthy corporations found it difficult to place corporate bonds, raise equity financing, and even borrow short-term by selling promissory notes such as commercial paper.1 As it got difficult to renew maturing commercial paper, firms relied on borrowing at shorter maturities, such as overnight financing. Even companies with continued access to the commercial paper market faced rising costs of funding. …

This article tests for asymmetric information problems between the lead arranger and the participants in a lending syndicate. One problem comes from adverse selection, whereby the lead has a private informational advantage over participants. A second problem comes from moral hazard, whereby the lead puts less effort in monitoring when it retains a smaller loan share. Applying an instrumental variables strategy using lending limits, borrower performance is improved by increasing the lead's share. The focus is on separating moral hazard from adverse selection and the results are consistently indicative of monitoring. First, the lead's share is more important for revocable credit lines than for fully funded term facilities. Second, a lead with greater liquidity risk reduces its share resulting in worse borrower performance, but its liquidity risk does not affect the quality of credits it chooses to syndicate in the first place. Third, covenants are paired with a higher lead share, and the sensitivity between share and borrower ex post performance is greater on loans with more covenants.

We demonstrate how the introduction of liability-side feedbacks affects the properties of a quantitative model of systemic risk. The preliminary version of the model, which is still in its development phase, is based on detailed balance sheets for UK banks and encompasses macro-credit risk, interest and non-interest income risk, network interactions, and feedback effects. Funding liquidity risk is introduced by allowing for rating downgrades and incorporating a simple framework in which concerns over solvency, funding profile and confidence may trigger the outright closure of funding markets. In presenting results, we focus on how policymakers could use the model with reference to both aggregate distributions and analysis of a scenario in which large losses at some banks can be exacerbated by liability-side feedbacks, leading to system-wide instability. All authors are Bank of England except Prasanna Gai (Australian National University). The corresponding author is: sujit.kapadia@bankofengland.co.uk. The RAMSI project represents a major investment of Bank of England resources and we are grateful to many people both inside and outside the Bank of England for their contributions. In particular the OeNB have been very generous in providing guidance and significant analytical contributions. The analysis in this paper has benefited from encouragement and contributions from Viral Acharya, Niki Anderson, Marnoch Aston, Richard Barwell, Emily Beau, Michael Boss, John Carmichael, Ethan Cohen-Cole, Geoff Coppins, Sebastiano Daros, Paul Doran, Mathias Drehmann, John Elliott, Helmut Elsinger, David England, Phil Evans, Antonella Foglia, Celine Gauthier, Brenda Gonzalez-Hermosillo, Charles Goodhart, Andy Haldane, Simon Hall, Jen Han, Florence Hubert, Gregor Irwin, Nigel Jenkinson, Rob Johnson, Charles Kahn, Sandhya Kawar, Will Kerry, Jack Mckeown, Alex McNeil, Andrew Mason, Colin Miles, Pierre Monnin, Haroon Mumtaz, Emma Murphy, Gareth Murphy, Rain Newton-Smith, Joseph Noss, Spyros Pagratis, Andrew Patton, Adrian Penalver, Silvia Pezzini, Laura Piscitelli, Claus Puhr, Victoria Saporta, Til Schuermann, Miguel Segoviano, Jack Selody, Hyun Shin, Steffen Sorensen, George Speight, Marco Stringa, Martin Summer, Ryland Thomas, Dimitri Tsomocos, Iman van Lelyveld, Nick Vause, Lewis Webber, Simon Wells and Peter Westaway. Harry Goodacre, Tony Lee and Emma Mattingley provided excellent research assistance. We would also like to thank seminar participants at the Bank of England, the Financial Services Authority, the European Central Bank, the Bundesbank, the 12 Annual Conference of the Central Bank of Chile on ‘Financial Stability, Monetary Policy and Central Banking’ (Santiago, 6-7 November 2008), the Bundesbank / Technical University of Dresden Conference on ‘Measuring and Forecasting Financial Stability’ (Dresden, 15-16 January 2009), the 11th Annual Bowles Symposium on ‘Liquidity, Valuation, and Financial Crisis’, Atlanta, 12 February 2009, and the MMF, Barrie and Hibbert Conference on ‘Challenges for Risk Management’ at CASS on 27 February 2009 for helpful comments and suggestions.

This paper assesses how shocks to bank capital may influence a bank’s portfolio behaviour using novel evidence from a UK bank panel data set from a period that pre-dates the recent financial crisis. Focusing on the behaviour of bank loans, we extract the dynamic response of a bank to innovations in its capital and in its regulatory capital buffer. We find that innovations in a bank’s capital in this (pre-crisis) sample period were coupled with a loan response that lasted up to three years. Banks also responded to scarce regulatory capital by raising their deposit rate to attract funds. The international presence of UK banks allows us to identify a specific driver of capital shocks in our data, independent of bank lending to UK residents. Specifically, we use write-offs on loans to non-residents to instrument bank capital’s impact on UK resident lending. A fall in capital brought about a significant drop in lending, in particular to private non-financial corporations. In contrast, household lending increased when capital fell, which may indicate that — in this pre-crisis period — banks substituted into less risky assets when capital was short.

Monetary policy is often intertwined with regulatory policy in developing countries. This paper considers the impact of currency-sensitive regulatory actions on bank credit. I make use of a reserve requirement change in Lebanon that was considerably greater on foreign currency deposits than on domestic currency deposits to answer this question. This variation is utilized to identify the credit consequences of changes in reserve requirements among dierent banks. Using a panel of roughly 60 commercial banks, I …nd that the currency composition of a bank's balance sheet matters. The tightening of the binding reserve requirement led banks to cut lending as they scrambled to adjust their asset portfolios. But the greater the proportion of liras in a bank's initial deposits, the less adversely aected was the bank by the reserve requirement tax. Liquidity buers, in the form of foreign currency liquid assets also helped to insulate lending. Matching …rms to their main banks indicates that small and young …rms were the most exposed to the drop in lending. This paper also elicits bank behavior and opinion by way of a unique bank survey.