Recent events emphasize the role of cross-border linkages between banking systems in transmitting local developments across national borders. This paper analyzes whether international linkages in interbank markets affect the stability of interconnected banking systems and channel financial distress within a network consisting of banking systems of main advanced countries for the period 1993-2009. Methodologically, I use a spatial modelling approach to test for spillovers in cross-border interbank markets. The results suggest that foreign exposures in banking play a significant role in channelling banking risk: I find that countries which are linked through foreign borrowing or lending positions to more stable banking systems abroad are significantly affected by positive spillover effects. From a policy point of view, this implies that especially in stable times linkages in the banking system can be beneficial, while they have to be taken with caution in times of financial turmoil covering the hole system.

We investigate whether and how financial constraints of private firms depend on bank lending behavior. Bank lending behavior, especially its scale, scope and timing, is largely driven by bank business models which differ between privately owned and state-owned banks. Using a unique dataset on private small and medium-sized enterprises (SMEs) we find that an increase in relative borrowings from local state-owned banks significantly reduces firms’ financial constraints, while there is no such effect for privately owned banks. Improved credit availability and private information production are the main channels that explain our result. We also show that the lending behavior of local state-owned banks can be sustainable because it is less cyclical and neither leads to more risk taking nor underperformance.

The interplay between banks and the macroeconomy is of key importance for financial and economic stability. We analyze this link using a factor-augmented vector autoregressive model (FAVAR) which extends a standard VAR for the U.S. macroeconomy. The model includes GDP growth, inflation, the Federal Funds rate, house price inflation, and a set of factors summarizing conditions in the banking sector. We use data of more than 1,500 commercial banks from the U.S. call reports to address the following questions. How are macroeconomic shocks transmitted to bank risk and other banking variables? What are the sources of bank heterogeneity, and what explains differences in individual banks’ responses to macroeconomic shocks? Our paper has two main findings: (i) Average bank risk declines, and average bank lending increases following expansionary shocks. (ii) The heterogeneity of banks is characterized by idiosyncratic shocks and the asymmetric transmission of common shocks. Risk of about 1/3 of all banks rises in response to a monetary loosening. The lending response of small, illiquid, and domestic banks is relatively large, and risk of banks with a low degree of capitalization and a high exposure to real estate loans decreases relatively strongly after expansionary monetary policy shocks. Also, lending of larger banks increases less while risk of riskier and domestic banks reacts more in response to house price shocks.

This paper empirically examines the role of soft information in the competitive interaction between relationship and transaction banks. Soft information can be interpreted as a private signal about the quality of a firm that is observable to a relationship bank, but not to a transaction bank. We show that borrowers self-select to relationship banks depending on whether their privately observed soft information is positive or negative. Competition affects the investment in learning the private signal from firms by relationship banks and transaction banks asymmetrically. Relationship banks invest more; transaction banks invest less in soft information, exacerbating the selection effect. Finally, we show that firms where soft information was important in the lending decision were no more likely to default compared to firms where only financial information was used.

Does the mere presence of big banks affect macroeconomic outcomes? In this paper, we develop a theory of granularity (Gabaix, 2011) for the banking sector, introducing Bertrand competition and heterogeneous banks charging variable markups. Using this framework, we show conditions under which idiosyncratic shocks to bank lending can generate aggregate fluctuations in the credit supply when the banking sector is highly concentrated. We empirically assess the relevance of these granular effects in banking using a linked micro-macro dataset of more than 80 countries for the years 1995-2009. The banking sector for many countries is indeed granular, as the right tail of the bank size distribution follows a power law. We then demonstrate granular effects in the banking sector on macroeconomic outcomes. The presence of big banks measured by high market concentration is associated with a positive and significant relationship between bank-level credit growth and aggregate growth of credit or gross domestic product.

This study investigates if the Troubled Asset Relief Program (TARP) distorted price competition in U.S. banking. Political indicators reveal bailout expectations after 2009, manifested as beliefs about the predicted probability of receiving equity support relative to failing during the TARP disbursement period. In addition, the TARP affected the competitive conduct of unsupported banks after the program stopped in the fourth quarter of 2009. Loan rates were higher, and the risk premium required by depositors was lower for banks with higher bailout expectations. The interest margins of unsupported banks increased in the immediate aftermath of the TARP disbursement but not after 2010. No effects emerged for loan or deposit growth, which suggests that protected banks did not increase their market shares at the expense of less protected banks.

Earlier studies have documented that foreign banks charge lower lending rates and interest spreads than domestic banks. We hypothesize that this may stem from the superior efficiency of foreign entrants that they decide to pass onto borrowers (“performance hypothesis”), but could also reflect a different loan allocation with respect to borrower transparency, loan maturity and currency (“portfolio composition hypothesis”). We are able to differentiate between the above hypotheses thanks to a novel dataset containing detailed bank-specific information for the Polish banking industry. Our findings demonstrate that banks differ significantly in terms of portfolio composition and we attest to the “portfolio composition hypothesis” by showing that, having controlled for portfolio composition, there are no differences in lending rates between banks.

We use a structural econometric model to provide empirical evidence that safety nets in the banking industry lead to additional risk taking. To identify the moral hazard effect of bailout expectations on bank risk, we exploit the fact that regional political factors explain bank bailouts but not bank risk. The sample includes all observed capital preservation measures and distressed exits in the German banking industry during 1995–2006. A change of bailout expectations by two standard deviations increases the probability of official distress from 6.6% to 9.4%, which is economically significant.

In the first months of 2012 there were some mild signs of improvement in the world economy, to a large degree due to political measures taken in the euro area at the end of 2011. In particular, the ECB secured financing of banks by offering liquidity for as longs as three years and by easing standards for collateral. However, the southern countries of the euro area will stay in recession for most of the year 2012: planned fiscal consolidation in Spain and Italy has a magnitude of about 3% relative to GDP, in Portugal and Greece the restriction is even larger. The structural reforms need time to take beneficial effects, and the real sector is largely out of reach of the expansive monetary policy.

We investigate whether the ECB aligns its monetary policy with financial crisis risk in EMU member countries. We find that since the outbreak of the subprime crisis the ECB has significantly increased net lending and reduced interest rates when banking and sovereign debt crisis risk in vulnerable EMU countries (Greece, Ireland, Italy, Portugal, and Spain) increases, while no significant effect is identified for the pre-crisis period and relatively tranquil EMU countries (Austria, Belgium, France, Germany, and the Netherlands). These findings suggest that the ECB acts as a Lender of Last Resort for vulnerable EMU countries.