Bank competition, securitization and risky investment

Li, Zhe and Sun, Jianfei (2011): Bank competition, securitization and risky investment.

Abstract

We build a general equilibrium model of bank competition in which securitization is the banks�optimal choice. A symmetric capacity-constrained Bertrand competition equilibrium exists as in the directed search literature, e.g., Burdett, Shi and Wright (2001). A key feature of the model is that banks face heterogeneous projects and they can use their lending rate as a tool to compete for good projects. The competition of banks lowers the lending rate, which in turn results in a low deposit rate. Consequently, a low level of credit supply coexists with some uninvested high-return projects. The shortage of credit supply resulting from bank competition naturally motivates banks to sell their assets through securities in order to raise more funds to invest in the projects being rationed.

• Item Type: MPRA Paper
• Language: English
• Keywords: bank competition, directed search, capital requirement, securitization, risky investment
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General > E02 - Institutions and the Macroeconomy; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

References

[1] Ahn, Jung-Hyun, 2010. "Loan Sales and Loan Market Competition." International Review of Finance 10 (2): 241-262.

[2] Ahn, Jung-Hyun, and Regis Breton, 2010. "Securitization, Competition and Efficiency." Manuscript.

[3] Allen, Franklin, and Elena Carletti, 2006. "Credit Risk Transfer and Contagion." Journal of Monetary Economics 53: 89�111.

[4] Allen, Franklin, and Douglas M. Gale, 2005. "Systemic Risk and Regulation" in The Risks of Financial Institutions, ed. by Mark Carey, and Rene M. Stulz, 341�375. The University of Chicago Press.

[5] Arnold, Michael A., 2000. "Costly Search, Capacity Constraints, and Bertrand Equilibrium Price Dispersion." International Economic Review 41 (1): 117-131.

[6] Acharya, Viral V., Philipp Schnabl, and Gustavo Suarez, 2010. "Securitization Without Risk Transfer." Manuscript.

[7] Albrecht, James, Pieter A. Gautier, and Susan Vroman, 2006. "Equilibrium Directed Search with Multiple Applications." Review of Economic Studies 73 (4): 869-891.

[8] Bernanke, Ben and Mark Gertler, 1990. "Financial Fragility and Economic Performance." The Quarterly Journal of Economics 105(1): 87-114.

[9] Berndt, Antje and Anurag Gupta, 2009. "Moral hazard and adverse selection in the originate-to-distribute model of bank credit." Journal of Monetory Economy 56, 725�-743.

[10] Bouckaert, Jan, and Hans Degryse, 2004. "Softening Competition by Inducing Switching in Credit Markets." Journal of Industrial Economics 52 (1): 27�52.

[11] Boot, Arnoud, and Anjolein Schmeits, 2006. "The Competitive Challenge in Banking", in Advances in Corporate Finance and Asset Pricing, Luc Renneboog ed., 133-160.

[12] Boyd, John, and Gianni De Nicolo, 2005. "The Theory of Bank Risk-Taking and Competition Revisited." Journal of Finance 60: 1329-1343.

[13] Burdett, Kenneth, Shouyong Shi, and Randall Wright, 2001. "Pricing and Matching with Frictions." Journal of Political Economy 109 (5): 1060-1085.

[14] Carlstrom, Charles T., and Katherine A. Samolyk, 1992. "Securitization: More than just a Regulatory Artifact." Economic Commentary, Federal Reserve Bank of Cleveland, issue May 1.

[15] Carlstrom, Charles T., and Katherine A. Samolyk, 1993. "Loan Sales as a Response to Market-Based Capital Constraints."Working paper, Federal Reserve Bank of Cleveland.

[16] Camera, Gabriele, and Cemil Selcuk, 2009. "Price Dispersion with Directed Search." Journal of the European Economic Association 7 (6): 1193-1224.

[17] Calomiris, Charles W., and Jeseph R. Mason, 2004. "Credit Card Securitization and Regulatory Arbitrage." Journal of Financial Services Research 26: 5�28.

[18] Cao, Melanie and Shouyong Shi, 2001. "Screening, Bidding, and the Loan Market Tightness." European Finance Review 5: 21�61.

[19] Dell�Ariccia, Giovanni, Deniz Igan, and Luc Laeven, 2008. "Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market." CEPR Discussion Paper No. DP6683.

[20] DeMarzo, Peter, and Darrel Duffie, 1999. "A Liquidity Based Model of Security Design." Econometrica 67: 65-99.

[21] Demsetz, Rebecca S., 2000. "Bank Loan Sales: A New Look at the Motivations for Secondary Market Activity." The Journal of Financial Research 23 (2): 197-222.

[22] Diamond, Douglas W., 1984. "Financial Intermediation and Delegated Monitoring." Review of Economic Studies 51: 393�414.

[23] Duffee, Gregory, and Chunsheng Zhou, 2001. "Credit Derivatives in Banking: Useful Tools for Managing Risk?" Journal of Monetary Economics 48: 25�54.

[24] Du¢ e, Darrell, 2007. "Innovations in Credit Risk Transfer: Implications for Financial Stability." Working paper.

[25] Gehrig, Thomas. and Rune Stenbacka, 2007. "Information Sharing and Lending Market Competition with Switching Costs and Poaching." European Economic Review 51 (1): 77�99.

[26] Gorton, Gary B., 2008. "The panic of 2007" in Maintaining Stability in a Changing Financial System, Proceedings of the 2008 Jackson Hole Conference, Federal Reserve Bank of Kansas City.

[27] Gorton, Gary B., and Joseph G. Haubrich, 1990. "The Loan Sales Market." Research in Financial Services 2: 85�135.

[28] Gordon, Gary B., and George G. Pennacchi, 1995. "Banks and Loan Sales - Marketing Nonmarketable Assets."Journal of Monetary Economy 35: 389-441.

[29] Greenlaw, D., Hatzius, J., Kashyap, A. and Hyun Song Shin, 2008. "Leveraged Losses: Lessons from the Mortgage Market Meltdown." Report of the US Monetary Monetary Form, 2.

[30] Haubrich, Joseph G., and James B. Thomson, 1996. "Loan Sales, Implicit Contracts, and Bank Structure." Review of Quantitative Finance and Accounting 7 (2): 137-162.

[31] Hellman, Thomas, Kevin Murdock and Joseph Stigliz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?" American Economic Review 90 (1): 147�-165.

[32] Hakenesa, Hendrik, Isabel Schnabelb, 2010. "Credit Risk Transfer and Bank Competition." Journal of Financial Intermediation 19 (3): 308-332.

[33] Keys, Benjamin J., Tanmoy Mukherjee, Amit Seru, and Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans." The Quarterly Journal of Economics 125 (1): 307-362.

[34] Kreps, David M., and Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes." Bell Journal of Economics 14 (2):326-337.

[35] Loutskina, Elena and Philip E. Strahan, 2009. "Securitization and the Declining Impact of Bank Finance on Loan Supply: Evidence from Mortgage Originations." Journal of Finance 64 (2): 861-889.

[36] Michalak, Tobias C., and Andro Uhde, 2009. "Credit Risk Securitization and Banking Stability: Evidence from the Micro-Level for Europe." 22nd Australasian Finance and Banking Conference, SSRN working paper.

[37] Morrison, Alan D., and Lucy White. 2005. "Crises and Capital Requirements in Banking." American Economic Review 95 (5): 1548�-1572.

[38] Murray, Alan P., 2001. "Has Securitization Increased Risk to the Financial System?" Business Economics 36: 63-67.

[39] Nicolo, Antonio, and Loriana Pelizzon, 2008. "Credit derivatives, capital requirements and opaque OTC markets." Journal of Financial Intermediation 17 (4): 444-463.

[40] Parlour, Christine A. and Guillaume Plantin, 2008. "Loan Sales and Relationship Banking." The Journal of Finance 63 (3): 1291-1314.

[41] Parlour, Christine A. and Uday Rajan, 2001. "Competition in Loan Contracts." American Economic Review 91 (5): 1311-1328.

[42] Pavel, Christine, and David Phillis, 1987. "Why Commercial Banks Sell Loans: An Empirical Analysis." Federal Reserve Bank of Chicago Economic Perspectives 14: 3-14.

[43] Pennacchi, George G., 1988. "Loan Sales and the Cost of Bank Capital." The Journal of Finance 43 (2): 375-396.

[44] Peters, Michael, 1984. "Bertrand Equilibrium with Capacity Constraints and Restricted Mobility." Econometrica 52 (5): 1117-1127.

[45] Petersen, Mitchell A. and Raghuram G. Rajan, 1995. "The Effect of Credit Market Competition on Lending Relationships." The Quarterly Journal of Economics 110 (2): 407-443.

[46] Purnanandam, Amiyatosh K., 2009. "Originate-to-Distribute Model and the Sub-Prime Mortgage Crisis." Working Paper.

[47] Rahi, Rohit, and Darrel Du¢ e, 1995. "Financial Market Innovation and Security Design." Journal of Economic Theory 65: 1-42.

[48] Salop, Steven C.,1979. "Monopolistic Competition with Outside Goods." Bell Journal of Economics 10(1): 141�156.

[49] Shi, Shouyong, 2009. "Directed Search for EquilibriumWage-Tenure Contracts." Econometrica 77 (2): 561�584.

[50] Shin, Hyun Song, 2009. "Securitisation and Financial Stability." The Economic Journal 119: 309�332.

[51] Shleifer, Andrei, and Robert W. Vishny, 2010. "Banking and Securitization, Asset Fire Sales and Credit Easing." American Economic Review: Papers and Proceedings 100 (2): 46�50.

[52] Sarkisyan, Anna, Barbara Casu, Andrew Clare, and Stephen Thomas, 2009. "Securitization and Credit Risk Taking: Empirical Evidence from US Bank Holding Companies." Working paper.

[53] Wagner, Wolf, and Ian W. Marsh, 2006. "Credit Risk Transfer and Financial Sector Stability." Journal of Financial Stability 2: 173�179.