ECB Paper on Impact of Bank Funding Shocks on Credit Reallocation
ECB published a paper that presents a comprehensive analysis of the sector- and firm-specific strategies that banks follow when their funding is affected by a negative shock. The authors focus on assessing the impact of bank funding shocks on credit allocation by banks, also providing evidence on the strategic lending decisions made by banks facing a negative funding shock and describing the implications of the findings for bank regulators.
The paper provides the results on the average impact of the interbank funding shock as well as the reallocation effects.Using bank-firm level credit data, the authors show that banks reallocate credit within their loan portfolio in at least three different ways. First, banks reallocate to sectors where they have a high market share. Second, they also reallocate to sectors in which they are more specialized. Third, they reallocate credit toward low-risk firms. These reallocation effects are economically large. A standard deviation increase in sector market share, sector specialization, or firm soundness reduces the transmission of the funding shock to credit supply by 22%, 8% and 10%, respectively. Overall, banks reallocate credit toward firms with low debt levels, low default risk, high available collateral, and a high interest coverage ratios. The paper also provides insights on the timing of funding shock impact and the timing of the reallocation channels. It investigates whether the funding shock has real effects on firm investment and growth, before presenting its conclusions.
The findings also contain interesting information for bank regulators. The results reveal a bright sight of lending concentration during the times of crisis and are thus informative when making the trade-off between portfolio concentration risk and having sufficient information about borrowers. Finally, the results suggest that not only systemic risk and financial stability issues should be taken into account when studying the welfare implications of portfolio diversification, but that it could also be relevant to consider the potentially beneficial impact of lending concentration on firm credit supply.
Related Link: Working Paper (PDF)
Keywords: Europe, EU, Banking, Concentration Risk, Systemic Risk, Credit Risk, Credit Allocation, Research, ECB
Featured Experts
Jun Chen
A well-recognized researcher in the field; offers many years of experience in the real estate finance industry, and leads research efforts in expanding credit risk analytics to commercial real estate.
James Partridge
Credit analytics expert helping clients understand, develop, and implement credit models for origination, monitoring, and regulatory reporting.
Michael Zeng
Credit risk modeling expert; data scientist; machine learning researcher
Previous Article
PRA Publishes Results of Survey on Cyber Insurance Underwriting RiskRelated Articles
BIS Innovation Hub Sets Out Work Program for 2021
BIS Innovation Hub published the work program for 2021, with focus on suptech and regtech, next-generation financial market infrastructure, central bank digital currencies, open finance, green finance, and cyber security.
EC Plans to Consult on Crisis Management and EDIS Framework Revisions
In an article published by SRB, Mairead McGuinness, the European Commissioner for Financial Services, Financial Stability, and Capital Markets Union, discussed the progress and next steps toward completion of the Banking Union.
EBA Finalizes Remuneration Standards for Investment Firms in EU
EBA finalized the two sets of draft regulatory technical standards on the identification of material risk-takers and on the classes of instruments used for remuneration under the Investment Firms Directive (IFD).
ECA Recommends Actions to Enhance Resolution Planning for Banks
EC published, in the Official Journal of the European Union, a notification that the European Court of Auditors (ECA) has published a special report on resolution planning in the Single Resolution Mechanism.
BoE Publishes Key Elements of the 2021 Stress Testing for Banks in UK
BoE published a scenario against which it will be stress testing banks in 2021, in addition to setting out the key elements of the 2021 stress test, guidance on the 2021 stress test, and the variable paths for the 2021 stress test.
PRA Proposes Rules on Identity Verification of Depositor Protection
PRA published a consultation paper (CP3/21) proposes rules regarding the timing of identity verification required for eligibility of depositor protection under the Financial Services Compensation Scheme (FSCS).
FSB Publishes Work Program for 2021
FSB published the work program for 2021, which reflects a strategic shift in priorities in the COVID-19 environment.
FCA Issues Update on Move to New Data Collection Platform
FCA announced that 50% firms have started using the new data collection platform RegData, which is slated to replace the existing platform known Gabriel.
Bundesbank Publishes Derivation Rules for Reporting by Banks
Bundesbank published Version 5.0 of the derivation rules for completeness check at the form level, with respect to the data quality of the European harmonized reporting system.
FED Revises Capital Planning and Stress Testing Requirements for Banks
FED finalized a rule that updates capital planning requirements to reflect the new framework from 2019 that sorts large banks into categories, with requirements that are tailored to the risks of each category.
