We study how the Basel III regulations, namely the Capital-to-Assets Ratio (CAR), the Net Stable Funding Ratio (NSFR) and the Liquidity Coverage Ratio (LCR), are likely to impact banks' profitability (i.e., ROA), capital levels and default. We estimate historical series of the new Basel III regulations for a panel of Luxembourgish banks for a period covering 2003q2-2011q3. We econometrically investigate whether historical LCR and NSFR components, as well as CAR positions are able to explain the variation in a measure of a bank's default risk (approximated by Z-score) and how these effects make their way through banks' ROA and CAR. We find that the liquidity regulations induce a decrease in average probabilities of default. We find that the liquidity regulation focusing on maturity mismatches (i.e., NSFR) induces a decrease in average probabilities of default. Conversely, the impact on banks' profitability is less clear-cut; what seems to matter is banks' funding structure rather than the characteristics of the portfolio of assets. Additionally, we use a model of bank behavior to simulate the banks' optimal adjustments of their balance sheets as if they had to adhere to the regulations starting in 2003q2. Then, we predict, using our preferred econometric model and based on the simulated data, the banks' Z-score and ROA. The simulation exercise suggests that basically all banks would have seen a decrease in their default risk during a crisis episode if they had previously adhered to Basel III.

No abstract

This paper uses individual household data from Luxembourg to evaluate how severe economic conditions could affect bank exposure to the household sector. Using data from a representative survey, information on household income, expenses and liquid assets are used to calculate a household-specific probability of default (PD). Aggregate bank exposure at default (EAD) is obtained by multiplying these household-level PDs by their corresponding volume of outstanding loans and summing across the population of households. Aggregate bank loss given default (LGD) is calculated by assuming that banks recover real estate assets from defaulting households and liquidate them with a haircut. To simulate adverse economic conditions, the exercise is repeated with scenarios combining severe but plausible shocks (i.e. tail risk) to real estate prices, bonds and stocks, household income and interest rates. Compared to the no-shock baseline, the LGD rises by a multiple of eight, reaching 4.2% of total bank exposure to the household sector. Thus, bank losses appear to be quite sensitive to severe stress. The high-stress scenario also generates a relatively high percentage of defaults among socioeconomically disadvantaged households (i.e. low net wealth, low income, low education, three or more dependent children). For instance, households in the lowest income quintile see their PD rise from 9.3% in the no-shock baseline to 14.8% in the most severe scenario. Our main conclusion is that bank losses appear to be quite sensitive to financial stress, despite three mitigating factors in Luxembourg: indebted households tend to hold liquid assets that can help smooth shocks, household leverage tends to decline rapidly once mortgages have been serviced several years, and loan-to-value ratios at origination appear not to be excessive.

We extend the literature on the bank lending channel in two aspects. First, rather than following the literature by analyzing the impact of banks' liquidity (measured via their asset portfolio) on monetary policy transmission, we study the role of banks' actual liquidity risk, as measured by the Basel III liquidity regulations. Second, we investigate the effect of complying with the Basel III liquidity standards on monetary policy transmission. We use highly detailed bank-level data from Luxembourg for the period 2003q1-2010q4. Our findings are that monetary policy transmission works its way through small banks that also have a large maturity mismatch, as measured by the Net Stable Funding Ratio. In contrast, large banks with a small maturity mismatch increase their lending following a monetary policy shock, which confirms existing results that Luxembourg's banks are liquidity providers to the European market. Based upon in-sample predictions and upon simulated data from an optimization model that takes the banks' business models into account, we conclude that the bank lending channel will no longer be effective once banks adhere to the new Basel III liquidity regulations.

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in Fixed Instruments to Cope with Stock Externalities An Experimental Evaluation SummaryWe evaluate the effectiveness of non optimal and temporally inconsistent incentive policies for regulating the exploitation of a renewable common-pool resource. The corresponding game is an N-person discrete-time deterministic dynamic game of T periods fixed duration. Three policy instruments with parameters that remain constant for the whole horizon are evaluated: a pigouvian tax (flat tax), an ambient tax (ambient flat tax) and an instrument combining the two previous ones (mixed flat instrument). We test in the lab the predictions of the model solved for 3 distinct behavioural assumptions: (a) sub-game perfection, (b) myopic behaviour, and (c) joint payoff maximization. We find that subjects behave myopically in the unregulated situation, which agrees with previous results in the literature. Conditional on predictions, the mixed flat instrument and the flat tax are the most effective policies in approaching the optimum extraction path. However, in absolute terms the ambient flat tax and the mixed flat instrument curb most significantly the mean extraction path towards the optimum path. Paradoxically, these instruments are the less efficient ones.