Has the US Bond Market Lost its Edge to the Eurobond Market?*
Atavros Peristiani(Federal Reserve Bank of New York)
Jo?o A. C. Santos(Federal Reserve Bank of New York)

The growth of the European financial markets, together with the new, stricter regulations on the US financial markets, has spurred a debate over the competitiveness of the US financial markets. In this paper, we contribute to this debate by investigating the relative competitiveness of the US bond market over the last 10 years. In the early 1990s, the gross spread in the US bond market were significantly lower than in the Eurobond market. While this spread continued to decline in the US bond market, it declined at an even faster rate in the Eurobond market, to the point of eliminating the wide cost differential that existed between the two markets in the early 1990s. These findings are robust and suggest that the relative costs of bond underwriting declined in the Eurobond market. We also find that US firms are increasingly opting to issue their bonds in the Eurobond market, and that this relocation is partly driven by the decline in the relative gross spreads in the Eurobond market. This finding adds support to our conclusion that the cost of bond underwriting declined faster in the Eurobond market, reinforcing the view that the US bond market is facing a greater challenge from the Eurobond market.

*The authors thank an anonymous referee, Darius Miller and seminar participants at the Federal Reserve Bank of New York, the conference ‘Global Market Integration and Financial Crises’ jointly organized by the Center for Asian Financial Markets at HKUST and the International Review of Finance for useful comments, and Sarita Subramanian for her research assistance. The views stated herein are those of the authors and are not necessarily those of the Federal Reserve Bank of New York, or the Federal Reserve System.

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Downturn Credit Portfolio Risk, Regulatory Capital and Prudential Incentives*
Daniel R?sch(Institute of Banking & Finance, Leibniz University of Hannover)
Harald Scheule(Department of Finance, Faculty of Economics and Commerce, University of Melbourne)

This paper analyzes the level and cyclicality of bank capital requirement in relation to (i) the model methodologies through-the-cycle and point-in-time, (ii) four distinct downturn loss rate given default concepts, and (iii) US corporate and mortgage loans. The major finding is that less accurate models may lead to a lower bank capital requirement for real estate loans. In other words, the current capital regulations may not support the development of credit portfolio risk measurement models as these would lead to higher capital requirements and hence lower lending volumes. The finding explains why risk measurement techniques in real estate lending may be less developed than in other credit risk instruments. In addition, various policy recommendations for prudential regulators are made.

*The authors would very much like to thank the anonymous reviewer(s) as well as the participants and discussants of the EFA Annual Meeting 2008 in Athens, the International Conference on Price, Liquidity, and Credit Risks 2009 in Konstanz, the FCCCE 2009 conference in Perth as well as the financial seminars at the University of Bristol, Deutsche Bundesbank, University of Edinburgh, Leibniz University Hannover, Hong Kong Institute of Monetary Research and The University of Melbourne. The financial support of the Melbourne Centre for Financial Studies and the Hong Kong Institute for Monetary Research is gratefully acknowledged.

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Cross-Border Exposures and Financial Contagion
Hans Degryse(CentER, European Banking Center, TILEC, Tilburg University and CESifo)
Muhammad Ather Elahi(CentER, Tilburg University)
Maria Fabiana Penas(CentER, European Banking Center, TILEC, Tilburg University and CESifo)

Integrated financial markets provide opportunities for expansion and improved risk sharing, but also pose threats of contagion risk through cross-border exposures. This paper examines cross-border contagion risk over the period 1999–2006. To that purpose we use aggregate cross-border exposures of 17 countries as reported in the Bank for International Settlements Consolidated Banking Statistics. We find that a shock that affects the liabilities of one country may undermine the stability of the entire financial system. Particularly, a shock wiping out 25% (35%) of US (UK) cross-border liabilities against non-US (non-UK) banks could lead to bank contagion eroding at least 94% (45%) of the recipient countries’ banking assets. We also find that since 2006 a shock to Eastern Europe, Turkey and Russia affects most countries. Our simulations also reveal that the ‘speed of propagation of contagion’ has increased in recent years resulting in a higher number of directly exposed banking systems. Finally, we find that contagion is more widespread in geographical proximities.

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Loan Sales and Loan Market Competition*
Jung-Hyun Ahn(Department of Economics and Finance, Rouen Business School)

In this article, I suggest a theoretical explanation for the recent spectacular growth of the loan sales market in terms of both quantity and quality. I show that banks can use loan sales as a strategic tool in order to preserve their informational advantage in a competitive environment. I consider a two-period competition model where banks acquire private information about their clientele during the lending relationship and where there is informational asymmetry in the loan sales market. In spite of the information dilution costs incurred in selling high-quality loans, banks have an incentive to imitate low-quality loan holders by selling their loans in order to avoid communicating negative signals about the quality of their clientele to potential competitors. As a result, loan market competition can lead to the emergence of a liquid loan sales market in which both low- and high-quality loans coexist, thereby improving the quantity and quality of the loan sales market.

*The author thanks David Andolfatto, Vincent Bignon, Régis Breton, Jean Cartelier, Antoine Martin, Bruno Parigi, Jean-Charles Rochet and Laurence Scialom as well as participants of the 26th Symposium on Money, Banking and Finance (Orléans, June 2009). The author also thanks an anonymous referee for helpful comments. The usual disclaimer applies.

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Financial Liberalization and Banking Crises: A Cross-Country Analysis*
Apanard P. Angkinand(Milken Institute and Department of Economics, University of Illinois Springfield)
Wanvimol Sawangncoenyuang(Department of Economics, University of Illinois Springfield)
Clas Wihlborg(Chapman University and Department of Finance, Copenhagen Business School)

Several studies indicate that financial liberalization contributes to the likelihood of a financial crisis. We focus on banking crises and argue that they are most likely to occur after an intermediate degree of liberalization. Using a recently updated dataset for financial reforms in 48 countries between 1973 and 2005, we find an inverted U-shaped relationship between liberalization and the likelihood of crisis. We ask whether the relationship remains when institutional characteristics of countries and dynamic effects of liberalization are considered. The empirical results indicate that the relationship between liberalization and banking crises depends strongly on the strength of capital regulation and supervision. With very weak regulation and supervision, the probability of banking crises is increasing with liberalization but this relationship is reversed as regulation and supervision become stricter. The most important type of liberalization in relation to banking crises seems to be behavioral (a relaxation of interest and credit controls). A policy implication is that positive growth effects of liberalization can be achieved without increasing the risk of a banking crisis if appropriate institutions are developed.

*We would like to thank an anonymous referee and our discussant, Jennifer Huang, as well as other participants in the ‘Global Market Integration and Financial Crises,’ July 12–13, 2009, for useful comments. We are also grateful to Arthur Denzau, Tripon Phumiwasana, and Thomas D. Willett for comments on earlier drafts. The views expressed in this paper are those of the authors and do not necessarily represent those of the Bank of Thailand.

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