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An unexpected crisis? Looking at pricing effectiveness of different banks

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  • Valerio Vacca

    () (Bank of Italy)

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    Abstract

    This paper shows how credit quality transition matrices of loans to Italian firms changed during a cyclical downturn (2008-09), compared with a previous time of growth (2006-07). Once transition matrices were linked to interest rates, banks appear to have been remarkably able at calibrating required risk premiums to actual idiosyncratic risk, both during expansion and recession. However, the uncertainty generated by the crisis accentuated the unexpected component of credit worsening, thus lowering pricing effectiveness. The main finding is that larger banking groups were more affected by the sudden deterioration of credit quality than smaller ones, as far as ability to price risk is concerned. The bank-size effect can be tackled through an efficient use of hard or soft information: both rating users and decentralized banks showed an above-average ability in calibrating rates to risk during the crisis; banks with a stronger relationship with borrowers smoothed the risk-price curve in normal times.

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    File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td11/td814_11/en_td814/en_tema_814.pdf
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    Bibliographic Info

    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 814.

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    Date of creation: Jul 2011
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    Handle: RePEc:bdi:wptemi:td_814_11

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    Web page: http://www.bancaditalia.it
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    Keywords: banking; crisis; credit migration; credit risk pricing;

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    1. benvenuti, m. & casolaro, l. & del prete, s. & mistrulli, p. e., 2010. "Loan Officer Authority and Small Business Lending.Evidence from a survey," MPRA Paper 26475, University Library of Munich, Germany.
    2. Estrella, Arturo, 2004. "The cyclical behavior of optimal bank capital," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1469-1498, June.
    3. Magri, Silvia & Pico, Raffaella, 2011. "The rise of risk-based pricing of mortgage interest rates in Italy," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1277-1290, May.
    4. Fabio Panetta & Fabiano Schivardi & Matthew Shum, 2004. "Do mergers improve information? Evidence from the loan market," Temi di discussione (Economic working papers) 521, Bank of Italy, Economic Research and International Relations Area.
    5. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
    6. Giorgio Gobbi & Francesca Lotti, 2004. "Entry decisions and adverse selection: an empirical analysis of a local credit markets," Temi di discussione (Economic working papers) 535, Bank of Italy, Economic Research and International Relations Area.
    7. Dell'Ariccia, Giovanni & Marquez, Robert, 2004. "Information and bank credit allocation," Journal of Financial Economics, Elsevier, vol. 72(1), pages 185-214, April.
    8. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
    9. Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
    10. Robert Hauswald & Robert Marquez, 2006. "Competition and Strategic Information Acquisition in Credit Markets," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 967-1000.
    11. Giorgio Albareto & Michele Benvenuti & Sauro Mocetti & Marcello Pagnini & Paola Rossi, 2008. "Lending organizational structure and the use of credit scoring: evidence from a survey on Italian banks," Questioni di Economia e Finanza (Occasional Papers) 12, Bank of Italy, Economic Research and International Relations Area.
    12. Marcello Bofondi & Giorgio Gobbi, 2004. "Bad Loans and Entry into Local Credit Markets," Temi di discussione (Economic working papers) 509, Bank of Italy, Economic Research and International Relations Area.
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    Cited by:
    1. Leonardo Gambacorta & Paolo Emilio Mistrulli, 2011. "Bank heterogeneity and interest rate setting: What lessons have we learned since Lehman Brothers?," BIS Working Papers 359, Bank for International Settlements.

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