Financial Stability 1/2004
Annex 2: Current research at Norges Bank on financial stability
Below are short summaries of articles dealing with financial stability issues written by researchers at Norges Bank and published in international professional journals with anonymous expert evaluations in 2003 and 2004. The conclusions and viewpoints presented in these articles are those of the authors and do not represent the views of Norges Bank.
Estimating switching costs: the case of banking
Authors: Moshe Kim (University of Haifa), Doron Kliger (University of Haifa) and Bent Vale (Norges Bank)
Publication: Journal of Financial Intermediation 12 (2003), pp. 25-56
We present an empirical model of bank behaviour when changing banks involves switching costs for borrowers. The model is applied to a panel of Norwegian banks for the period 1991 to 1993 to assess the switching costs. Switching costs comprise all kinds of costs for customers who switch banks, including the loss of advantages built up through a bank-customer relationship. The point estimate of the average switching cost for a borrower is 4.1% of the stock in question. This amounts to approximately one-third of the average lending rate in the estimation period. The estimate is statistically significant. More than a quarter of the added value to the bank of a customer relationship is attributed to the lock-in phenomenon generated by these switching costs. If one only considers switches between the largest banks, the estimate for switching costs is no longer statistically significant. Methodologically, a multiperiod model is used. This model contains customers’ transition probabilities (probability of switching banks). The model derives estimable equations of banks’ first-order conditions, market shares (demand) and cost equations. The novelty of the model is in its ability to extract information on both the magnitude and significance of switching costs from bank-specific aggregated data which do not contain customer-specific information.
Banks’ buffer capital: how important is risk?
Author: Kjersti-Gro Lindquist (Norges Bank)
Publication: Journal of International Money and Finance 23 (2004), pp. 493-513
Most banks hold a capital to asset ratio well above the required minimum defined by the present capital adequacy regulation (Basel I). Using bank-level panel data from Norway, important hypotheses concerning the determination of this buffer capital are analyzed. Focus is on the importance of: (i) risk, (ii) the buffer as an insurance, (iii) the competition effect, (iv) supervisory discipline, and (v) economic growth. A negative or non-significant risk effect is found, which suggests that introducing a more risk-sensitive capital regulation (Basel II) is likely to affect Norwegian banks. Support is found for the hypothesis that buffer capital serves as an insurance against failure to meet the capital requirements.
Scale economies, bank mergers, and electronic payments: A spline function approach
Authors: David B. Humphrey (Florida State University, Tallahassee) and Bent Vale (Norges Bank)
Publication: Journal of Banking and Finance 28 (2004), s. 1671-1696
This paper demonstrates the importance of using a flexible cost function specification when analyzing economies of scale and estimating the cost effect of banking mergers. The inflexibility of the translog cost function is illustrated and results are compared to more flexible spline and Fourier cost functions. Using these different approaches, we predict the ex ante effect on average cost from mergers over the period 1987–1998 using a balanced panel of 130 Norwegian banks. On average, mergers are predicted to lower costs. Predictions using the Fourier or spline approaches are in overall agreement with computed actual average merger-cost changes ex post. On the whole, the 26 mergers studied have lowered average bank costs. Cost effects of the transition from paper-based to electronic payments are also estimated and exceed cost reductions associated with mergers.