The essence of structured finance activities is the pooling of economic assets like loans, bonds, and mortgages, and the subsequent issuance of a prioritized capital structure of claims, known as tranches, against these collateral pools. As a result of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. This ability of structured finance to repackage risks and to create “safe” assets from otherwise risky collateral led to a dramatic expansion in the issuance of structured securities, most of which were viewed by investors to be virtually risk-free and certified as such by the rating agencies. At the core of the recent financial market crisis has been the discovery that these securities are actually far riskier than originally advertised. We examine how the process of securitization allowed trillions of dollars of risky assets to be transformed into securities that were widely considered to be safe, and argue that two key features of the structured finance machinery fueled its spectacular growth. First, we show that most securities could only have received high credit ratings if the rating agencies were extraordinarily confident about their ability to estimate the underlying securities’ default risks, and how likely defaults were to be correlated. Using the prototypical structured finance security—the collateralized debt obligation (CDO)—as an example, we illustrate that issuing a capital structure amplifies errors in evaluating the risk of the underlying securities.

/pdf/the-economics-of-structured-finance-g4s0jtjqs5.pdf

The Economics of Structured Finance

The essence of structured finance activities is the pooling of economic assets (e.g. loans, bonds, mortgages) and subsequent issuance of a prioritized capital structure of claims, known as tranches, against these collateral pools. As a result of the prioritization scheme used in structuring claims, many of the manufactured tranches are far safer than the average asset in the underlying pool. We examine how the process of securitization allowed trillions of dollars of risky assets to be transformed into securities that were widely considered to be safe, and argue that two key features of the structured finance machinery fueled its spectacular growth. At the core of the recent financial market crisis has been the discovery that these securities are actually far riskier than originally advertised.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1287363_code698198.pdf?abstractid=1287363&rulid=828&mirid=3

States and economic growth: Capacity and constraints☆

Introduction Part I. An Imperial Ecology: 1. Regions, resources, and settlement 2. Growth and its limits 3. Disasters of the later sixteenth century 4. Land at the margins: Karaman and Larende Part II. The Little Ice Age Crisis: 5. The Little Ice Age in the Near East 6. The great drought 7. The Celali Rebellion 8. In the wake of the Celalis: climate and crisis in the seventeenth century Part III. Ecological Transformation: 9. Desert and sown 10. City and country 11. Provisioning and commerce Conclusion.

The Climate of Rebellion in the Early Modern Ottoman Empire

The use of accounting measures and disclosures in banks’ contracts and regulation suggests that the quality of banks’ financial reporting is central to the efficacy of market discipline and nonmarket mechanisms in limiting banks’ development of debt and risk overhangs in economic good times and in mitigating the adverse consequences of those overhangs for the stability of the financial system in downturns. This essay examines how research on banks’ financial reporting, informed by the financial economics literature on banking, can generate insights about how to enhance the stability of the financial system. We begin with a foundational discussion of how aspects of banks’ accounting and disclosures may affect stability. We then evaluate representative papers in the empirical literature on banks’ financial reporting and stability, pointing out the research design issues that empirical accounting researchers need to confront to develop well-specified tests able to generate reliably interpretable findings. To this end, we provide examples of settings amenable to addressing these issues. We conclude with considerations for accounting standard setters and financial system policy makers.

https://pages.stern.nyu.edu/~sternfin/vacharya/public_html/pdfs/acharya%20ryan%20september%2029%202015%20docx.pdf

Banks' Financial Reporting and Financial System Stability

In the wake of the financial crisis of 2007–2009, as various banking policymakers revisit loan loss provisioning rules, the Spanish approach of dynamic provisioning has garnered attention as a potential alternative to the current incurred loss approach. We review the current approach to loan loss reserves in the United States, focusing on how loan loss reserves relate to bank solvency and why the current accounting approach may have procyclical effects. We present a conceptual framework to compare loan loss provisioning under the incurred loss framework and dynamic provisioning. Then we simulate dynamic provisioning with U.S. data to present an empirical comparison.

Dynamic Provisioning: A Countercyclical Tool for Loan Loss Reserves

Tail dependence and indicators of systemic risk for large US depositories

Loan loss provisions, accounting constraints, and bank ownership structure

The rules governing banks' loan loss provisioning and reserves require a trade-off between the goals of bank regulators, who emphasize safety and soundness, and the goals of accounting standard setters, who emphasize the transparency of financial statements. A strengthening of accounting priorities in the decade prior to the financial crisis was associated with a decrease in the level of loan loss reserves in the banking system.

/pdf/loan-loss-reserve-accounting-and-bank-behavior-1k3wa72o99.pdf

Loan Loss Reserve Accounting and Bank Behavior

(ProQuest: ... denotes formula omitted.) The methodology to recognize loan losses set forth by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) is referred to as the incurred loss model and defined as the identification of inherent losses in a loan or portfolio of loans. Inherent credit losses, under current accounting standards in countries following FASB and IASB, are event driven and should only be recognized upon an event's occurrence.1 This has tended to mean that reserves for loan losses on a bank's balance sheet need to grow significantly during an economic downturn, a time associated with increased credit impairment and default events. Critics of the incurred loss model have pointed to it as one of the causes of the severity of strain many financial institutions experienced at the onset of the financial crisis of 2007-2009. As rapid provisioning to increase loan loss reserves made headlines, discussions of international regulatory banking reform included the method of dynamic provisioning as a potential alternative to the incurred loss approach (see, for example, Cohen 2009). Dynamic provisioning is a statistical method for loan loss provisioning that relies on historical data for various asset classes to determine the level of provisioning that should occur on a quarterly basis in addition to any provisions that are event driven.2 The primary goal of dynamic provisioning is the incremental building of reserves during good economic times to be used to absorb losses experienced during economic downturns. We begin this paper with a discussion of the current approach to loan loss reserves (LLR) in the United States. We argue that, to a social planner who cares both about avoiding bank failures and the efficiency of bank lending, the current accounting and regulatory approach for LLR may be suboptimal on both fronts. First, by taking provisions after the economic downturn has set in, a bank faces higher insolvency risk. When a banker or regulator determines that a bank has inadequate LLR, the bank will have to build the reserves in an unfavorable economic environment. Also, inadequate reserves imply that regulatory capital ratios have been overstated, placing the bank at a higher risk for resolution by the Federal Deposit Insurance Corporation (FDIC). Second, as most banks tend to increase LLR during the economic downturn, the current approach may be procyclical; that is, it may amplify the business cycle. We aim to highlight some of the potential inefficiencies under the incurred loss approach by contrasting it to dynamic provisioning. Dynamic provisioning was instituted in Spain in 2000 in response to some of the same problems we highlight in the United States. We present a conceptual framework to compare loan loss provisioning under the incurred loss framework and dynamic provisioning. Then we simulate dynamic provisioning with U.S. data to present an empirical comparison. In the remainder of this section, we offer a brief summary of our main arguments and the conclusions from the simulation exercise. In accounting terms, the LLR account, also known as the allowance for loan and lease losses (ALLL), is a contra-asset account used to reduce the value of total loans and leases on a bank's balance sheet by the amount of losses that bank managers anticipate in the most likely future state of the world.3 LLR incorporate both statistical estimates and subjective assessments. Provisioning is the act of building the LLR account through a provision expense item on the income statement. While we present the intuition behind LLR in this section, the Appendix to the paper describes their important accounting features in basic terms. Interest margin income from loans is a smooth flow whereas a loan default or impairment event causes a lumpy drop in the stock of bank assets. This introduces volatility to banks' balance sheets. By themselves, a large number of loans may be insufficient to smooth these fluctuations out due to the correlation between the risks in the portfolio of bank loans. …

/pdf/dynamic-provisioning-a-countercyclical-tool-for-loan-loss-1fov1p0za8.pdf

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Dynamic Provisioning: A Countercyclical Tool for Loan Loss Reserves

Tail dependence and indicators of systemic risk for large US depositories

Loan loss provisions, accounting constraints, and bank ownership structure

Loan Loss Reserve Accounting and Bank Behavior

Dynamic Provisioning: A Countercyclical Tool for Loan Loss Reserves