Abstract:
The policy response to the recent financial crisis has broadly focused on two themes: 1) Increasing the banking sectorsâ resilience to future financial shocks: 2) Improving credit availability to households and firms via lowering both short and long-term interest rates and thereby affecting short-term output and inflation. This dissertation studies how banks and firms have responded to these policy measures. The dissertation comprises of three chapters. The first two analyze the impact of capital regulation on bank lending for two different jurisdictions - United States and Switzerland. The third evaluates the response of U.S. non-financial firms to lower interest rates. The first chapter is joint work with Luisa Lambertini. We estimate the impact of bank capital regulation on lending spreads. We use U.S. firm-level data on syndicated loans matched with Bank Holding Company (BHC) data for the lending banks in our panel regressions. We find that higher bank capital leads to an increase in the loan pricing. Further, we investigate if stress test failure under the Supervisory Capital Assessment Program and Comprehensive Capital Analysis and Review leads to higher loan spreads, since financial institutions that failed were required to raise capital in the short run. Using a difference-in-difference framework, we find: 1) BHCs that failed the stress tests increased their loan pricing; 2) Loan pricing is higher for all banks after the commencement of the stress tests. These findings suggest that greater regulatory oversight and higher capital requirements have made syndicated loans more costly for firms. The second chapter is joint work with Luisa Lambertini, Dan Wunderli and Robert Bichsel. We use confidential loan-by-loan data of Swiss banks to study the impact of higher capital requirements on lending. Our data allows us to trace the link between bank capital and new credit granted at the bank level. Additionally bank-specific variation of capital targets allows us to analyze how deviation from the regulatory capital target impacts loan pricing and volume. We find that tighter capital regulation has small but statistically significant short-term effects on loan pricing and growth. We do not find a permanent effect of higher capital ratios on loan growth. In the third chapter, I study the behavior of U.S. non-financial corporates after the recent financial crisis. I document an increase in the real debt holdings and correspondingly the book leverage for these firms. Controlling for firm and time fixed-effects, I find a higher long-term debt to asset ratio to be associated with lower capital expenditures and growth in fixed capital post-crisis. This is also true for financially unconstrained firms, as determined by the Whited-Wu index, vis-a-vis pre-crisis. Moreover, firms with a higher share of long-term debt after the crisis appear to have a greater likelihood of repurchasing shares and larger dollar payouts to equity holders. The evidence points to the fact that any increase in long-term debt has had an impact on firms' capital structure but no positive effect on real investment.Keywords:
Stress test
Syndicated loan
Capital (architecture)
Risk appetite
Leverage (statistics)
Intermediation
Bank failure
Capital (architecture)
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This paper documents the characteristics of public recapitalizations of banks undertaken since 2008 and examines their relationship with bank lending. The analysis covers the 15 OECD countries whose banking sectors were most severely hit by the crisis and that provided the largest public bailouts relative to their national gross domestic product (GDP). We show that the design of the interventions varied considerably across banks and countries. Larger and higher loss-absorbing capital injections were targeted at weaker banks and at banks of ‘systemically relevant’ size, when the state of public finances allowed. Our results encourage theoretical research with respect to non-linear and potentially adverse effects of bailouts, as well as further investigation into the link between the loss absorbing properties of bank capital and loan growth. With respect to bank lending, we find that only large recapitalizations and infusions of common equity are associated with higher total regulatory capital ratios and sustained loan growth. We find no significant relationship between public capital provisions and interbank lending and challenge the view that local banks increase loan growth relatively more in response to a recapitalization.— Mike Mariathasan and Ouarda Merrouche (This abstract was borrowed from another version of this item.)
Recapitalization
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We study the impact of higher capital requirements on banks’ balance sheets and their transmission to the real economy. The 2011 EBA capital exercise is an almost ideal quasi-natural experiment to identify this impact with a difference-in-differences matching estimator. We find that treated banks increase their capital ratios by reducing their risk-weighted assets, not by raising their levels of equity, consistent with debt overhang. Banks reduce lending to corporate and retail customers, resulting in lower asset, investment, and sales growth for firms obtaining a larger share of their bank credit from the treated banks. Received November 28, 2016; editorial decision March 9, 2018 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which are available on the Oxford University Press Web site next to the link to the final published paper online.
Natural experiment
Equity
Capital (architecture)
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This paper investigates the impact of the new capital requirements introduced under the Basel III framework on bank lending rates and loan growth. Higher capital requirements, by raising banks’ marginal cost of funding, lead to higher lending rates. The data presented in the paper suggest that large banks would on average need to increase their equity-to-asset ratio by 1.3 percentage points under the Basel III framework. GMM estimations indicate that this would lead large banks to increase their lending rates by 16 basis points, causing loan growth to decline by 1.3 percent in the long run. The results also suggest that banks’ responses to the new regulations will vary considerably from one advanced economy to another (e.g. a relatively large impact on loan growth in Japan and Denmark and a relatively lower impact in the U.S.) depending on cross-country variations in banks’ net cost of raising equity and the elasticity of loan demand with respect to changes in loan rates.
Basel III
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Using information of the balance sheets of Spanish banks between 1995 and 2009, we estimate the average impact of current and anticipated changes in banks' capital on firm lending. We isolate the role of credit supply factors using the variation in capital growth associated to the bank-specific historical exposure to real estate development – measured 10 years before the outburst of the financial crisis - and its interaction with the change in housing prices in the provinces where they operate. We further control for the quality of borrowers by using industry fixed effects. Our main results suggest firstly that lagged exposure to real estate development and its interaction with prices explain banks' capital growth and the overall doubtful loans ratio after 2008 – in turn, a determinant of anticipated changes in capital. And, secondly, that the deterioration of banks' capital position has had a negative, although of a limited magnitude, effect on the supply of loans to non-construction firms. Our interpretation is that banks that have experienced capital shortfalls or banks that have increased their capital but without reaching the level that is demanded by financial markets might have had no option but to reduce their lending. The relatively small magnitude of credit supply factors may be explained by the weakness of loan demand in a context of a deep recession.
Slowdown
Supply side
Demand side
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Within the context of a banking institution, economic capital is a statistical measure of the amount of resources required to meet unexpected losses over a specified time period and specified level of certainty. The amount of economic capital held by banks is thus a function of their target insolvency rate (the probability that losses will exceed a certain threshold) and is linked to an implied credit rating. In Australia, for example, the top four banks maintain sufficient economic capital to achieve a target credit rating of AA, which is equivalent to a 0.03% probability of insolvency. The benefits that accrue to banks from a high credit rating, in general, are access to lower cost funds in debt markets and low counterparty margins in swap and foreign exchange markets. However, as banks increase their economic capital to achieve a higher credit rating, the breakeven price on their asset portfolios will rise to the extent that the bank prices these assets to achieve a minimum return on economic capital. Ceteris paribus, the increase in loan rates may make the bank uncompetitive in specific asset markets, depending on the extent to which loan rates and other asset prices are market driven. Thus an increase in the solvency standard for a bank has two opposing effects on bank asset prices. To the extent that a bank prices its assets to achieve a target return on economic capital, an increase in economic capital will increase the net income that the bank needs to earn on its assets, resulting in higher asset prices. Offset against this, is the impact of a higher solvency standard on the cost of funds and market credit spreads for the bank. We propose that a bank that carries a large proportion of its funding book in retail funds may not benefit by targeting a high credit rating, depending on the sensitivity of retail depositors to incremental changes in credit rating. We model this relationship to ascertain an optimal economic capital requirement, varying the relative proportion of retail funds in the funding book. We compare the results of our model to empirical data on bank credit spreads in capital to markets to assess the extent to which an upgrade in the credit rating of a bank will be beneficial to the bank.
Probability of default
Credit rating
Credit crunch
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Margin (machine learning)
Stress test
Bank credit
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This paper addresses the question whether the existence of a secondary loan market changes the capital structure decision of banks. The results show that banks issue more debt if there is a secondary loan market in good times, when loans are sold at the fair price. The fair price ensures that an increase in investment increases the profit of the bank. On the other hand, banks issue less debt if there is a secondary loan market in bad times. This implies that the effect of loan sales on the bank's capital structure depends on the state of the economy. The bank engages in over-investment, if it can sell its loans in the secondary loan market in good times, as opposed to under-investment in bad times. In summary, the existence of a secondary loan market amplifies the effects of booms and busts linked to macroeconomic cycles.
Capital (architecture)
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We use a large matched sample of individual loans, borrowers, and banks to investigate whether financial health affects terms of lending, holding constant proxies for borrower risk and information costs. In particular, we focus on measuring effects of borrower and characteristics on loan interest rates; we also investigate implications of borrower and characteristics for indirect measures of credit availability. ; Our principal findings are six. First, even after controlling for proxies for borrower risk and information costs, the cost of borrowing from low-capital banks is higher than the cost of borrowing from well-capitalized banks. Second, this cost difference is traceable to borrowers for which information costs and incentive problems are a piori important. Third, weak effects on the cost of funds are higher in periods of aggregate contractions in lending. Fourth, estimated weak effects remain even after controlling for unobserved heterogeneity in the matching of borrowers and banks. Fifth, weak effects are quantitatively important only for high-information-cost borrowers, consistent with models of switching costs in bank-borrower relationships and with the underpinnings of the lending of monetary policy. Sixth, when we investigate determinants of cash holdings of borrowing firms, we find that firms facing high information costs hold more cash than other firms, all else being equal, and those firms (and only those firms) have higher cash holdings when they are loan customers of weak banks. These results suggest declines in banks' financial health can lead to precautionary saving by some firms, a response which may affect their investment spending. ; This evidence sheds light on two sets of questions. First, our estimated effects of characteristics on borrowing cost are consistent with models of switching costs for borrowers for whom banking relationships are most valuable. Second, our findings are consistent with switching costs for the borrowers stressed by the bank lending channel of monetary policy.
Capital expenditure
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