Managerial Rationale for Entry and the Relation to Performance and Small-Business Lending

In a survey of banks founded from 1994–2002, we find over 85% of respondents think their small-business market was underserved, 72% felt the market needed more competition, almost half indicated they were likely to start a bank because takeover activity displaced them, and 75% entered due to a market merger. Markets of banks started by displaced managers or following a merger have performance and lending characteristics similar to comparable banks, but larger changes in asset growth rates. Managers who responded that small-businesses were underserved have higher numbers and amounts of small-business loans 3 years after entry. Managers responding that entry was due to mergers eliminating community banks have lower ROA, but larger changes in market ROA. Markets had smaller changes in ROA when entry was to provide competition or when managers thought the small business market was underserved.

Bank capitalization and lending behavior after the introduction of the Basle Accord

In this paper, we provide evidence that banks with a low level of capitalization have reduced their commitment with respect to lines of credit after the introduction of the Basle Accord. A bank's lending behavior reflects its level of commitment towards borrowers, which in turn affects the level of effort it exerts on screening and monitoring the activities of borrowers. We find that the post-Basle Accord market reaction to the announcement of lines of credit issued by banks with a low level of capitalization is significantly lower than the reaction to other types of bank credit announcements. We interpret this result as evidence that some banks have a low level of commitment associated with lines of credit after the Basle Accord.

Bank Competition,Risk, and Subordinated Debt

This paper studies a dynamic model of banking in which banks compete for insured deposits, issue subordinated debt, and invest in either a prudent or a gambling asset. The model allows banks to choose their level of risk after the interest rate on subordinated debt is contracted. We show that requiring banks to issue a small amount of subordinated debt can reduce their gambling incentives. Moreover, when equity capital is more expensive than subordinated debt, adding a subordinated debt requirement to a policy regime that only uses equity capital requirements is Pareto improving.

Bank Competition and Financial Stability

Under the traditional “competition-fragility” view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative “competition-stability” view, more market power in the loan market may result in higher bank risk as the higher interest rates charged to loan customers make it harder to repay loans, and exacerbate moral hazard and adverse selection problems. The two strands of the literature need not necessarily yield opposing predictions regarding the effects of competition and market power on stability in banking. Even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques. We test these theories by regressing measures of loan risk, bank risk, and bank equity capital on several measures of market power, as well as indicators of the business environment, using data for 8,235 banks in 23 developed nations. Our results suggest that—consistent with the traditional “competition-fragility” view—banks with a higher degree of market power also have less overall risk exposure. The data also provides some support for one element of the “competition-stability” view—that market power increases loan portfolio risk. We show that this risk may be offset in part by higher equity capital ratios.

Publicly traded versus privately held: implications for conditional conservatism in bank accounting

Compared with privately held banks, publicly traded banks face greater agency costs because of greater separation of ownership and control but enjoy greater benefits from access to the equity capital market. Differences in control and capital market access influence public versus private banks’ accounting. We predict and find that public banks exhibit greater degrees of conditional conservatism (asymmetric timeliness of the recognition of losses versus gains in accounting income) than private banks. We predict and find that public banks recognize more timely earnings declines, less timely earnings increases, and larger and more timely loan losses. Although public ownership gives managers greater ability and incentive to exercise income-increasing accounting, our findings show that the demand for conservatism dominates within public banks and that the demand for conservatism is greater among public banks than private banks. Our results provide insights for accounting and finance academics, bank managers, auditors, and regulators concerning the effects of ownership structure on conditional conservatism in banks’ financial reporting.

Information, Credit Risk, Lender Specialization and Loan Pricing: Evidence from the DIP Financing Market

We provide an empirical support for theories of lender specialization using the recently developed market for Debtor-in-Possession (DIP) financing. The legal environment in which DIP financing operates represents a natural laboratory for testing determinants of lending specialization (e.g. lender choice). We find that the choice of lender is not driven by credit risk, but by information considerations and that this lending specialization has loan pricing effects. In short, banks (non-bank lenders) lend to more (less) transparent firms and at lower (higher) loan spreads. Our results are consistent with the interpretation that banks provide important and useful services.

Credit Unions and Small Business Lending

Among the issues raised by consolidation within the banking industry is a concern that small businesses will be less able to obtain credit as community banks are acquired by larger or non-local institutions. Community banks have traditionally been a major source of funding for small businesses. The impact of bank consolidation on credit availability may depend in part on whether the remaining community institutions expand their small business lending activities. This study examines whether credit unions have a propensity to extend business loans in markets that have experienced bank merger and acquisition activity. We find some evidence that credit unions are more likely to engage in business lending in markets characterized by greater bank merger and acquisition activity. Moreover, the estimated economic significance is meaningful in many of the specifications.

Do Internet Activities Add Value? Evidence from the Traditional Banks

Very little is known about how adopting Internet activities impact traditional banks. By tracing the experience of Italian commercial banks, we provide evidence and implications for banks’ use of new Internet technology and innovative banking products as they relate to performance. Using different definitions for what is considered as Internet activity and by examining alternative proxies for bank return and risk, we find a significant link between offerings of Internet banking products and bank performance. Although this link is significantly positive for bank returns, we find a negative, marginally significant, association between the adoption of Internet activities and bank risk.

The Sensitivity of the Loss Given Default Rate to Systematic Risk: New Empirical Evidence on Bank Loans

We verify the existence of a relation between loss given default rate (LGDR) and macroeconomic conditions by examining 11,649 bank loans concerning the Italian market. Using both the univariate and multivariate analyses, we pinpoint diverse macroeconomic explanatory variables for LGDR on loans to households and SMEs. For households, LGDR is more sensitive to the default-to-loan ratio, the unemployment rate, and household consumption. For SMEs, LGDR is influenced by the total number of employed people and the GDP growth rate. These findings corroborate the Basel Committee’s provision that LGDR quantification process must identify distinct downturn conditions for each supervisory asset class.

Bank Liability Structure,FDIC Loss,and Time to Failure: A Quantile Regression Approach

Deposit insurers are particularly concerned about high-cost failures. When the factors driving such failures differ systematically from the determinants of low- and moderate-cost failures, a new estimation technique is required. Using a sample of more than 1,000 bank failures in the U.S. between 1984 and 2003, I present a quantile regression approach that illustrates the sensitivity of the dollar value of losses in different quantiles to my explanatory variables. These findings suggest that reliance on standard econometric techniques results in misleading inferences, and that losses are not homogeneously driven by the same factors across the quantiles. I also find that liability composition affects time to failure.

Regulator Scrutiny and Bank CEO Incentives

This study analyzes the effects of monitoring intensity on compensation and turnover for CEOs of publicly-traded banks. Using a sample of banks from 1992 to 2004, I find that monitoring intensity plays a significant role in compensation levels, pay-for-performance sensitivity, and CEO turnover. The results show that CEOs from highly-rated institutions receive smaller pay than CEOs from competing institutions, and that monitoring intensity, as proxied by CEO age, influences the relationship between market performance and executive incentives. These findings suggest that regulatory ratings and CEO age impact optimal bank governance structure by varying incentive sensitivity to market performance.

Income Diversification and Bank Performance: Evidence from Italian Banks

Using annual data from Italian banks, we study the link between non-interest revenues and profitability. We find that income diversification increases risk-adjusted returns. Our results provide econometric evidence consistent with current studies on EU banks, but do not support findings on the U.S. experience. In our view, the differences depend primarily on the relative importance of local banks: we find that the relation is stronger at large banks. In addition, we find that there are limits to diversification gains as banks get larger. Small banks can make gains from increasing non-interest income, but only when they have very little non-interest income share to start with. The source of non-interest income is less important than its level.

Relationship Banking and the Pricing of Financial Services

We investigate pricing effects of the joint production of loans and security underwritings. We control for firm and borrower characteristics, including differences in sequencing, which are important for pricing. Contrary to previous studies, when banks combine lending and underwriting within the same customer relationship they charge premiums for both loans and underwriting services. Abstracting from effects of joint production within relationships, depository banks engaged in underwriting price lending and underwriting more cheaply than stand alone investment banks. One advantage borrowers enjoy from bundling products within a banking relationship is a form of liquidity risk insurance, which is manifested in a reduced demand for lines of credit. We also find evidence of a “road show” effect; firms enjoy loan pricing discounts on loans that are negotiated at times close to the debt underwritings, whether or not the same bank provides both services. Relationship effects are only visible when lending and underwriting both occur, and are stronger for equity-loan relationships than for debt-loan relationships. Electronic supplementary material  The online version of this article (doi:) contains supplementary material, which is available to authorized users.

Distribution of the shareholder base of Swiss cantonal banks

In this paper, the equity distribution of the free float of shareholders and shares is examined at six different Swiss cantonal banks. The percentage of shareholders and shares held in the home canton of a given cantonal bank is significantly higher than compared to the averages of the rest of the cantonal banks. When scaling this data to the population/legal entities in a given canton, in all cases (excluding outlier data from the smallest of Swiss cantons), the shareholder and share ratio is much higher for the home canton than the rest of the cantons. We also see some evidence that the scaled shareholder and share ratio is higher at neighboring cantons compared to the rest of Swiss cantons; it is significantly so in two cases. Lastly, we also see some evidence that the scaled shareholder and share ratio is higher at cantons that speak the same language compared to cantons that speak a different language for a given cantonal bank; it is significantly so in about half the shareholder and one third of the share distribution data.

The value relevance of corporate restructuring charges

We document in this study that investors react positively to restructuring that is expected to be successful in improving firm performance. Investors’ reaction is significantly negative to unsuccessful firms when the magnitude of restructuring charges is high. Our results also show that investors’ reaction is significantly positive to restructuring that is intended to save costs through “workforce reduction” and “facility closings/consolidations”, but it is insignificant when restructuring is undertaken to recognize decline in asset values by asset write-offs and/or write-downs. Investor reaction is measured by 12-month buy-and-hold abnormal returns, whereas successful restructuring to improve the firm performance is based on the change in operating performance, measured by the industry-adjusted return on equity (ROE), over two subsequent years after restructuring.

How Much Do Banks Use Credit Derivatives to Hedge Loans?

Before the credit crisis that started in mid-2007, it was generally believed by top regulators that credit derivatives make banks sounder. In this paper, we investigate the validity of this view. We examine the use of credit derivatives by US bank holding companies with assets in excess of one billion dollars from 1999 to 2005. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2005 the gross notional amount of credit derivatives held by banks exceeds the amount of loans on their books. Only 23 large banks out of 395 use credit derivatives and most of their derivatives positions are held for dealer activities rather than for hedging of loans. The net notional amount of credit derivatives used for hedging of loans in 2005 represents less than 2% of the total notional amount of credit derivatives held by banks and less than 2% of their loans. We conclude that the use of credit derivatives by banks to hedge loans is limited because of adverse selection and moral hazard problems and because of the inability of banks to use hedge accounting when hedging with credit derivatives. Our evidence raises important questions about the extent to which the use of credit derivatives makes banks sounder.

Valuation of global IPOs: a stochastic frontier approach

This paper studies the impact of global offerings on US IPO firms’ offer price using the stochastic frontier approach. We find that the offer price valuation efficiency for global IPOs exceeds that of IPOs with purely domestic offers by 3.1%. In particular, the global offering approach is most appropriate to those IPO firms, which offer larger proportion of new shares to international investors, underwritten by less prestigious investment banks and with larger firm-specific return variance. Our findings are consistent with the demand inelasticity, certification effect and investor recognition arguments that account for the benefits of global offering.

Regulatory Capital Arbitrage and the Potential Competitive Impact of Basel II in the Market for Residential Mortgages

U.S. banking regulators have proposed a bifurcated system of capital regulation where the largest, internationally active banking organizations would be subject to significantly more risk sensitive regulatory capital requirements than are currently in place, while most others would remain subject to the current rules. The proposed new capital regime has the potential to affect the competitive landscape among banking institutions, particularly in the area of residential mortgage lending. We analyze the potential competitive effects of the proposed, bifurcated regulatory capital system on competition in the residential mortgage market from the perspective of the theory of regulatory capital arbitrage. We then apply the theory and available evidence to perform some benchmark calculations that suggest a significant, potential shift of market share and income to the largest banking institutions in the mortgage market.

Heterogeneous multiple bank financing: does it reduce inefficient credit-renegotiation incidences?

Small and medium-sized firms often obtain capital via a mixture of relationship and arm’s-length bank lending. We show that such heterogeneous multiple bank financing leads to a lower probability of inefficient credit foreclosure than both monopoly relationship lending and homogeneous multiple bank financing. Yet, in order to reduce hold-up and coordination-failure risk, the relationship bank’s fraction of total firm debt must not become too large. For firms with intermediate expected profits, the probability of inefficient credit-renegotiation is shown to decrease along with the relationship bank’s information precision. For firms with extremely high or extremely low expected returns, however, it increases.

The Effect of SFAS No. 131 on the Cross-segment Variability of Profits Reported by Multiple Segment Firms

Our study assesses whether SFAS No. 131 improved disclosure about the diversity of multiple segment firms’ operations. We find a post-SFAS No. 131 increase in cross-segment variability of segment profits, an increase in the association between reported and inherent cross-segment variability, and an increase in association between reported variability and capital market incentives to disclose. We interpret the results as evidence that SFAS No. 131 increased the transparency of segment profitability disclosures, and as indicating SFAS No. 131 allowed firms depending more on external financing to disclose more about differences in segment profitability.