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.

The changing structure of local credit markets: Are small businesses special?

In many countries consolidation in the banking industry has reduced the number of small banks and led to significant shifts in market shares; deregulation has fostered entry in local credit markets and the expansion of branch networks, increasing competition in local markets. Small businesses are believed to be more vulnerable to these changes, since they are more dependent on credit from local banks. In this paper we investigate the consequences of consolidation and entry for these borrowers compared with those for large firms. We employ a data set for Italy, which provides information on volumes of loans and bad loans by size of borrower with a detailed geographical partition. We find that mergers are followed by a temporary reduction in outstanding credit to all sizes of borrowers and by an increase in bad loans, most likely due to the reassessment of banks portfolios. Entry has a relatively persistent negative impact on credit supply to small and medium-sized firms. Our results also show that concentration, branch density and the share of branches of small banks affect the volumes of credit and bad loans of small borrowers.     

Bank lending during the financial crisis of 2008

This paper shows that new loans to large borrowers fell by 47% during the peak period of the financial crisis (fourth quarter of 2008) relative to the prior quarter and by 79% relative to the peak of the credit boom (second quarter of 2007). New lending for real investment (such as working capital and capital expenditures) fell by only 14% in the last quarter of 2008, but contracted nearly as much as new lending for restructuring (LBOs, M&As, share repurchases) relative to the peak of the credit boom. After the failure of Lehman Brothers in September 2008, there was a run by short-term bank creditors, making it difficult for banks to roll over their short term debt. We find that there was a simultaneous run by borrowers who drew down their credit lines, leading to a spike in commercial and industrial loans reported on bank balance sheets. We examine whether these two stresses on bank liquidity led them to cut lending. In particular, we show that banks cut their lending less if they had better access to deposit financing and thus, they were not as reliant on short-term debt. We also show that banks that were more vulnerable to credit-line drawdowns because they co-syndicated more of their credit lines with Lehman Brothers reduced their lending to a greater extent.     

Debt maturity dispersion and the cost of bank loans

This paper examines the relation between corporate debt maturity dispersion and the pricing and terms of bank loans. Analyzing a sample of U.S. bank loans from 2002 to 2016, we find that firms with a dispersed debt maturity structure pay a lower interest rate. The rate-reduction effect is significant only for firms without a credit rating. For these firms, spreading debt maturity dates also results in lower commitment fees, fewer covenant restrictions, and less collateral in their loan contracts. The impact of debt maturity dispersion on the pricing and structure of bank loans is stronger when borrowers have higher rollover risk or when the need for monitoring is greater. Our results suggest that dispersion in debt maturity structure mitigates the agency problem associated with shareholder–creditor conflicts by reducing rollover risk and alleviating the need for monitoring, which results in borrowers receiving more favorable terms in loan contracts.     

A Comparison of Syndicated Loan Pricing at Investment and Commercial Banks

We reject the hypothesis that investment and commercial banks have identical loan-pricing policies. We find that compared to commercial banks, investment banks lend to less profitable, more lever aged firms, price riskier classes of term loans more generously, and offer relatively longer-term credits, usually with term, not commitment contracts. Investment banks typically establish higher credit spreads, although the premium declines when a commercial bank joins as syndicate co-arranger. Investment banks also price riskier classes of term loans more generously to borrowers than do commercial banks. Commercial-bank funding advantages do not appear to be a source of the pricing differences.     

The Role of Bank Reputation in “Certifying” Future Performance Implications of Borrowers’ Accounting Numbers

We investigate the role played by the reputation of lead arrangers of syndicated loans in mitigating information asymmetries between borrowers and lenders. We hypothesize that syndications by more reputable arrangers are indicative of higher borrower quality at loan inception and more rigorous monitoring during the term of the loan. We investigate whether borrowers with more reputable lead arrangers realize superior performance subsequent to loan origination relative to borrowers with less reputable arrangers. We further examine whether certification by high‐reputation lead banks extends to the quality of borrowers’ reported accounting numbers. Controlling for endogenous matching of borrowers and lead banks, we find that higher bank reputation is associated with higher profitability and credit quality in the three years subsequent to loan initiation. We also show that bank reputation is associated with long‐run sustainability of earnings via higher earnings persistence, and debt contracting value of accounting via a stronger connection between pre‐loan profitability and future credit quality. We further document that the enhanced earnings sustainability associated with higher reputation lead banks reflects both superior fundamentals and accruals more closely linked with future cash flows.     

Finance and inequality: The distributional impacts of bank credit rationing

We analyze reductions in bank credit using a natural experiment where unprecedented flooding in Pakistan differentially affected banks that were more exposed to the floods. Using a unique data set that covers the universe of consumer loans in Pakistan and this exogenous shock to bank funding, we find two key results. First, following an increase in their funding costs, banks disproportionately reduce credit to borrowers with little education, little credit history, and seasonal occupations. Second, the credit reduction is not compensated by relatively more lending by less-affected banks. The empirical evidence suggests that a reduction in bank monitoring incentives caused the large relative decreases in lending to these borrowers.     

Competition,financial innovation and commercial bank loan portfolios

I examine how US commercial bank loan portfolios change in response to the rise of securitization markets and banking market deregulations over 1976–2003. Banks increasingly tilt their portfolios toward real-estate-backed loans. However, there are significant differences across banks. Larger banks and younger banks disproportionately shift their lending toward real-estate-backed loans, particularly commercial real-estate-backed loans, whereas smaller banks and older banks maintain greater shares of their loan portfolios in commercial and personal loans. When larger banks make more real-estate-backed loans, they charge lower interest rates, consistent with these banks lowering the costs of lending and expanding credit for borrowers. In contrast, smaller banks charge higher interest rates, consistent with these banks restricting lending to a select group of borrowers.     

Bank loan announcements and borrower stock returns before and during the recent financial crisis

The impact of U.S. bank loan announcements on the stock prices of the corporate borrowers has been decreasing during the two last decades with estimated two-day cumulative abnormal returns slipping from almost 200 basis points in the beginning of the 1980s to close to zero by the turn of the Century. We estimate excess returns before and after the onset of the most recent financial crisis. We find that while prior to August 2007 returns were indeed close to zero, afterwards returns jump back up to around 200 basis points. We surmise that in a booming credit market the certification of corporate borrowers by banks started to play a lesser role, while during the crisis the banks’ role was revitalized. Consistent with this interpretation we find that after August 2007 excess returns increase especially for loans with a longer maturity, and for smaller, levered, less profitable or lowly rated firms.     

The Effects of Banking Mergers on Loan Contracts

This paper studies the effects of banking mergers on individual business borrowers. Using information on individual loan contracts between banks and companies, I analyze the effect of banking consolidation on banks' credit policies. I find that in-market mergers benefit borrowers if these mergers involve the acquisition of banks with small market shares. Interest rates charged by the consolidated banks decrease, but as the local market share of the acquired bank increases, the efficiency effect is offset by market power. Mergers have different distributional effects across borrowers. When banks become larger, they reduce the supply of loans to small borrowers.     

Do Tighter Loan Covenants Signal Improved Future Corporate Results? The Case of Performance Pricing Covenants

Covenants in corporate bonds and loan agreements mitigate agency conflicts between borrowers and lenders and may provide a signal of borrower quality to help resolve information asymmetry. Performance pricing covenants in bank loans specify automatic adjustments to loan spreads based on borrowers’ subsequent performance. Our covenant signaling framework views interest‐decreasing performance pricing as a tight covenant associated with borrowers’ private information on improved future performance accompanied by reduced credit risk. This positive signal is associated with larger positive loan announcement returns and greater improvements in future borrower performance. Further, in addition to signaling value, we find that the spread impact of this class of covenant also depends on its option value and reduction in transaction costs.     

Intellectual property rights reform and the cost of corporate debt

This paper investigates the role of intellectual property rights (IPR) protection on the cost of bank loans for firms in 48 countries. Using substantial reforms of patent rights as a source of identifying variation, the paper provides strong evidence that borrowers from countries that underwent IPR reform experience significant reductions in the cost of bank debt. Importantly, the effects of IPR reform on loan rates are significantly larger in industries that are more IP-intensive. Additional analysis shows that in the wake of reforms borrowers obtain larger size loans, which indicates that improvements in IPR are associated with greater credit availability. IPR reform also increases foreign lenders participation in loan syndicates. Overall, these findings suggest that legal protection afforded to intellectual property has a significant impact on the cost of corporate borrowing and the ability of innovative firms to raise debt capital.     

Currency-Induced Credit Risk in a Dollarized Economy

We analyze the effects of exchange rate fluctuations on corporate credit default in a dollarized economy. The application, before an exogenous exchange rate shock, of a new regulation concerning currency-induced credit risk (CICR) in the Peruvian banking system created natural conditions for a comparison between exposed and unexposed corporate borrowers. We use firm-level data to find that CICR and debt dollarization have opposite effects on credit risk. While CICR increases default, debt dollarization reduces it. Our results suggest that banks transfer exchange risk as a hedging mechanism by lending to such borrowers in dollars only.     

The Promise of Credit Derivatives in Nonfinancial Corporations (and Why It's Failed to Materialize)

Although industrial companies played a big part in the growth of foreign exchange, interest rate, and commodity price derivatives, such companies have had almost no role in the growth of credit derivatives. As the authors point out, industrial corporates are exposed to credit risk in a variety of ways, including customer accounts receivable, longer‐term supply contracts, loans to customers and vendors, and counterparty exposures. Credit derivatives, moreover, would allow corporate users to avoid a number of drawbacks associated with other methods for managing credit risk, including credit insurance, factoring, and surety bonds or securitization. But, as both surveys and interviews with credit derivatives dealers suggest, corporates' direct use of credit derivatives has been very limited, accounting for less than 5% of the credit protection purchased using credit derivatives. As the surveys and interviews also indicate, there are a number of reasons why corporates may be reluctant to use credit derivatives: (1) Unlike the cases of interest rate or currency risk, credit risk management is typically the purview of business units rather than the corporate treasury, and the business units tend to have considerably less experience with derivatives. (2) The protection provided by a credit derivative is unlikely to provide a perfect match for the loss that would be suffered by a corporate in the event of a default. (3) The liquidity in credit derivatives tends to be greatest in maturities that are much longer than those of most corporate credit exposures. (4) It is harder for a corporate to determine how much protection to buy than for a financial. (5) While the existing credit derivative documentation (which is based on loans or bonds) works well for banks and investors, it is less satisfactory for the credit risk faced by corporates, which is often based on “payment.” (6) While accounting standards require that credit derivatives be marked to market, the inability of corporates to mark to market their underlying exposure being hedged leads to unwanted volatility of earnings. Nevertheless, as the authors predict in closing, if the corporate demand for credit risk transfer becomes large and urgent enough, these obstacles will likely turn out to be temporary roadblocks.     

The ability of banks to lend to informationally opaque small businesses

We test hypotheses about the effects of bank size, foreign ownership, and distress on lending to informationally opaque small firms using a rich new data set on Argentinean banks, firms, and loans. We also test hypotheses about borrowing from a single bank versus multiple banks. Our results suggest that large and foreign-owned institutions may have difficulty extending relationship loans to opaque small firms. Bank distress appears to have no greater effect on small borrowers than on large borrowers, although even small firms may react to bank distress by borrowing from multiple banks, raising borrowing costs and destroying some relationship benefits.     

Bank loans during the 2008 quantitative easing

We examine the effect of quantitative easing on the supply of bank loans. During the Fed’s quantitative easing programs, lending banks reduced relatively more loan spreads, offered longer loan maturities, provided larger loans, and loosened more covenants for firms whose long-term bond ratings were below BBB and were lower than those with investment-grade bond ratings. Furthermore, we find that new bank loans in this period were associated with a reduction in a firm’s value and an increase in default risk. These results indicate that banks took greater risk during the 2008 quantitative easing by relaxing lending standards to relatively riskier borrowers.     

Winners and losers from supervisory enforcement actions against banks

We investigate how supervisory enforcement actions (EAs) against banks affect their business borrowers. We find negative short-term valuation effects of EAs for large relationship borrowers, which are reversed after new loans are granted. Large non-relationship borrowers' valuations are unaffected by EAs, but turn negative after relationships are established with sanctioned banks. Additionally, sanctioned banks appear to offset uncertainty and reputational damage of EAs by improving credit terms and availability for relationship and non-relationship large businesses, but decrease credit availability to small businesses. The small business credit contraction may have significant negative economic consequences due to bank dependency and credit constraints.     

Bad Times,Good Credit

Banks’ limited knowledge about borrowers’ creditworthiness constitutes an important friction in credit markets. Is this friction deeper in recessions, thereby contributing to cyclical swings in credit, or is the friction reduced, as bad times reveal information about firm quality? We test these alternative hypotheses using internal ratings data from a large Swedish cross-border bank and credit scores from a credit bureau. The ability to classify corporate borrowers by credit quality is greater during bad times and worse during good times. Soft and hard information measures both display countercyclical patterns. Our results suggest that information frictions in corporate credit markets are intrinsically countercyclical and not due to cyclical variation in monitoring effort. The presence of countercyclical information frictions provides a rationale for countercyclical provisions or capital in banks to smooth credit cycles.     

Bank ownership and lending patterns during the 2008–2009 financial crisis: Evidence from Latin America and Eastern Europe

This paper examines the impact of bank ownership on credit growth in developing countries before and during the 2008–2009 crisis. Using bank-level data for countries in Eastern Europe and Latin America, we analyze the growth of banks’ total gross loans as well as the growth of corporate, consumer, and residential mortgage loans. While domestic private banks in Eastern Europe and Latin America contracted their loan growth rates during the crisis, there are notable differences in foreign and government-owned bank credit growth across regions. In Eastern Europe, foreign bank total lending fell by more than domestic private bank credit. These results are primarily driven by reductions in corporate loans. Furthermore, government-owned banks in Eastern Europe did not act counter-cyclically. The opposite is true in Latin America, where the growth of government-owned banks’ corporate and consumer loans during the crisis exceeded that of domestic and foreign banks. Contrary to the case of foreign banks in Eastern Europe, those in Latin America did not fuel loan growth prior to the crisis. Also, there are less pronounced and robust differences in the behavior of foreign and domestic banks during the crisis in Latin America.     

经济政策不确定性与企业贷款成本

基于大样本微观银行信贷数据,本文研究经济政策不确定性对企业的银行贷款成本的影响。研究发现,经济政策不确定性升高导致企业的银行贷款成本增加,且使得在中小型银行贷款的企业成本增加更多。异质性分析表明,经济政策不确定性升高对受政策因素影响较大的企业如小微企业、私营企业等的银行贷款成本的影响更为明显。进一步,对企业的银行贷款违约风险的研究发现,随着经济政策不确定性升高,企业的银行贷款违约风险反而降低。这表明,经济政策不确定性升高使得银行选择风险评级更低的贷款,符合谨慎性动机。本文研究结论表明,经济政策不确定性升高时,银行“自我保险”动机的增强使得企业的银行贷款成本增加,这在中小型银行中表现得更加明显,同时也更多地转嫁给中小企业。本文为经济政策不确定性对企业投资、宏观经济波动等的研究提供了微观解释机制,并揭示了政府经济政策的一致性、稳定性对维护金融稳定的重要作用。