Market response to bank relationships: Evidence from Korean bank reform

This paper examines how the forced closure of failing banks and the transfer of their loans to surviving banks affect the market value of firms that borrow from the closed banks. Pre-existing relationships between firms and the banks that acquire their loans are detrimental to the positive valuation effects of the event. Banks may have an incentive to favor pre-existing relationships to increase the value of previously extended loans. Therefore, loan renewals to firms with prior relationships do not signal borrower quality to the market, which is aware of the banks’ conflicts of interest. This study highlights the importance of the specific mechanisms employed to replace failed banks without decreasing the value of their client firms.     

Foreign bank entry and firms’ access to bank credit: Evidence from China

This paper studies the impact of foreign bank entry on domestic firms’ access to bank credit using a within-country staggered geographic variation in the policy of foreign bank lending in China. The paper finds that after foreign bank entry profitable firms use more long-term bank loans; whereas firms with higher value of potential collateral do not. It also finds that non-state-owned firms become able to substitute some trade credit with long-term bank loans. The findings suggest that less opaque firms and non-state-owned firms benefit more from foreign bank entry and that collateral may only play a limited role in mitigating the problem of information asymmetry when creditors’ rights are not well protected in a host country.     

Market discipline during crisis: Evidence from bank depositors in transition countries

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in a worse financial condition than their subsidiaries. This situation created a unique opportunity to study new aspects of market discipline exercised by non-financial depositors. Using a comprehensive data set, we find that the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. We establish that depositors’ actions were more strongly influenced by negative press rumors concerning parent companies than by fundamentals. The impact of rumors was especially perceptible when rumors turned out ex post to be founded. Additionally, we document that public aid announcements were primarily interpreted by depositors as confirmation of a parent company’s financial distress. Our results indicate that depositors react rationally to sources of information other than financial statements; this discovery has policy implications, as depositor discipline is usually the only viable and universal source of market discipline for banks in emerging economies.     

Does IT investment improve bank performance? Evidence from Europe

This paper investigates whether investment in information technology (IT) – hardware, software and other IT services – influences the performance of banks. Using a sample of 737 European banks over the period 1995–2000 we analyse whether IT investment is reflected in improved performance (measured using both standard accounting ratios and cost and alternative profit efficiency measures). Despite banks being major investors in IT we find little relationship between total IT investment and improved bank profitability or efficiency indicating the existence of a profitability paradox. However, the impact of different types of IT investment (hardware, software and services) on banks’ performance is heterogeneous. Investment in IT services from external providers (consulting services, implementation services, training and education, support services) appears to have a positive influence on accounting profits and profit efficiency, while the acquisition of hardware and software seems to reduce banks’ performance.     

CEO pay incentives and risk-taking: Evidence from bank acquisitions

We analyze how the structure of executive compensation affects the risk choices made by bank CEOs. For a sample of acquiring U.S. banks, we employ the Merton distance to default model to show that CEOs with higher pay-risk sensitivity engage in risk-inducing mergers. Our findings are driven by two types of acquisitions: acquisitions completed during the last decade (after bank deregulation had expanded banks' risk-taking opportunities) and acquisitions completed by the largest banks in our sample (where shareholders benefit from ‘too big to fail’ support by regulators and gain most from shifting risk to other stakeholders). Our results control for CEO pay-performance sensitivity and offer evidence consistent with a causal link between financial stability and the risk-taking incentives embedded in the executive compensation contracts at banks.     

Effect of collateral characteristics on bank performance: Evidence from collateralized stocks in Taiwan

Taiwanese law requires directors of listed firms to disclose their stocks collateralized at banks creating the possibility of examining the characteristics of collateralized stocks and their influence on bank performance. This study demonstrates that the risk (value) attributes of collateralized stocks increase (reduce) bank efficiency yet reduce (increase) bank profits. Government-owned banks but not private banks require sufficiently high margins to prevent stock loans from non-performing. Furthermore, banks charge higher interest to cover the non-performing risk. Directors who lack funds, hold high turnover stocks, and/or have weak relationships with their banks prefer to collateralize their stocks at private banks.     

The effects of focus versus diversification on bank performance: Evidence from Chinese banks

This paper investigates the effects of focus versus diversification on bank performance using data on Chinese banks during the 1996–2006 period. We construct a new measure, economies of diversification, and compare the results to those of the more conventional focus indices, which are based on the sum of squares of shares in different products or regions. Diversification is captured in four dimensions: loans, deposits, assets, and geography. We find that all four dimensions of diversification are associated with reduced profits and higher costs. These results are robust regardless of alternative measures of diversification and performance. Furthermore, we observe that banks with foreign ownership (both majority and minority ownership) and banks with conglomerate affiliation are associated with fewer diseconomies of diversification, suggesting that foreign ownership and conglomerate affiliation may play important mitigating roles. This analysis may provide important implications for bank managers and regulators in China as well as in other emerging economies.     

Explaining underpricing of IPOs in frontier markets: Evidence from the Nigeria Stock Exchange

The paper provides empirical analyses of IPO underpricing on the Nigerian Stock Exchange, from the period 1990 to 2006. The results indicate an average abnormal initial day returns of 43.1%. There is evidence of long-run underperformance of 0.6%. Results from our regression model explaining initial abnormal returns for the IPOs of Nigeria show that size of firm and audit quality are important variables affecting underpricing. The results also show the presence of a non-linear relationship between the offer price and underpricing.     

Corporate fraud and bank loans: Evidence from china

Receiving punishment from regulators for corporate fraud can affect financing contracts between a firm and its bank, as both the firm’s credit risk and information risk increase after punishment. By focusing on Chinese firms’ borrowing behavior after events of corporate fraud, we find that firms’ bank loans after punishment are not only significantly lower, but are also less than those for non-fraudulent firms. In addition, loan interest rates after punishment are not only higher than before, but also higher than those for their non-fraudulent counterparts. In addition, we find that corporate fraud indirectly destabilizes the “performance-bank loan” relationship. Our results suggest that corporate fraud negatively affects a firm’s ability to source debt financing, which provides new evidence about the economic consequences of fraud.     

Explaining bank distress in Eastern European transition economies

This paper considers the joint role of macroeconomic, structural and bank-specific factors in explaining the occurrence of banking problems in the nineteen Eastern European transition countries over the last decade. With data at the individual bank level we show, using a discrete time survival model, that all three factors interact in their impact and have a rich dynamic profile, which underlines the highly volatile cycles challenging the stability of banks in this region. A fragile funding basis accompanied by high exposure to market risk in an environment of reforms and macroeconomic disturbances is the typical precursor of bank distress.     

Financial freedom and bank efficiency: Evidence from the European Union

This paper investigates the dynamics between the financial freedom counterparts of the economic freedom index drawn from the Heritage Foundation database and bank efficiency levels. We rely on a large sample of commercial banks operating in the 27 European Union member states over the 2000s. After estimating bank-specific efficiency scores using Data Envelopment Analysis (DEA), we develop a truncated regression model combined with bootstrapped confidence intervals to test our main hypotheses. Results suggest that the higher the degree of an economy’s financial freedom, the higher the benefits for banks in terms of cost advantages and overall efficiency. Our results also show that the effects of financial freedom on bank efficiency tend to be more pronounced in countries with freer political systems in which governments formulate and implement sound policies and higher quality governance.     

Structural models of credit risk are useful: Evidence from hedge ratios on corporate bonds

Structural models of credit risk provide poor predictions of bond prices. We show that, despite this, they provide quite accurate predictions of the sensitivity of corporate bond returns to changes in the value of equity (hedge ratios). This is important since it suggests that the poor performance of structural models may have more to do with the influence of non-credit factors rather than their failure to capture the credit exposure of corporate debt. The main result of this paper is that even the simplest of the structural models [Merton, R., 1974. On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance 29, 449–470] produces hedge ratios that are not rejected in time-series tests. However, we find that the Merton model (with or without stochastic interest rates) does not capture the interest rate sensitivity of corporate debt, which is substantially lower than would be expected from conventional duration measures. The paper also shows that corporate bond prices are related to a number of market-wide factors such as the Fama-French SMB (small minus big) factor in a way that is not predicted by structural models.     

The effects of bank relationships on firm private debt restructuring: Evidence from an emerging market

Our paper seeks to examine the direct benefit of bank relationships for a distressed borrower by assessing its influence on the success of firm private debt restructuring. We find that a distressed firm with a stronger bank relationship has a greater probability to successfully restructure its debt through private renegotiation. Accordingly, an analysis of credit rating recovery provides complementary evidence on the factors of successful debt restructuring. A duration analysis of the length of time needed for a debt restructuring to be completed is fully consistent with our documented results. We conclude that in a bank dominated financial system like Taiwan's where firms are heavily bank-dependent, the bank-firm relationship is of crucial importance to the success of financially distressed firms in private debt restructuring.     

Greasing the wheels of bank lending: Evidence from private firms in China

Bribery, rather than firm performance, largely determines the extent to which private firms access bank credit in China. Bribery enables an economic outcome whereby firms with better economic performance are awarded larger loans. These firms also pay more in terms of bribes. Although satisfactory firm performance does determine whether firms can access loans, it does so only for loans originated by the big-four banks. For loans originated by smaller banks, performance is not essential for firms to secure loan access. Our evidence sheds light on the surprising finding of earlier studies that Chinese banks use commercial logic in their lending practices despite being endowed with a weak institutional framework.     

Banking relationships and access to equity capital markets: Evidence from Japan’s main bank system

We study the role of banking relationships in IPO underwriting. When a firm in Japan goes public, it can engage an investment bank that is related through a common main bank, or can select an alternative investment bank. The main bank relationship can be an efficient way for the investment bank to acquire information generated by the main bank, but may give rise to conflicts of interest. We find that main bank relationships give small issuers increased access to equity capital markets, but that issuers of large IPOs often switch to non-related investment banks that are capable of managing large offerings. While investment banks seek to exploit bargaining power with related issuers, issuers respond to expected high issue cost by switching to non-related investment banks. The net result is that total issue costs through related and non-related investment banks are similar. With respect to aftermarket performance and use of proceeds, we find no evidence of conflict of interest or self-dealing for either the main bank or the investment bank.     

Common risk factors in bank stocks

This paper provides evidence on the risk factors that are priced in bank equities. Alternative empirical models with precedent in the nonfinancial asset pricing literature are tested, including the single-factor CAPM, three-factor Fama–French model, and ICAPM. Our empirical results indicate that an unconditional two-factor ICAPM model that includes the stock market excess return and shocks to the slope of the yield curve is useful in explaining the cross-section of bank stock returns. However, we find no evidence that firm specific factors such as size and book-to-market ratios are priced in bank stock returns. These results have a number of important implications for the estimation of the banks’ cost of capital as well as regulatory initiatives to utilize market discipline to evaluate bank risk under Basel II.     

Bank incentives and suboptimal lending decisions: Evidence from the valuation effect of bank loan announcements in Japan

Using a sample of bank loan announcements in Japan, we examine whether or not banks have incentives to engage in suboptimal lending that results in wealth transfer from the banks to the borrowing firms. We find that abnormal returns for borrowing firms are significantly positive, but those for lending banks are sometimes significantly negative. Furthermore, the announcement returns for borrowing firms are negatively related to those for lending banks, especially when poorly performing firms borrow from financially healthy (low-risk) banks. Our results suggest that the positive valuation effect of bank loan announcements for borrowing firms is mainly due to a wealth transfer from lending banks.     

The international transmission of bank capital requirements: Evidence from the UK

We use data on UK banks? minimum capital requirements to study the impact of changes to bank-specific capital requirements on cross-border bank loan supply from 1999Q1 to 2006Q4. By examining a sample in which each recipient country has multiple relationships with UK-resident banks, we are able to control for demand effects. We find a negative and statistically significant effect of changes to banks? capital requirements on cross-border lending: a 100 basis point increase in the requirement is associated with a reduction in the growth rate of cross-border credit of 5.5 percentage points. We also find that banks tend to favor their most important country relationships, so that the negative cross-border credit supply response in “core” countries is significantly less than in others. Banks tend to cut back cross-border credit to other banks (including foreign affiliates) more than to firms and households, consistent with shorter maturity, wholesale lending which is easier to roll off and may be associated with weaker borrowing relationships.     

Corporate tax,capital structure,and the accessibility of bank loans: Evidence from China

In this paper, we investigate whether listed firms in China adjust their capital structure in response to an increase in the corporate tax rate. Although theories of capital structure suggest that corporate tax is an important determinant of capital structure, how exogenous changes of the tax rate affect firms’ leverage decisions has not been fully explored. We examine a unique circumstance in which the Chinese government increased the corporate tax rate of firms that had previously received local government tax rebates. The evidence indicates that these firms increased their leverage when the corporate tax rate increased. Further investigation suggests that the adjustment of leverage was mostly driven by firms with a high level of access to bank loans.     

Implications of bank ownership for the credit channel of monetary policy transmission: Evidence from India

Using bank-level data from India, we examine the impact of ownership on the reaction of banks to monetary policy, and also test whether the reaction of different types of banks to monetary policy changes is different in easy and tight policy regimes. Our results suggest that there are considerable differences in the reactions of different types of banks to monetary policy initiatives of the central bank, and that the bank lending channel of monetary policy is likely to be much more effective in a tight money period than in an easy money period. We also find differences in impact of monetary policy changes on less risky short-term and more risky medium-term lending. We discuss the policy implications of the findings.