Access to external finance: Theory and evidence on the impact of monetary policy and firm-specific characteristics

This paper examines firms’ access to bank and market finance when allowance is made for differences in firm-specific characteristics. A theoretical model determines the characteristics such as size, risk and debt that would determine firms’ access to bank or market finance; these characteristics can result in greater (or lesser) tightening of credit when interest rates increase. An empirical evaluation of the predictions of the model is conducted on a large panel of UK manufacturing firms. We confirm that small, young and risky firms are more significantly affected by tight monetary conditions than large, old and secure firms.     

Are There Optimal Multiple-Reserve Requirements?

A number of developing countries have adopted deficit finance regimes involving multiple- (currency and bond) reserve requirements. A key characteristic of these regimes is that the real interest rates on reservable bonds are higher than the real return rates on currency, so that the nominal interest rates on the bonds are positive. We seek an efficiency-based explanation for the existence of multiple-reserve regimes and for this key characteristic. We find that there are economies in which some of the efficient allocations can be supported only by multiple-reserve requirements, and that positive nominal bond rates may be needed to support some of these allocations. We also find that there are economies in which allocations supported by multiple-reserve regimes with negative nominal bond rates Pareto dominate single-reserve allocations, even when the latter are efficient relative to other single-reserve allocations. Journal of Economic Literature Classification Numbers: E42, E58, H62.     

Can Banks in Emerging Economies Benefit from Revenue Diversification?

This paper investigates the effect of revenue diversification on bank performance and risk. Using a panel dataset of 226 listed banks across 11 emerging economies and a new methodological approach, System Generalized Method of Moments estimators (System GMM), the results in this paper provide empirical evidence of the impact of the observed shift towards non-interest income generating activities on insolvency risk and bank performance. The core finding is that diversification across and within both interest and non-interest income generating activities decrease insolvency risk and enhance profitability. The results also show that these benefits are largest for banks with moderate risk exposures. By extension, these results have significant strategic implications for bank managers, regulators and supervisors who share a common interest in boosting bank performance and stability.     

Analysis of U.S. savings bonds

U.S. savings bonds are complex contracts. Financial planners have traditionally paid little attention to savings bonds, in part because they often offer below-market interest rates. However, they sometimes offer above-market interest rates, especially when one learns how to view and value their option features. All savings bonds contain put options that protect the investor against a rise in interest rates. Thus, they can be viewed as short-term, intermediate-term, or long-term bonds. The EE bonds also offer several tax options. We show how savings bonds can be used to beat the kiddie tax, to finance postsecondary education, and in retirement planning.     

Portfolio rebalancing and the transmission of large-scale asset purchase programs: Evidence from the Euro area

The European Central Bank's large-scale asset purchase program targeted safe assets, but also aimed to impact prices of risky assets. The mechanism for this is the “portfolio rebalancing channel”, where financial institutions’ portfolio decisions impact financial prices more broadly. We examine this mechanism using cross-sectional heterogeneity in how the financial portfolios of different sectors of the European economy were affected around the purchase program. We find evidence of rebalancing. In vulnerable countries, where macroeconomic unbalances and relatively high risk premia remained, we document rebalancing towards riskier securities. In less vulnerable countries, based on granular information for large European banks, we document rebalancing toward bank loans.     

An Investigation of the Impact of Interest Rates and Interest Rate Volatility on Australian Financial Sector Stock Return Distributions

Abstract:   This paper extends the existing literature by analysing the dual impact of changes in the interest rate and interest rate volatility on the distribution of Australian financial sector stock returns. In addition, a multivariate GARCH‐M model is used to analyse the impact of deregulation on the financial institutions sector. It was found that there is a consistent inter‐temporal trade off between risk and return over the different regulatory periods. Moreover, finance corporations were found to be highly sensitive to new shocks across the financial sector and deregulation increased the risk faced by finance corporations and small banks – effectively increasing the required rate of return and explaining the continued rationalisation of these sectors. Furthermore, deregulation has changed the fundamental relationship between interest rates and large bank stock excess returns from positive in the pre‐deregulation period to negative in the post‐deregulation period. This reflects the changing institutional environment from one of controlled credit rationing to a more competitive environment.     

Interventions in Markets with Adverse Selection: Implications for Discount Window Stigma

I study the implications for central bank discount window stigma of a workhorse model of adverse selection in financial markets. In the model, firms (banks) need to borrow to finance a productive project. There is limited liability and firms have private information about their ability to repay their debts, which gives rise to the possibility of adverse selection. The central bank can ameliorate the impact of adverse selection by lending to firms. Discount window borrowing is observable and it may be taken as a signal of firms' credit worthiness. Under some conditions, firms borrowing from the discount window may pay higher interest rates to borrow in the market, a phenomenon often associated with the presence of stigma. I discuss these and other outcomes in detail and what they suggest about the relevance of stigma as an empirical phenomenon.     

What Goes Up Must Come Down? Asymmetries and Persistence in Bank Deposit Rates

This paper contains a model of price setting in the presence of heterogeneous customers, explaining why bank interest rates respond sluggishly to some extended movements in market interest rates but not to others. Price (the bank interest rate) is likely to change only slightly with cost (the market interest rate) when the price-cost margin is already large and to be responsive when the price-cost margin is relatively small. The model is tested using data on interest rates offered for bank deposit instruments during 1987–2001. The results support the theoretical model, indicating that customer behavior plays a role in bank interest rate decisions.     

利率市场化改革与货币政策银行利率传导

现代货币政策框架的内涵之一是畅通的货币政策传导机制。在货币政策对银行利率的传导中,政策利率尤其是再融资工具利率能够通过市场利率向贷款利率和存款利率顺畅传导。本文构造了一个多部门局部均衡模型,刻画利率市场化程度的时变特征,从理论上讨论利率市场化程度与货币政策银行利率传导之间的内生关系,两者共同决定了利率市场化改革的成效。基于时变因子扩展向量自回归模型,本文进一步验证了理论分析的结论。研究发现:(1)利率市场化改革具有阶段性波动特征,利率市场化程度不是一直上升的,改革可能会曲折迂回。(2)利率市场化改革具有动态政策效应,多种改革政策共同推动渐进的利率市场化,但从货币政策银行利率传导的有效性进行考察,利率市场化改革仍然存在进一步推进的空间。因此,有必要完善贷款市场报价利率的形成、传导与调控机制,理顺不同利率之间的联动关系,疏通货币政策对银行利率的传导,充分发挥利率市场化改革的潜力。     

Return generating process and the determinants of term premiums

This paper examines asset pricing theories for treasury bonds using longer maturities than previous studies and employing a simple multi-factor model. We allow bond factor loadings to vary over time according to term structure variables. The model examines not only the time variation in the expected returns of bonds but also their unexpected returns. This allows us to explicitly test some asset pricing restrictions which are difficult to study under existing frameworks. We confirm that the pure expectation theory of the term structure of interest rates is rejected by the data. Our empirical study of a two-factor model finds substantial evidence of time-varying term-premiums and factor loadings. The fact that factor loadings vary with long-term interest rates and yield spreads suggest that bond return volatilities are sensitive to interest rate levels.     

Money,Bonds, and the Liquidity Trap

This paper examines a search model of money and public bonds in which coordination frictions lead to multiple, Pareto ranked equilibria. Whether money and bonds are substitutes or complements, is not a primitive of the economy, but an equilibrium outcome. There exists an equilibrium resembling a liquidity trap, in which money and bonds are perfect substitutes, interest rates are zero, and monetary policy is ineffective; and a superior equilibrium in which money and bonds are complements, interest rates are positive and monetary policy has a liquidity effect. On this view, the liquidity trap is a belief-driven phenomenon.     

Interest rates and currency prices in a two-country world

This paper is a theoretical study of the determination of prices, interest rates and currency exchange rates, set in an infinitely-lived two-country world which is subject both to stochastic endowment shocks and to monetary instability. Formulas are obtained for pricing all equity claims, nominally-denominated bonds, and currencies, and these formulas are related to earlier, closely related results in the theories of money, finance international trade.     

ILLIQUIDITY RISK,PROJECT CHARACTERISTICS,AND THE OPTIMAL MATURITY OF CORPORATE DEBT

I derive the optimal maturity period for corporate debt used to finance a specific project, when costly financial distress is triggered by the inability to meet coupon obligations. My model predicts a negative relation between bond risk and maturity, and it explains why high-grade bonds show greater maturity dispersion than low-grade bonds, as observed in U.S. corporate bond markets. The major determinant of bond maturity is project duration for low-risk bonds and project risk for high-risk bonds. Other determinants of bond maturity are debt burden, reorganization costs, corporate tax rate, interest rate, and project growth rate.     

Robust portfolio choice with stochastic interest rates

We determine the optimal investment strategy for an ambiguity-averse investor in a setting with stochastic interest rates. The investor has access to stocks, bonds, and a bank account and he is ambiguous about the expected rate of return of both bonds and stocks. The investor can have different levels of ambiguity aversion about the two types of risky assets. We find that it is more important to take model uncertainty about the stock dynamics than model uncertainty about the bond dynamics into account. Furthermore, the investor’s ambiguity increases his hedging demand. Consequently, the bond/stock ratio increases with his ambiguity and implies less extreme positions in the bank account. Altogether, our model yields portfolio allocations which are more in line with what is implementable in practice. Finally, we demonstrate that neglecting model uncertainty implies significant losses for the investor.     

Visual performance management in housing associations: a crisis of legitimation or the shape of things to come?

Housing associations in the UK are undergoing significant reform, potentially facing a crisis of legitimation with respect to their values. The latest reforms have included further deregulation and limiting the availability of bank finance at fixed low interest rates. These are challenging times for housing associations; forcing leaders to effectively manage organizational business performance, becoming less reliant on regulatory bodies for guidance and legitimation.     

Why are excess returns on China’s Treasury bonds so predictable? The role of the monetary system

It is well documented that the time-varying bond excess returns can be explained by predetermined variables such as information in the term structure and macro economic variables. Recent studies suggest that demand and supply of bonds influence bond excess returns. We extend the literature and find that monetary system attributes affect return dynamics in the bond market. By introducing a theoretical model to forecast excess returns on Treasury bonds in the context of China’s unique monetary system, this paper attributes the predicted components of bond excess returns mainly to the inflexible term structures of official interest rates set by China’s central bank.     

Adaptive credit granting policies

We analyze here the optimal interest rate determination of a bank that learns about the repayment behavior of its customers from their past behavior. Optimal dynamic methods are first suggested for determining the interest rate for a bank that learns about the probability of default of its borrowers. It is shown that such a bank determines lower than or equal interest rates than a bank that does not adapt its probability of default according to its past experience. Similar results also obtain when the bank learns about the probabilities that its borrowers belong to each of K (K larger than 2) quality groups.     

Tax planning, regulatory capital planning, and financial reporting strategy for commercial banks

We test whether banks' investment and financing policies canbe explained by tax status. We document changes in bank holdingsof municipal bonds in response to changes in tax rules relatingto deductibility of interest expense. We also document an associationbetween banks' marginal tax rates and their investment and financingdecisions, which is consistent with the existence of tax clienteles.However, banks do not sort themselves perfectly into investmentand financing clienteles because of adjustment costs. We positspecific types of transaction-cost impediments to tax planning,and document that banks apparently trade off these costs againsttax-planning benefits.     

Financial effects of an uncertain change in VAT rates in the EU

The paper analyses how close relationships to banks influence a firm’s choice of financing its debt through publicly marketed bonds or bank loans. It is shown that large Japanese firms use less bank debt, if banks own shares in the firm or bank employees are members of the firm’s board. This result supports a theoretical framework, where banks are able to control agency problems associated with debt. Firms use bank loans in order to be monitored, which enables them to access cheaper bond finance. Closer bank–firm relationships facilitate monitoring for the bank and reduce therefore the need for bank finance.     

Does competition from new equity mitigate bank rent extraction? Insights from Japanese data

Previous research shows that bank information production mitigates asymmetric information problems. However, this literature has ignored the concern that firms with better growth prospects are more vulnerable to bank rent extraction. This paper points out that funding competition from new equity as an effective natural mechanism solves this important concern. Using Japanese data from 1983 to 1997, we show that the relationship between loan-to-debt ratio and growth, while starting significantly negative (consistent with holdup theory), turns significantly positive towards the high end of the growth spectrum. We confirm that high-growth firms raise more new equity than do low growth firms and use more equity relative to bonds in external finance. This is consistent with a generalized Myers–Majluf framework. These results suggest that for high growth firms, when competition from public debt lessens due to increased growth-based valuations, competition from new equity steps in to restrain bank rent extraction.