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Abstract:
This paper reviews the theoretical literature on bank capital regulation and analyses some of the approaches to redesigning the 1988 Basel Accord on capital standards. The paper starts with a review of the literature on the design of the financial system and the existence of banks. It proceeds with a presentation of the market failures that justify banking regulation and an analysis of the mechanisms that have been suggested to deal with these failures. The paper then reviews the theoretical literature on bank capital regulation. This is followed by a brief history of capital regulation since the 1988 Basel Capital Accord and a presentation of both the alternative approaches that have been put forward on setting capital standards and the Basel Committee's proposal for a new capital adequacy framework.

Banking regulation, capital standards, Basel Capital Accord

Abstract:
This paper reviews the theoretical literature on bank capital regulation and analyses some of the approaches to redesigning the 1988 Basel Accord on capital standards. The paper starts with a review of the literature on the design of the financial system and the existence of banks. It proceeds with a presentation of the market failures that justify banking regulation and an analysis of the mechanisms that have been suggested to deal with these failures. The paper then reviews the theoretical literature on bank capital regulation. This is followed by a brief history of capital regulation since the 1988 Basel Capital Accord and a presentation of both the alternative approaches that have been put forward on setting capital standards and the Basel Committee's proposal for a new capital adequacy framework.

Banking regulation, capital standards, Basel Capital Accord

Abstract:
We show that efficiency is greater when financial institutions simultaneously offer different products, such as banking, insurance and investment banking (cross selling). Our results are based on the fact that offering multiple products improves the no-deviation constraints of the implicit contract established between a buyer and a seller in a world of one-sided or two-sided moral hazard. The results do not depend on cost synergies or efficiencies in information gathering (though these may imply greater economies from cross selling). Our analysis suggests that, when market competition is sufficiently intense and diseconomies of scope are not very significant, banks will only survive if they follow the strategy of cross selling.

cross selling, commercial banking, investment banking, insurance

Abstract:
Using a unique sample, we attempt to identify the consequence of the separation between inside ownership and control for firm performance. We exploit the fact that banking institutions may hold their own shares in trust to construct a clean measure of the wedge between inside voting control and cash flow rights. These shares provide managers with no monetary incentives, since their dividends accrue to trust beneficiaries.

However, managers may have the authority to vote these shares. Contrary to the belief that managerial control is purely detrimental, we find that it has positive effects on performance over at least some range.

Managerial control, Voting rights, Performance measurement, Trust investments

Abstract:
We attempt to identify the consequence of the separation of inside ownership from control for firm performance. Exploiting the fact that banking institutions may hold their own shares in trust, we construct a clean measure of the wedge between inside voting control and cash flow rights. These shares provide managers with no monetary incentives, since the cash flows accrue to trust beneficiaries. However, managers may have the authority to vote these shares. Using a unique sample of data, we identify a pure effect of managerial voting control on firm performance. Contrary to the belief that managerial control is purely detrimental, we find that it has positive effects.

Managerial control, Voting rights, Performance measurement, Trust investments

Abstract:
We examine the optimal institutional allocation of bank regulation. We find that centralizing the lending of last resort and deposit insurance functions in a regulator leads to excessive forbearance. It also leads the bank to invest suboptimaly in loans. Giving this regulator supervision improves on both problems, but it still does not lead to the efficient outcome. In the multi-regulator arrangement, we find that it is beneficial to give supervision to the deposit insurer. The choice between the unified-regulator arrangement and the multi-regulator arrangement involves a trade-off: The multi-regulator arrangement reduces the forbearance problem at high levels of liquidity shortage but may exacerbate it at low levels. These results assume the absence of information frictions. When banks are better informed than regulators, we show that regulators may have an incentive notto share private information, suggesting it is important to consider regulators' informational advantages when deciding on the allocation of regulation.

Abstract:
Bank regulation in most countries encompasses a lender of last resort, deposit insurance and supervision. These functions are interrelated and therefore require coordination among the authorities responsible for them. These authorities, however, are often established with different mandates, some of which are likely to be in conflict. We consider these issues by studying the optimal institutional allocation of such functions.

We find that a single regulator will lead to insufficient bank monitoring and suboptimal bank investment in loans. It may also lead to too much forbearance. We consider alternative structures to deal with the problem of excess forbearance both in a full information setting and in settings with asymmetry of information between regulators. We show in the former setting that if it is feasible to prespecify the rates on lending of last resort, then it is useful to make this function the exclusive province of one regulator. By giving the deposit insurer the authority to close banks and by having last resort lending insured, one gives the deposit insurer strong incentives against forbearance. If it is not possible to pre-specify such rates, then a useful arrangement is to have both the central bank and the deposit insurer acting as lenders of last resort. In this structure it is important for the last resort lending to be uninsured in order to reduce temptation to overlend, although this somewhat increases the deposit insurer's temptation to forbear.

The final section of the paper analyses asymmetry of information between regulators. We show that regulators may have an incentive not to share gathered information. Since some regulators find it easier to collect particular information, this result suggests that it is important to consider informational advantages in the allocation of bank regulation.

Abstract:
Theory suggests that banks' private information about borrowers lets them hold up borrowers for higher interest rates. Since hold-up power increases with borrower risk, banks with exploitable information should be able to raise their rates in recessions by more than is justified by borrower risk alone. We test this hypothesis by comparing the pricing of loans for bank-dependent borrowers with the pricing of loans for borrowers with access to public debt markets, controlling for loan- and firm-specific risk factors. Loan spreads rise in recessions, but firms with public debt market access pay lower spreads and their spreads rise significantly less in recessions.

bank loans, bonds, information rents, hold-up problem

Abstract:
Theory suggests that banks' private information about borrowers lets them hold up borrowers for higher interest rates. Since hold-up power increases with borrower risk, banks with exploitable information should be able to raise their rates in recessions by more than is justified by borrower risk alone. We test this hypothesis by comparing the pricing of loans for bank-dependent borrowers with the pricing of loans for borrowers with access to public debt markets, controlling for loan- and firm-specific risk factors. Loan spreads rise in recessions, but firms with public debt market access pay lower spreads and their spreads rise significantly less in recessions. Our findings suggest that, during recessions, banks do in fact charge higher rates to customers with limited outside funding options, and that the magnitude of this effect is economically significant.

bank loans, bonds, information rents, hold-up problem

Abstract:
This paper uses survival analysis to investigate the timing of a firm's decision to issue for the first time in the public bond market. We find that firms that are more creditworthy and have higher demand for external funds issue their first public bond earlier. We also find that issuing private bonds or taking out syndicated loans is associated with a faster entry to the public bond market. According to our results, the relationships that firms develop with investment banks in connection with their private bond issues and syndicated loans further speed up their entry to the public bond market. Finally, we find that a firm's reputation has a "U-shaped" effect on the timing of a firm's bond IPO. Consistent with Diamond's (1991) reputational theory, firms that establish a track record of high creditworthiness as well as those that establish a track record of low creditworthiness enter the public bond market earlier than firms with intermediate reputation.

bond financing, reputation, bank relationships, duration analysis

Abstract:
This paper uses duration analysis to investigate the timing of firms' decision to first access the public bond market. We find that, consistent with Diamond's (1991) model, reputation has a non-monotonic effect on the timing of firms' first public bond issue: firms with the highest and lowest reputation enter the public bond market earlier than firms with intermediate reputation. We also find that, controlling for reputation, issuing a private bond or taking out a syndicated loan speeds up firms' entry to the public bond market. Among the firms that issue private bonds, those that select as an underwriter for their first public bond issue a bank that bought their prior private placements are able to access the public bond market faster than those which do not capitalize on these relationships. In contrast, the relationships that firms develop with banks when they borrow in the syndicated loan market do not affect the timing of their access to the public bond market. Finally, our results show that entry in the public bond market is important in that it lowers the cost of raising external funding subsequently in both the private bond market and the syndicated loan market.

bond financing, reputation, bank relationships, duration analysis

Abstract:
The advent of the euro has eroded many of the barriers that segmented the European corporate bond market along currency lines and given rise to a unified market comparable in size to the one denominated in US dollars. In doing so, the new currency has made it easier for investment banks to explore scale economies in the provision of underwriting services, lowered the entry barriers to this industry, and made it easier for European borrowers to benefit from scope economies by combining their purchasing of commercial and investment banking services. This paper shows that the arrival of the euro led to a reduction in the underwriting fees of corporate bonds issued in the new currency and that this reduction was largely due to greater contestability of the investment banking business in the post-EMU European market. Our paper also shows that the elimination of market segmentation led to a migration of underwriting business towards the larger international investment banking houses, particularly those from the United States, rather than an intensification of the business links between euro area borrowers and bankers from the same country. Moreover, borrowers that chose American investment banks appear to have made extra savings in the underwriting fees. Finally, our analysis shows that these fee savings were not overcome by an increase in the credit spreads of these borrowers' bonds at issue date. Altogether, these results suggest that borrowers attach more weight to placing capacity than to business relationships in the choice of an underwriter.

market segmentation, corporate bond underwriting, euro

Abstract:
Much of the discussion about banking and commerce in America has failed to make several crucial distinctions and has not accounted for many arrangements that have promoted the mixing of these activities. We investigate the history of banking and commerce in the United States, looking both at bank control of commercial firms and commercial firms' control of banks. We trace how these controls have changed with shifting definitions of "bank" and changing methods of "control." Despite the regulations prohibiting some arrangements that promote financial control, we find evidence of extensive linkages between banking and commerce in the United States. These linkages usually build on devices that are very close substitutes to the arrangements prohibited by law. Altogether, our findings question the often made claim that traditionally banking in the United States has been separated from commerce. Furthermore, given that research on Japan and Germany has shown that the mixing of banking and commerce matters for a variety of issues, our evidence also raises some questions on similar research in the United States which makes the simplifying assumption that these industries are separated.

Banking, commerce, equity investments, trust departments, director interlocks

Abstract:
Much of the discussion about banking and commerce in America has failed to make several crucial distinctions and has not accounted for many arrangements that have promoted the mixing of these activities. We investigate the history of banking and commerce in the United States, looking both at bank control of commercial firms and commercial firms' control of banks. We trace how these controls have changed with shifting definitions of "bank" and changing methods of "control." Despite the regulations prohibiting some arrangements that promote financial control, we find evidence of extensive linkages between banking and commerce in the United States. These linkages usually build on devices that are very close substitutes to the arrangements prohibited by law. Altogether, our findings question the often made claim that traditionally banking in the United States has been separated from commerce. Furthermore, given that research on Japan and Germany has shown that the mixing of banking and commerce matters for a variety of issues, our evidence also raises some questions on similar research in the United States which makes the simplifying assumption that these industries are separated.

Banking, commerce, equity investments, trust departments, director interlocks

Abstract:
Many have claimed that credit default swaps (CDSs) have lowered the cost of debt financing to firms by creating new hedging opportunities and information for investors. This paper evaluates the impact that the onset of CDS trading has on the spreads that underlying firms pay to raise funding in the corporate bond and syndicated loan markets. Employing a range of methodologies, we fail to find evidence that the onset of CDS trading lowers the cost of debt financing for the average borrower. Further, we uncover economically significant adverse effects on risky and informationally opaque firms.

Credit default swaps, loan spreads, credit spreads

Abstract:
Many have claimed that credit default swaps (CDSs) have lowered the cost of debt financing to firms by creating new hedging opportunities and information for investors. This paper evaluates the impact that the onset of CDS trading has on the spreads that underlying firms pay to raise funding in the corporate bond and syndicated loan markets. Employing a range of methodologies, we fail to find evidence that the onset of CDS trading lowers the cost of debt financing for the average borrower. Further, we uncover economically significant adverse effects on risky and informationally opaque firms.

Credit default swaps, loan spreads, credit spreads.

Abstract:
This paper investigates the equity investments and voting rights that American banks control through their trust business.

Following the evidence that German banks use the proxy voting rights they control to place their representatives on the firm's board of directors, the paper also studies whether the voting rights American banks control through their trust business help explain their presence on U.S. firms' boards.

We find that on average the largest 100 American banks control 10% of the voting rights of S&P 500 firms. We also find that there are several firms in the S&P 500 index in which the top banks altogether control more than 20% of their voting rights and several firms in the country in which these banks control more than 60% of their voting rights.

Our investigation into the presence of American bankers on corporate boards shows that bankers are more likely to join the boards of firms in which they control a large voting stake. We also find that banks' lending relationships help explain bankers' board memberships.

Our results further show that bankers who have both a voting stake in a firm and a lending relationship with it have a higher likelihood of joining the firm's board of directors.

Abstract:
There has been a great deal of interest among researchers on the voting
rights of nonfinancial firms' stock controlled by Japanese and German banks. In the United States, little attention has been devoted to this issue because banks traditionally have been barred from making equity investments in nonfinancial firms for their own account. Despite this prohibition, American banks control important stakes of the voting rights of nonfinancial firms. The source of these voting rights is the trust business. This paper investigates the equity investments and voting
rights that American banks control through their trust business. Following the evidence that German banks use the proxy voting rights they control to place their representatives on the firm's board of directors, we also study whether the voting rights American banks control through their trust business help explain their presence on the boards of nonfinancial firms. We find that, on average, the largest 100 American banks control 10% of the voting rights of S&P 500 nonfinancial firms. We also find that there are several nonfinancial firms in the S&P 500 index in which the top banks altogether control more than 20% of their voting rights and several nonfinancial firms in the country in which they control more than 60% of the firm's voting rights. Our investigation into the presence of American bankers on the boards of nonfinancial corporations shows that, ceteris paribus, bankers are more likely to join the board of a firm in which their bank controls a large voting stake through its trust business.

Abstract:
This paper presents a theory of firm access to the bond market in which information gathering agencies are valuable but alter the relative cost of bond financing across firms and over the business cycle. The theory builds on the assumption that information frictions prevent these agencies from rating firms correctly all of the time. Under these conditions, the cost of bond financing becomes dependent on the state of the economy and the quality of the signal provided by these agencies' ratings. As a result, when the mix of bond issuers becomes riskier, as happens in recessions, bond financing becomes more expensive for mid-quality firms. Bond financing may even become more expensive to all firms in which case mid-quality firms will be subject to the largest cost increase. The analysis of the bonds issued in the last two decades by American firms shows that split ratings, our proxy for the quality of the rating agencies' signal, do not affect the relative cost of bond financing across firms in expansions, but they do increase the relative cost of this funding source for mid-credit quality issuers in recessions.

Business cycles, bond financing, bond spreads, credit ratings

Abstract:
This paper presents a theory of firm access to the bond market in which information gathering agencies provide a valuable service but alter the relative cost of this funding source across firms of different creditworthiness and over the business cycle. The theory builds on two assumptions. First, the "quality" of the signal produced by the information agencies that firms use to access this market varies with firms' creditworthiness. Second, the mix of bond applicants in recessions is riskier than in expansions. According to this paper's theory, rating agencies affect the cost to access the bond market and recessions increase the impact that these agencies have on the cost of this funding source. Importantly, the impact of recessions is not uniform across firms. It may, for instance, be largest for mid-credit quality firms. The analysis of the bonds issued in the last two decades by American nonfinancial firms produces evidence in support of the model's key assumption. I find that rating agencies are more likely to produce split ratings at issue date, my proxy for the "quality" of the signal produced by information agencies, on bonds of mid-credit quality issuers. The analysis of bond-credit spreads at issue date, in turn, shows that split ratings do not affect the relative cost of bond financing across firms in expansions, but they do increase the relative cost of this funding source for mid-credit quality issuers in recessions. Furthermore, this analysis shows that split ratings make bond financing more expensive for these mid-credit quality issuers in recessions than in expansions. These findings confirm the model's key result that information gathering agencies influence access conditions to the bond market across firms and over the business cycle. They also suggest that recessions alter the substitutability between bank funding and market funding, and that the extent of this effect is largest for mid-credit quality firms. This has several potentially important implications, in connection, for example, with firm choices of funding sources, bank lending policies and the credit channel of monetary policy.

Business cycles, bond financing, bond spreads, credit ratings

Abstract:
Our data show that nearly all firms borrow for the first time in their life from a single bank, but soon afterwards some of them start borrowing from additional banks. Duration analysis shows that the likelihood of a firm substituting a single relationship with multiple relationships increases with the duration of that relationship. It also shows that this substitution is more likely to occur for firms with more growth opportunities and for firms with poor performance. The analysis of the ex post effects of the initiation of multiple relationships, in turn, shows that firms with higher levels of investment prior to the initiation of multiple relationships increase their investment even further when they start to borrow from multiple banks, and that firms with poor prior performance continue to perform poorly afterwards. These results suggest that concerns with hold-up costs, together with an unwillingness by the incumbent bank to increase its exposure to a firm because of its past poor performance, are the key reasons for these firms to initiate an additional relationship this early in their life.

Relationship lending, single relationships, multiple relationships

Abstract:
Our results show that the majority of firms borrow for the first time from a single bank, but soon afterwards some of them start borrowing from several banks. Duration analysis shows that the likelihood of a firm substituting a single with multiple relationships increases with the duration of the single relationship and that firms with more growth opportunities and more bank debt are more likely to initiate multiple relationships. Firms with poor performance, too, are more likely to initiate multiple relationships. The analysis of the ex post effects of the initiation of multiple relationships does not detect an increase in the firm's overall indebtedness and investment, but it finds an increase in its trade credit reliance and no improvement in its performance. Overall these results suggest to us that a potential unwillingness by the incumbent bank to increase its exposure to a firm because of its past poor performance appears to explain better firms' decision to initiate multiple relationships than the hypothesis that they do so to protect themselves against the hold-up rents inherent to exclusive relationships because they have many growth opportunities.

Abstract:
This paper looks at the advantages and disadvantages of mixing banking and commerce, using the liquidity approach to financial intermediation. Bringing a nonfinancial firm into a banking conglomerate may be advantageous because it makes it easier for the bank to dispose of assets seized in a loan default. The conglomerate's internal market increases the liquidity of such assets and improves the bank's ability to perform financial intermediation. More generally, owning a nonfinancial firm may act either as a substitute or a complement to commercial lending. In some cases, a bank will voluntarily refrain from making loans, choosing to become a non-bank bank in an unregulated environment.

banking, commerce, liquidity

Abstract:
This paper looks at the advantages and disadvantages of mixing banking and commerce, using the "liquidity" approach to financial intermediation. Bringing a nonfinancial firm into a banking conglomerate may be advantageous because it may make it easier for the bank to dispose of assets seized in a loan default. The internal market formed inside the banking and commerce conglomerate increases the liquidity of such assets and improves the bank's ability to perform financial intermediation. More generally, owning a nonfinancial firm may act either as a substitute or a complement to commercial lending. In some cases, a bank will voluntarily refrain from making loans, choosing to become a non-bank bank in an unregulated environment.

Banking, commerce, liquidity, synnergies, economies of scope

Abstract:
The idea that banks exist to reduce the costs of monitoring is central to modern theories of financial intermediation. The fact that banks are generally granted senior positions on their small-business loans, however, is hard to reconcile with the typical view that junior lenders have the best incentives to engage in this costly monitoring. Our paper addresses this puzzling contradiction by showing that bank seniority plays an important role in encouraging the formation of valuable bank-firm relationships.

The intuition behind our model lies in the fact that once the firm's prospects have deteriorated, junior creditors have incentives much like those of the firm's shareholders. Thus, it is the most senior claimant that benefits from helping the firm improve its quality. If banks are made junior to other creditors, they benefit little from additional investment in the firm during times of poor performance and hence will have little incentive to build relationships that enable them to determine the value of such an investment. As a result, making the bank senior improves its incentives to build a relationship with the firm, thereby fulfilling an important function of intermediated debt.

Abstract:
This paper brings together two seemingly unrelated branches of the literature that focuses on different aspects of a bank's interaction with its borrowers: the relative priority of bank debt, and the role of banks as "relationship lenders". Specifically, we show that bank seniority plays an important role in encouraging the formation of ongoing bank/firm relationships. Because the bank is senior, it is more able to reap the benefits from its relationship with the firm; because the firm has a relationship with a bank, it is more willing to exert effort, thus reducing the impact of a recession on its prospects. As a result, the firm's ex ante value is enhanced when the bank's debt is senior to that of the firm's other creditors.

The intuition behind our model lies in the fact that, when the firm's prospects deteriorate, the most senior claimant first benefits from helping the firm improve its quality, and it is in such states that the true value of relationship lending comes to light. If banks are made junior to other creditors, they may benefit little in bad states from additional investment in the firm, and hence will have little incentive to build relationships that might allow them to determine the value of such an investment. As a result, making the bank senior improves its incentives to build a relationship with the firm, thereby fulfilling an important function of intermediated debt.

Abstract:
Theory suggests that banks' private information lets them hold up borrowers for higher interest rates. Since new information about a firm is revealed at the time of its bond IPO, it follows that banks will be forced to adjust their loan interest rates downwards after firms undertake their bond IPO. We test this hypothesis and find that firms are able to borrow at lower interest rates after their bond IPO. Importantly, firms that get their first credit rating at the time of their bond IPO benefit from larger interest rate savings than those that already had a credit rating. These findings provide support for the hypothesis that banks price their informational monopoly. We also find that it is costly for firms to enter the public bond market.

informational rents, loan spreads, Bond IPOs, bond spreads, bank relationships

Abstract:
Modern corporate finance theory argues that although bank monitoring is beneficial to borrowers, it also allows banks banks to use the private information they gain through monitoring to "hold-up" borrowers for higher interest rates. In this paper, we seek empirical evidence for this information hold-up cost. Since new information about a firm's creditworthiness is revealed at the time of its first issue in the public bond market, it follows that after firms undertake their bond IPO, banks with an exploitable information advantage will be forced to adjust their loan interest rates downwards, particularly for firms that are revealed to be safe. Our findings show that firms are able to borrow from banks at lower interest rates after they issue for the first time in the public bond market and that the magnitude of these savings is larger for safer firms. We further find that among safe firms, those that get their first credit rating at the time of their bond IPO benefit from larger interest rate savings than those that already had a credit rating when they entered the bond market. Since more information is revealed at the time of the bond IPO on the former firms and since this information will increase competition from uninformed banks, these findings provide support for the hypothesis that banks price their informational monopoly.

Finally, we find that while entering the public bond market may reduce these informational rents, it is costly to firms because they have to pay higher underwriting costs on their IPO bonds. Moreover, IPO bonds are subject to more underpricing than subsequent bonds when they first trade in the secondary bond market.

Informational rents, loan spreads, bond IPOs, bond spreads, bank relationships

Abstract:
The Maastricht Treaty created the European System of Central Banks and the European Central Bank to head this system. The Treaty entrusted the European Central Bank with the responsibility for monetary policy, but it did not give this institution supervisory powers or an explicit mandate for providing emergency liquidity support to individual banks. National authorities remained responsible for financial stability. As a result, in the euro area some bank regulatory functions are centralized, while others are allocated to not one, but multiple, competing national regulators. Previous researchers have discussed the potential implications of this institutional allocation of regulation on the financial stability of the region. In this chapter, we investigate instead the potential efficiency implications. We focus on the consequences of the allocation of the lender of last resort and supervisory functions for the degree of forbearance in closing distressed banks and for the level of diligence in bank supervision. We conclude that the integration of banking markets without the integration of regulatory functions increases forbearance and decreases supervision. Centralizing regulatory functions will tend to reverse this decline. If only one of the two functions is centralized, then it will be more effective to centralize the supervisory function.

Abstract:
The ubiquity of bank seniority is now a widely accepted fact in the academic literature. At the same time, trade creditors are sometimes granted a purchase money security interest in the materials or equipment they provide the firm. These two conflicting facts present a puzzle: Why would banks willingly give up a valuable priority claim on the firm, but only with respect to a subset of the firm's assets? We propose a resolution to this paradox of priority by arguing that trade creditors are better able to liquidate the materials they supply to a firm. When trade creditors have a security interest in these assets, their claims are state-contingent, and therefore dependent on the value of the assets pledged as collateral. Surprisingly, this ability of trade creditors to more efficiently liquidate the materials they supply to a firm also makes it desirable to subordinate the non-collateralized portion of their claims. Doing so increases the face value of a trade creditor's claim for a given level of borrowing, thereby increasing the "liquidation bang" from each trade credit buck. This combined priority structure maximizes social welfare by reducing the firm's overall cost of funding.

Abstract:
The ubiquity of bank seniority is now a widely accepted fact in the academic literature. At the same time, trade creditors are sometimes granted a purchase money security interest in the materials or equipment they provide the firm. These two conflicting facts present a puzzle: Why would banks willingly give up a valuable priority claim on the firm, but only with respect to a subset of the firm's assets; We propose a resolution to this paradox of priority by arguing that trade creditors are better able to liquidate the materials they supply to a firm. When trade creditors have a security interest in these assets, their claims are state-contingent, and therefore dependent on the value of the assets pledged as collateral. Surprisingly, this ability of trade creditors to more efficiently liquidate the materials they supply to a firm also makes it desirable to subordinate the non-collateralized portion of their claims. Doing so increases the face value of a trade creditor's claim for a given level of borrowing, thereby increasing the "liquidation bang" from each trade credit buck. This combined priority structure maximizes social welfare by reducing the firm's overall cost of funding.

Abstract:
In this paper we examine the importance of banks' corporate control by investigating the loan policy pricing effect of banks' voting stakes on their borrowers. We exploit the fact that banks may hold shares of firms in a fiduciary capacity to identify a clean measure of banks' control over firms. These shares provide no direct cash incentives to banks, but they may give them control over a stake of the firm's voting rights. Using a sample of loans taken out over the 2000-2002 time period, we document the instances where firms borrow from banks that have a trust equity investment in the firm and determine the share of the firm's voting rights that the bank controls as a result. Our investigation of loan interest rates shows that banks charge lower rates on loans to firms in which they have a voting stake, and that the interest rate discount increases with the bank's voting stake. These findings are robust to a number of firm- and loan-specific controls as well as to banks' selection of trust investments. Our investigation into the covenants of loan contracts also shows that banks are less likely to demand collateral and to impose dividend restrictions when they have control over a stake of the borrower's voting rights. These findings, together with the interest rate discount the bank offers when it holds a voting stake in the borrower, support the hypothesis that banks' corporate control over their borrowers is effective at reducing the agency costs of debt.

Corporate control, trust business, voting rights, agency costs of debt

Abstract:
When supervisors have imperfect information about the soundness of banks, they may be unaware of insolvency problems that develop in the interval between on-site examinations. Supervising banks more often will alleviate this problem but will increase the costs of supervision. This paper analyzes the trade-offs that supervisors face between the cost of supervision and their need to monitor banks effectively. We first characterize the optimal supervisory policy, in terms of the time between examinations and the closure rule at examinations, and compare it with the policy of an independent supervisor. We then show that making this supervisor accountable for deposit insurance losses in general reduces the excessive forbearance of the independent supervisor and may also improve on the time between examinations. Finally, we extend our analysis to the impact of depositor-preference laws on supervisors' monitoring incentives and show that these laws may lead to conflicting effects on the time between examinations and closure policy vis-à-vis the social optimum.

Deposit insurance, depositor preference, supervision

Abstract:
We study the fragility of the banking system and its implications for prudential regulation. In our framework, fragility stems from the interconnections banks establish to protect themselves from liquidity shocks. Like Allen and Gale (2000) we find mutual insurance of assets is privately advantageous. An assumption of Allen and Gale's analysis is that aggregate shocks are a zero probability event. This makes banks indifferent between arrangements leading to varying degrees of fragility should the zero probability event actually materialize.

We depart from Allen and Gale by assuming that the aggregate shock is no longer a zero probability event. As a result, banks find insurance by other banks valuable, but are no longer indifferent about the form the insurance takes. We build a framework examining the consequences for interbank insurance when individual bank fragility stems from a moral hazard problem, as in Calomiris Kahn (1991) or Diamond Rajan (1998).

We examine the implications of bank insurance choices for system fragility. In some conditions, banks prefer universal mutual insurance, and will opt for this arrangement. Depositors may also prefer universal mutual insurance as well, it may be socially suboptimal, since it places too high a correlation on individual bank failures. If banks also provide payments services, then the social costs may be much higher from having all fail than from having some failing, thus creating a justification for a regulatory intervention. We briefly examine possible modes of intervention.

Abstract:
In recent years, the secondary loan market has developed into an over-the-counter market where loans are sold and subsequently traded. This shift away from traditional banking is altering the business of lending for both banks and their borrowers. Loan sales are valuable to banks because they free up capital and facilitate risk management; but they may be costly to borrowers because they negatively affect bank monitoring incentives. In this paper, however, we argue that there is another potential benefit to borrowers from loan sales. Borrowers with trading loans, in particular those with liquid loans, may "demand" a share of bank benefits from loan sales when they take out new loans as it will be easier for banks to sell these loans afterwards. We investigate this potential benefit of the secondary loan market by comparing the interest rates borrowers pay before their loans start to trade with the interest rates they pay on loans originated post-trading. Our results show that, on average, borrowers pay higher spreads on the loans they take out after the onset of trading on their loans. Importantly, our results also show that borrowers with liquid trading loans are able to borrow at lower interest rates after the onset of trading on their loans. This interest rate discount is robust and economically meaningful. Thus, while the banks' decision to sell loans may initially impose a cost on borrowers, those whose loans enter the secondary loan market and become liquid benefit from an interest rate discount on their subsequent loans.

loan spreads, bid-ask spreads, liquidity, secondary loan market

Abstract:
The growth of the European financial markets, together with the new, stricter regulations on the U.S. financial system, has spurred a debate about the competitiveness of the U.S. financial markets. In this paper, we compare underwriting costs in the U.S. bond market and the Eurobond market over the last ten years and investigate whether recent changes in the U.S. bond market's relative competitiveness have affected U.S. firms' choice of bond issuing market. Our results show that ten years ago, it was less expensive to issue in the U.S. bond market than in the Eurobond market and that underwriting costs have declined continuously in the U.S. market over the last decade. Importantly, we also find that these costs decreased at an even faster rate in the Eurobond market to the point of eliminating the competitive wedge of the U.S. bond market. These findings are robust to bond-, firm-, and underwriter-specific characteristics and do not appear to be driven by sample selection, as they hold when we consider a sample of issuers that is both constant over time and common to both markets. Finally, we find that U.S. firms are increasingly opting to issue their bonds in the Eurobond market instead of the U.S. market, and that this relocation toward the Eurobond market is partly caused by the decline in the relative competitiveness of the U.S. bond market.

Bonds, gross spreads, credit spreads, Eurobond market, U.S. bond market

Abstract:
This paper investigates if the bond market disciplines all banks equally, in the sense of demanding the same relative risk premium across banks of different risk over the business cycle. To test this hypothesis, the paper compares the difference between the credit spreads in the primary market of bank and firm bonds with the same credit rating issued during expansions with that same difference of spreads for bonds issued during recessions. The paper finds that during recessions investors demand higher risk premiums. Importantly, the paper finds that the impact of recessions is not uniform across banks – it affects riskier banks more than safer ones. In other words, in recessions investors are relatively more demanding on riskier banks than on safer ones. These findings have important policy implications because they show that a bond-issuance policy aimed at promoting market discipline could affect the relative funding costs of banks over the business cycle. They also indicate that the information which can be extracted from the credit spreads on bank bonds varies across banks for reasons unrelated to their risk.

Market discipline, bond financing, bond spreads, credit ratings

Abstract:
This paper investigates whether the bond market disciplines all banks equally in the sense of demanding the same relative risk premium across banks of different risk over time. To test this hypothesis the paper compares the difference between the credit spreads in the primary market of bank and firm bonds with the same credit rating issued during expansions with that same difference of spreads for bonds issued during recessions. Our results show that the bond market is relatively "tougher" on riskier banks than on safer ones. This is an important issue because otherwise a bond-issuance policy aimed at promoting market discipline will affect the relative funding costs of banks. Further, the information that can be extracted from the credit spreads on bank bonds will vary across banks for reasons unrelated to their risk.

Market discipline, bond financing, bond spreads, credit ratings

Abstract:
The link between financial market concentration and stability is a topic of great interest to policymakers and other market participants. Are concentrated markets - those where a relatively small number of firms hold large market shares - inherently more prone to disruption? This article considers that question by drawing on academic studies as well as introducing new analysis. Like other researchers, the authors find an ambiguous relationship between concentration and instability when a large firm in a concentrated market fails. In a complementary review of concentration trends across a number of specific markets, the authors document that most U.S. wholesale credit and capital markets are only moderately concentrated, and that concentration trends are mixed - rising in some markets and falling in others. The article also identifies market characteristics that might lead to greater, or less, concern about the consequences of a large firm's exit. It argues that the ease of substitution by other firms in concentrated markets is a critical factor supporting market resiliency.

Financial stability, financial crises, market concentration, competition, substitutability

Abstract:
We test the predictions of several recent theories of how bank capital affects the rates that banks charge their borrowers. Key to all these theories is the notion that the relative bargaining power of a bank and its borrower are critical. We find that banks with low capital are more sensitive to borrower cash flow than are banks with high capital: low-capital banks charge relatively more for borrowers with low cash flow, but offer relatively steeper discounts for borrowers with high cash flow. These effects are robust to controls for business conditions and bank fixed effects. Our results suggest that low bank capital generally toughens bank bargaining power, especially vis-a-vis low-cash-flow borrowers, but weakens bank bargaining power vis-a-vis high-cash-flow borrowers. This is consistent with Diamond and Rajan's (2000) theory of bank capital. By contrast, although earlier work has found that rates for borrowers with access to public debt markets are unaffected by their bank's capital level, once we control for economic conditions, lower bank capital leads to higher spreads for these borrowers as well.

Bank loans, bank capital, loan spreads, cash flow, hold-up, information monopolies

Abstract:
In this paper we seek evidence for the theory that start-ups' founding choices imprint them, affecting their chances of survival for a long period of time. Based on a unique dataset of Portuguese start-ups, we find that larger start-ups and start-ups with less leverage are more likely to survive for longer periods of time. The same is true of start-ups that opt for maintaining a unique bank-lending relationship and those that have a bank among their shareholders. Lending relationships with state-owned banks do not affect these firms' chances of survival. Our investigation into the effects of start-ups' founding choices of these variables shows that their founding size and leverage as well as the mix of funding sources that they choose at birth affect their chances of survival for several years. Importantly, the future effects of some of these choices do not decay as firms age, providing, therefore, support to the theory that start-ups' founding choices imprint them.

Start-ups, funding sources, lending relationships, bank equity stakes in firms

Abstract:
This paper analyzes the potential effects of commercial banks' expansion into the securities business, taking into account the underlying conditions assumed by the modern literature to explain the existence of financial intermediaries. The analysis focuses on the gains claimed to emerge with that expansion, particularly the gains due to information advantages and economies of scope, and on the costs claimed to arise with it, namely, those due to conflicts of interest and risk considerations. In addition, the paper discusses how these effects depend on the corporate structure chosen by banks, and it presents the securities powers of commercial banks in the OECD countries.

Abstract:
This paper analyzes the potential effects of commercial banks' expansion into the securities business, taking into account the underlying conditions assumed by the modern literature to explain the existence of financial intermediaries. The analysis focuses on the gains claimed to emerge with that expansion, particularly the gains due to information advantages and economies of scope, and on the costs claimed to arise with it, namely, those due to conflicts of interest and risk considerations. In addition, the paper discusses how these effects depend on the corporate structure chosen by banks, and it presents the securities powers of commercial banks in the OECD countries.

Abstract:
The massive losses that banks have incurred with the meltdown of subprime mortgages have raised concerns with their ability to continue extending loans to corporations. In this paper, we attempt to ascertain these concerns by investigating if banks have changed their loan pricing policies in response to the losses they have incurred since the onset of the subprime crisis. We find that firms that borrowed after the onset of the crisis paid an additional 16 bps over Libor when compared to the loans they took out from the same bank prior to the crisis, after we control for firm-, bank-, and loan-specific factors. We also find that the increase in loan spreads is higher for those firms that have borrowed from banks that incurred larger losses in the current crisis. In addition, we find that these banks increased the interest rates on their loans to bank-dependent borrowers by more than they did on their loans to borrowers that have access to the bond market. These results are likely bank-driven because we derive them on a set of borrowers that took out loans both before and after the crisis from the same bank. Our findings, therefore, add some support to the concerns with the availability of bank credit since the onset of the subprime crisis.

subprime losses, bank losses, loan spreads, hold-up, information monopolies

Abstract:
This paper studies the effects of acquisitions on both acquired and acquiring banks. Through the use of overlap, von Mises, and other distance statistics, we confirm that, prior to acquisition, the acquirer generally performs better than the bank it acquired. Following the acquisition, the performance of the two banks starts to converge, mainly due to improvements in the acquired institution. During this process, the acquired is transformed in such a way that it becomes a replica of its acquirer, a result that confirms a strong policy integration among banks that are part of a bank holding company. These post--acquisition effects hint at an explanation for the abnormal returns usually observed at the time of the acquisition announcement, and provide some insight on the dominant motivations for the consolidation taking place in the banking industry.

Abstract:
This paper investigates whether investors' domestic experience helps them enter foreign markets. We show that investors first invest in domestic securities and only some time later they invest in foreign securities. Our investigation of the length of time it takes investors to start investing in foreign securities shows that investors who trade more often in the domestic market start to invest abroad earlier. It appears that the experience these investors acquire while they trade in the domestic market is a key reason why they enter the foreign market earlier. A reason is that highly educated investors as well as investors with more financial knowledge, arguably those for whom learning by trading is the least important, do not need to trade as much in the domestic market before they start investing in foreign securities. Another reason is that investors who start investing in foreign securities are able to improve on their performance afterwards. This improvement in performance, besides adding support to the learning explanation, constitutes also evidence that the home country bias is costly.

learning, home country bias, duration analysis

Abstract:
Special Issue: Central Bank Liquidity Tools and Perspectives on Regulatory Reform.

Abstract:
It has long been recognized that banks' simultaneous provision of monitoring and liquidity services is advantageous but leaves them susceptible to liquidity shocks that may culminate in a system failure. Because a system failure is costly, this provides a rationale for adopting arrangements, including a lender of last resort and deposit insurance (DI), to insure banks against liquidity shocks. These arrangements have proven themselves very successful, but they have also been the source of problems. Researchers have identified some of the main sources of these problems and have suggested ways to improve the design of these arrangements, but there are still many issues that remain unaddressed. This paper reviews the literature on the two arrangements that most countries have adopted to insure banks against liquidity shocks, a lender of last resort and DI, and compares the design of these arrangements across countries. The paper ends with a brief summary of the key lessons learned about the design of these arrangements and the issues related to them that remain unaddressed.

Abstract:
It has long been recognised that banks' simultaneous provision of monitoring and liquidity services is advantageous, but leaves them susceptible to liquidity shocks that may culminate in a system failure. Because a system failure is costly, this provides a rationale for adopting arrangements, including a lender of last resort and deposit insurance, to insure banks against liquidity shocks. These arrangements have proven themselves very successful, but they have also been the source of problems. Researchers have identified some of the main sources of these problems and have suggested ways to improve the design of these arrangements, but there are still many issues that remain unaddressed. This paper reviews the literature on the two arrangements that most countries have adopted to insure banks against liquidity shocks, a lender of last resort and deposit insurance, and compares the design of these arrangements across countries. The paper ends with a brief summary of the key lessons learned about the design of these arrangements and the issues related to them that remain unaddressed.

Banks, central bank, lending of last resort, deposit insurance

Abstract:
Over the years, U.S. banks have increasingly relied on the bond market to finance their business. This creates the potential for a link between the bond market and the corporate sector whereby borrowers, including those that do not rely on bond funding, become exposed to the conditions in the bond market. We investigate the importance of this link. Our results show that when the cost to access the bond market goes up, banks that rely on bond financing charge higher interest rates on their loans. They also show that on these occasions, banks that rely exclusively on deposit funding follow bond financing banks and increase the interest rates on their loans, though by smaller amounts. Our results further reveal that banks pass the bond market shocks predominantly to their risky borrowers that have access to the bond market and to their borrowers that do not have access to the bond market. These results show that banks propagate shocks to the bond market by passing them through their loan policies to their borrowers, including those that do not use bond financing.

Bank subdebt, bond spreads, lending channel, loan spreads

Abstract:
This paper uses an intermediation model to study the efficiency and welfare implications of both banks' required capital-asset ratio and the regulation that limits, and in some countries forbids, banks' investments in equity to a certain proportion of each firm's capital. There are two sources of moral hazard in the model: one between the bank and the provider of deposit insurance, and the other between the bank and the entrepreneur who demands funds to finance an investment project. Among other things, the paper shows that capital regulation improves the bank's stability and can also be Pareto-improving. Equity regulation is never Pareto-improving and does not increase the bank's stability.

Abstract:
This paper uses an intermediation model to study the efficiency and welfare implications of both banks' required capital-asset ratio and the regulation that limits, and in some countries forbids, banks' investments in equity to a certain proportion of each firm's capital. There are two sources of moral hazard in the model: one between the bank and the provider of deposit insurance, and the other between the bank and the entrepreneur who demands funds to finance an investment project. Among other things, the paper shows that capital regulation improves the bank's stability and can also be Pareto-improving. Equity regulation is never Pareto-improving and does not increase the bank's stability.

Abstract:
The model presented in this paper is a particular case of the principal-agent problem. An entrepreneur has an investment project whose returns depend on his effort, which is not observable by the financier. After determining the optimal contract that is used to finance such a project, I show that this contract can be replicated by a unique combination of debt and equity, which proves the optimality of these financial instruments.

Abstract:
The model presented in this paper is a particular case of the principal-agent problem. An entrepreneur has an investment project whose returns depend on his effort, which is not observable by the financier. After determining the optimal contract that is used to finance such a project, I show that this contract can be replicated by a unique combination of debt and equity, which proves the optimality of these financial instruments.

Abstract:
This paper reviews the arguments as to whether the location of the securities unit in a banking conglomerate should be subject to regulation. This review is complemented with evidence on the regulations and on securities units' predominant location in the G--10 countries and in the United States before the Glass--Steagall Act. The paper argues that correcting the safety net's distortions and allowing banks to choose where to locate their securities units is a better alternative than retaining such distortions and relying on corporate separateness to limit the problems they may create. Separateness imposes costs and provides banks with insulation that is more apparent than real. However, if authorities opt for requiring separateness, a regulation allowing banks to choose between the bank-parent model and the holding- company model seems more appropriate than a regulation requiring them to adopt either one of these models.