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Abstract:
This article evaluates the causes, consequences, and future implications of financial services industry consolidation using a value maximization framework. We also reviews the extant research literature within the context of this framework (over 250 references), and suggest future research topics. The evidence is consistent with increases in market power from some types of consolidation, improvements in profit efficiency and diversification of risks on average, and potential improvements in payments system efficiency. However, the data suggest little or no cost efficiency improvements on average; relatively little effect on the availability of services to small customers; and potential costs on the financial system from increasing systemic risk or expanding the financial safety net.

Abstract:
This article designs a framework for evaluating the causes, consequences, and future implications of financial services industry consolidation, reviews the extant research literature within the context of this framework (over 250 references), and suggests fruitful avenues for future research. The evidence is consistent with increases in market power from some types of consolidation; improvements in profit efficiency and diversification of risks, but little or no cost efficiency improvements on average; relatively little effect on the availability of services to small customers; potential improvements in payments system efficiency; and potential costs on the financial system from increasing systemic risk or expanding the financial safety net.

banks, mergers, payments, small business

Abstract:
We test how active management of bank credit risk exposure through the loan sales market affects capital structure, lending, profits, and risk. We find that banks that rebalance their C&I loan portfolio exposures by both buying and selling loans - that is, banks that use the loan sales market for risk management purposes rather than to alter their holdings of loans - hold less capital than other banks; they also make more risky loans (loans to businesses) as a percentage of total assets than other banks. Holding size, leverage and lending activities constant, banks active in the loan sales market have lower risk and higher profits than other banks. We conclude that increasingly sophisticated risk management practices in banking are likely to improve the availability of bank credit but not to reduce bank risk.

Risk management, bank lending, capital structure

Abstract:
This paper investigates private interest, public interest, and political-institutional theories of regulatory change to analyze state-level deregulation of bank branching restrictions. Using a hazard model, we find that interest group factors related to the relative strength of potential winners (large banks and small, bank-dependent firms) and losers (small banks and the rival insurance firms) can explain the timing of branching deregulation across states during the last quarter century. The same factors also explain congressional voting on interstate branching deregulation. While we find some support for each theory, the private interest approach provides the most compelling overall explanation of our results.

Abstract:
This paper investigates private interest, public interest, and political-institutional theories of regulatory change to analyze state-level deregulation of bank branching restrictions. Using a hazard model, we find that interest group factors related to the relative strength of potential winners (large banks and small, bank-dependent firms) and losers (small banks and the rival insurance firms) can explain the timing of branching deregulation across states during the last quarter century. The same factors also explain congressional voting on interstate branching deregulation. While we find some support for each theory, the private interest approach provides the most compelling overall explanation of our results.

Abstract:
Banks are in the business of lending to risky and hard-to-value businesses. This paper show that both the price and non-price terms of bank loans reflect observable components of borrower risk. As expected, riskier borrowers - smaller borrowers, borrowers with less cash, and borrowers that are harder for outside investors to value - pay more for their loans. In addition, the non-price terms of loans are systematically related to pricing; small loans, loans that are secured, and loans with relatively short maturity carry higher interest rates than other loans, even after controlling for publicly available measures of risk. This suggests that banks use both the price and non-price terms of loans as complements in dealing with borrower risk. To validate this interpretation, I also show that observably riskier firms face tighter non-price terms in their loan contracts. Loans to small firms, firms with low ratings, and firms with little cash available to service debt, for example, are more likely to be small, to be secured by collateral, and to have a short contractual maturity. Larger and more profitable firms are able to borrow on better terms across all three of these non-price dimensions.

Abstract:
Legal and institutional differences shape the ownership and terms of bank loans across the world. With strong creditor protection, we show that loans have concentrated ownership, long maturity and low interest rates. The impact of creditor rights on loans also depends on borrower characteristics such as the size and tangibility of assets. Foreign banks appear especially sensitive to the legal and institutional environment. Their ownership declines relative to domestic banks as creditor protection falls. Our multi-dimensional empirical model paints a more complete picture of how financial contracts respond to the legal and institutional environment than existing studies.

Creditor rights, institution, bank loan, collateral, maturity

Abstract:
We examine empirically how legal origin, creditor rights, property rights, legal formalism, and financial development affect the design of price and non-price terms of bank loans in almost 60 countries. Our results support the law and finance view that private contracts reflect differences in legal protection of creditors and the enforcement of contracts. Loans made to borrowers in countries where creditors can seize collateral in case of default are more likely to be secured, have longer maturity, and have lower interest rates. We also find evidence, however, that ?Coasian? bargaining can partially offset weak legal or institutional arrangements. For example, lenders mitigate risks associated with weak property rights and government corruption by securing loans with collateral and shortening maturity. Our results also suggest that the choice of loan ownership structure affects loan contract terms.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper shows that securitization reduces the influence of bank financial condition on loan supply. Low-cost funding and increased balance-sheet liquidity raise bank willingness to approve mortgages that are hard to sell (jumbo mortgages), while having no effect on their willingness to approve mortgages easy to sell (non-jumbos). Thus, the increasing depth of the mortgage secondary market fostered by securitization has reduced the impact of local funding shocks on credit supply. By extension, securitization has weakened the link from bank funding conditions to credit supply in aggregate, thereby mitigating the real effects of monetary policy.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper shows that securitization reduces the influence of bank financial condition on loan supply. Low-cost funding and increased balance-sheet liquidity raise bank willingness to approve mortgages that are hard to sell (jumbo mortgages), while having no effect on their willingness to approve mortgages easy to sell (non-jumbos). Thus, the increasing depth of the mortgage secondary market fostered by securitization has reduced the impact of local funding shocks on credit supply. By extension, securitization has weakened the link from bank funding conditions to credit supply in aggregate, thereby mitigating the real effects of monetary policy.

Bank Loan Supply, GSEs, Securitization

Abstract:
This paper investigates what factors determine whether a commercial banker is on the board of a non-financial firm. We consider the tradeoff between the benefits of direct bank monitoring to the firm and the costs of active bank involvement in firm management. Given the different payoff structures to debt and equity, lenders and shareholders may have conflicting interests in running the firm. In addition, the U.S. legal doctrines of ?equitable subordination? and ?lender liability? could generate high costs for banks which have a representative on the board of a client firm that experiences financial distress. Consistent with high potential costs of active bank involvement, we find that bankers tend to be represented on the boards of large stable firms with high proportions of tangible (?collateralizable?) assets and low reliance on short-term financing. U.S. bank regulation and bankruptcy doctrines may reduce the role that banks play in corporate governance and the management of financial distress, in contrast to Germany and Japan. We conclude with implications for the current bank regulatory reform debate, such as whether to permit banks to own equity in non-financial firms that, in turn, could allow them to mitigate the conflict.

Abstract:
This paper argues that banks have a unique ability to hedge against market-wide liquidity shocks. Deposit inflows provide funding for loan demand shocks that follow declines in market liquidity. Consequently, one dimension of bank 'specialness' is that banks can insure firms against systematic declines in market liquidity at lower cost than other financial institutions. We provide supporting empirical evidence from the commercial paper (CP) market. When market liquidity dries up and CP spreads increase, banks experience funding inflows. These flows allow banks to meet increased loan demand from borrowers drawing funds from pre-existing commercial paper backup lines, without running down their holdings of liquid assets. Moreover, the supply of cheap funds is sufficiently large so that pricing on new lines of credit actually falls as market spreads widen.

Abstract:
This paper argues that banks have a unique ability to hedge against market-wide liquidity shocks. Deposit inflows provide a natural hedge for loan demand shocks that follow declines in market liquidity. Consequently, one dimension of bank "specialness" is that banks can insure firms against systematic declines in market liquidity at lower cost than other financial institutions. We provide supporting empirical evidence from the commercial paper (CP) market. When market liquidity dries up and CP spreads increase, banks experience funding inflows. These allow banks to meet increased loan demand from borrowers drawing funds from pre-existing commercial paper backup lines, without running down their holdings of liquid assets. Moreover, the supply of cheap funds is sufficiently large so that pricing on new lines of credit actually falls as market spreads widen.

banking, liquidity, commercial paper

Abstract:
Liquidity risk in banking has been attributed to transactions deposits and their potential to spark runs or panics. We show instead that transactions deposits help banks hedge liquidity risk from unused loan commitments. Bank stock-return volatility increases with unused commitments, but the increase is smaller for banks with high levels of transactions deposits. This deposit-lending risk management synergy becomes more powerful during periods of tight liquidity, when nervous investors move funds into their banks. Our results reverse the standard notion of liquidity risk at banks, where runs from depositors had been seen as the cause of trouble.

Abstract:
Unused loan commitments expose banks to systematic liquidity risk, but this exposure can be reduced by combining loan commitments with transactions deposits. We show that bank equity volatility increases with unused loan commitments, but this increase is reduced for banks with high levels of transaction deposits. This deposit-lending synergy becomes even more powerful during periods of tight liquidity, when nervous investors move funds into their banks. Thus, the simultaneous taking of deposits and lending may be thought of as a liquidity hedge.

Liquidity, banking, financial crisis

Abstract:
This paper provides support for the proposition that securities class actions help solve agency problems. Two key findings support this conclusion. First, firms that are more likely to suffer from agency problems are more likely to face class actions. Risky firms, large firms, young firms, low market-to-book firms and non-dividend paying firms as of the end of 1990 were more likely to face a class action filing during the January 1991 to March 1998 period. Second, the probability of CEO turnover increases dramatically after class action filings. The increase can not be explained by omitted firm-specific characteristics, financial distress, or the possibility that CEO turnover increases the likelihood that a lawyer will file a class action.

Abstract:
This paper tests how competition in local U.S. banking markets affects the market structure of non-financial sectors. Theory offers competing hypotheses about how competition ought to influence firm entry and access to bank credit by mature firms. The empirical evidence, however, strongly supports the idea that in markets with concentrated banking, potential entrants face greater difficulty gaining access to credit than in markets where banking is more competitive.

Abstract:
This paper tests how competition in local U.S. banking markets affects the market structure of non-financial sectors. Theory offers competing hypotheses about how competition ought to influence firm entry and access to bank credit by mature firms. Using data on U.S. local markets for banking and non-financial sectors, we find that more vigorous banking competition - that is, lower concentration and looser restrictions on geographical expansion - is associated with more firms in operation and with a smaller average firm size. In fact, the whole firm-size distribution shifts toward the origin as our measures of banking competition increase. Because we exploit data at the industry level, we are able to control for alternative (omitted) variables that may drive market structure both within and outside banking by exploiting differential reliance on bank finance across industrial sectors.

Abstract:
This paper examines the consequences of the Financial Services Modernization Act of 1999 for the structure of the U.S. financial services industry. We ask how the industry may evolve as this new legislation interacts with the consolidation trend already under way, what types of mergers are most likely to occur, and how profitable and risky the resulting firms might be.

Gramm Leach Bliley, Financial Services Modernization Act, bank consolidation, financial services consolidation

Abstract:
This paper investigates the frequency of connections between banks and non-financial firms through board linkages and whether those connections affect lending and borrowing behavior. Although a board linkages may reduce the costs of information flows between the lender and borrower, a board linkage may generate pressure for special treatment of a borrower not normally justifiable on economic grounds. To address this issue, we first document that banks are heavily involved in the corporate governance network through frequent board linkages. Banks tend to have larger boards with a higher proportion of outside directors than non-financial firms, and bank officer-directors tend to have more external board directorships than executives of non-financial firms. We then show that low-information cost firms large firms with a high proportion of tangible assets and relatively stable stock returns - are most likely to have board connections to banks. These same low-information cost firms are also more likely to borrow from their connected bank, and when they do so the terms of the loan appear similar to loans to unconnected firms. In contrast to studies of Mexico, Russia and Asia where connections have been misused, our results suggest that avoidance of potential conflicts of interest explains both the allocation and behavior of bankers in the U.S. corporate governance system.

board of directors, banks, lending, corporate governance

Abstract:
This paper provides a positive political economy analysis of the most important revision of the U.S. supervision and regulation system during the last two decades, the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA). We analyze the impact of private interest groups as well as political-institutional factors on the voting patterns on amendments related to FDICIA and its final passage to assess the empirical importance of different types of obstacles to welfare-enhancing reforms. Rivalry of interests within the industry (large versus small banks) and between industries (banks versus insurance) as well as measures of legislator ideology and partisanship play important roles and, hence, should be taken into account in order to implement successful change. A "divide and conquer" strategy with respect to the private interests appears to be effective in bringing about legislative reform. The concluding section draws tentative lessons from the political economy approaches about how to increase the likelihood of welfare-enhancing regulatory change.

Abstract:
This paper provides a positive political economy analysis of the most important revision of the U.S. supervision and regulation system during the last two decades, the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA). We analyze the impact of private interest groups as well as political-institutional factors on the voting patterns on amendments related to FDICIA and its final passage to assess the empirical importance of different types of obstacles to welfare-enhancing reforms. Rivalry of interests within the industry (large versus small banks) and between industries (banks versus insurance) as well as measures of legislator ideology and partisanship play important roles and, hence, should be taken into account in order to implement successful change. A divide and conquer' strategy with respect to the private interests appears to be effective in bringing about legislative reform. The concluding section draws tentative lessons from the political economy approaches about how to increase the likelihood of welfare-enhancing regulatory change.

Abstract:
We produce a comprehensive decomposition of syndicated loan risk into credit, market and liquidity risk and test how these shape loan syndicate structure. Banks dominate relative to onbank investors in loan syndicates that expose lenders to liquidity risk. This dominance is most pronounced when borrowers have high levels of credit or market risk. We then tie banks' comparative advantage in liquidity risk bearing to their access to transactions deposits by comparing investments across banks. The results suggest that risk-management considerations matter most for participants relative to lead arrangers. Links from transactions deposits to liquidity exposure, for instance, are more than 50% larger at participants than at lead arrangers.

Liquidity Risk, Banks, Syndicates, Syndicated Loans

Abstract:
The moral hazard problem associated with deposit insurance generates the potential for excessive risk taking on the part of bank owners. The banking literature identifies franchise value—a firm's profit-generating potential—as one force mitigating that risk taking. We argue that in the presence of owner/manager agency problems, managerial risk aversion may also offset the excessive risk taking that stems from moral hazard. Empirical models of bank risk tend to focus either on the disciplinary role of franchise value or on owner/manager agency problems. We estimate a unified model and find that both franchise value and ownership structure affect risk at banks. More important, we identify an interesting interaction effect: The relationship between ownership structure and risk is significant only at low franchise value banks—those where moral hazard problems are most severe and where conflicts between owner and manager risk preferences are therefore strongest. Risk is lower at banks with no insider holdings, but among other banks, there is no relationship between the level of insider holdings and risk. This suggests that the owner/manager agency problem affects the choice of risk for only a small number of banks—those with low franchise value and no insider holdings. Most of these banks increase their insider holdings within a year, and these changes in ownership structure are associated with increased risk. This suggests that owner/manager agency problems are quickly addressed.

Abstract:
This paper examines the impact of increased competition from
deregulation on the dynamics of the U.S. banking industry.
We find the link between a bank's relative performance and its
subsequent market share growth strengthens significantly after
deregulation as competitive reallocation effects transfer
assets to better performers. Exit dynamics also change in ways
consistent with the disciplinary role of competition.
The net effect is a substantial reallocation of market share
toward better banks. We conclude that earlier regulation of
U.S. banks blunted this market mechanism and seriously hindered the competitive process.

Abstract:
We test how active management of bank credit risk exposure affects capital structure, capital budgeting and profits. We find that banks that rebalance their C&I loan portfolio exposures by both buying and selling loans hold less capital and lower levels of liquid assets than other banks; they also lend more to businesses, both as a percentage of total assets and as a percentage of their overall lending, and they enjoy higher profits. The results hold controlling for bank size and holding company affiliation and are robust over time. We conclude that increasingly sophisticated risk management practices in banking are likely to improve the availability of bank credit.

Abstract:
We test how active management of bank credit risk exposure affects capital structure, capital budgeting and profits. We find that banks that rebalance their C&I loan portfolio exposures by both buying and selling loans hold less capital and lower levels of liquid assets than other banks; they also lend more to businesses, both as a percentage of total assets and as a percentage of their overall lending, and they enjoy higher profits. The results hold controlling for bank size and holding company affiliation and are robust over time. We conclude that increasingly sophisticated risk management practices in banking are likely to improve the availability of bank credit.

Abstract:
We test how active management of bank credit risk exposure affects capital structure, capital budgeting and profits. We find that banks that rebalance their C&I loan portfolio exposures by both buying and selling loans hold less capital and lower levels of liquid assets than other banks; they also lend more to businesses, both as a percentage of total assets and as a percentage of their overall lending, and they enjoy higher profits. The results hold controlling for bank size and holding company affiliation and are robust over time. We conclude that increasingly sophisticated risk management practices in banking are likely to improve the availability of bank credit.

Abstract:
In February 2003, the SEC officially certified a fourth credit rating agency, Dominion Bond Rating Service ("DBRS"), for use in bond investment regulations. After DBRS certification, bond yields change in the direction implied by the firm's DBRS rating relative to its ratings from other certified rating agencies. A one notch better DBRS rating corresponds to a 42 basis point reduction in a firm's debt cost of capital. The impact on yields is driven by cases where the DBRS rating is better than other ratings and is larger among bonds rated near the investment-grade cutoff. These findings indicate that ratings-based regulations on bond investment affect a firm's cost of debt capital.

Credit Ratings, Cost of Capital, SEC, Debt, Regulations, Capital Structure

Abstract:
Using the September 15, 2008 bankruptcy of Lehman Brothers as an exogenous shock to funding costs, we show that hedge funds act as liquidity providers. Hedge funds using Lehman as prime broker could not trade after the bankruptcy, and these funds failed twice as often as otherwise-similar funds after September 15 (but not before). Stocks traded by the Lehman-connected hedge funds in turn experienced greater declines in market liquidity following the bankruptcy than other stocks; and, the effect was larger for ex ante illiquid stocks. We conclude that shocks to traders’ funding liquidity reduce the market liquidity of the assets that they trade.

Abstract:
States were granted authority to limit interstate branching following passage of Federal legislation in 1994 relaxing restrictions on geographical expansion by banks. We show that differences in state's branching restrictions affected credit supply. In states more open to branching, small firms borrow at interest rates 25 to 45 basis points lower than firms operating in less open states. Firms in open states also are more likely to borrow from banks. Despite this evidence that interstate branch openness expands credit supply, we find no effect of variation in state restrictions on branching on small-firm borrowing or other indicators of credit constraints.

capital structure, small-firm finance, banking, deregulation

Abstract:
As more corporations turn to the securities markets to meet their funding needs, the role of banks as providers of credit to large businesses seems increasingly uncertain. But a look at developments during the financial market turmoil last fall suggests that banks are still a critical source of liquidity at times of economic stress.

Banking, Financial Intermediation, Commercial Paper

Abstract:
We investigate how bank migration across state lines over the last quarter century has affected the size and covariance of business fluctuations within states. Starting with a two-state version of the unit banking model in Holmstrom and Tirole(1997), we conclude that the theoretical affect of integration on business cycle size is ambiguous, as some shocks are dampened by integration, but others are amplified. Empirically, we find that integration diminishes employment growth fluctuations within states, and decreases the deviations in employment growth across states. Business cycles within states become smaller with integration, in other words, but more alike. Our results for the United States bear on the financial convergence underway in Europe, where banks remain highly fragmented across nations.

Abstract:
Concentrated lending declined dramatically between 1992 and 2006. We show that mortgage lenders that concentrate in a few markets behave like informed investors, while diversified lenders behave like uninformed investors. First, concentrated lenders accept and retain more mortgage applications than diversified lenders. Second, they have higher profits than diversified lenders, their profits vary less systematically, and their stock prices fell much less during the 2007-08 credit crisis. Third, when concentrated lenders retain more mortgages, future housing prices tend to appreciate, but retention rates of diversified lenders have no power to explain price changes. Both across markets and over time, the share of concentrated lending - that is, the share of informed lending - is negatively related to the recent housing price run-up. We conclude that inadequate information production helps explain the 2001-2008 real estate bubble and crash.

sub-prime mortgages, housing crisis

Abstract:
As protectors of the safety and soundness of the banking system, banking supervisors are responsible for keeping banks' risk taking in check. The authors explain that franchise value - the present value of the stream of profits that a firm is expected to earn as a going concern - makes the supervisor's job easier by reducing banks' incentives to take risks. The authors explore the relationship between franchise value and risk taking from 1986 to 1994 using both balance-sheet data and stock returns. They find that banks with high franchise value operate more safely than those with low franchise value. In particular, high-franchise-value banks hold more capital and take on less portfolio risk, primarily by diversifying their lending activities.

franchise value, bank supervision, portfolio risk

Abstract:
What is the relationship between a bank holding company's size and the risk it takes? The authors find that although the level of risk at large and small bank holding companies has not differed significantly, important distinctions exist in the nature of that risk. Historically, large companies' diversification advantages were offset by lower capital ratios and the pursuit of risk-enhancing activities. More recently, however, differences between the capital ratios and activities of large and small companies have narrowed. As a result, an inverse relationship between risk and bank holding company size has begun to emerge.

risk, bank size, diversification, capital ratio

Abstract:
Small banks are a major source of credit for small businesses. As banking consolidation continues, will a resulting decline in the presence of small banks adversely affect the availability of that credit?

banking, consolidation, small business lending

Abstract:
We investigate how the better integration of U.S. banks across states has affected economic volatility within states. In theory, the link between bank integration and volatility is ambiguous; integration tends to dampen the impact of bank capital shocks on state activity, but it amplifies the impact of firm collateral shocks. Empirically, the net effect has been stabilizing as year-to-year fluctuations in employment growth within states fall as that state's banks become better integrated (via holding companies) with banks in other states. The magnitudes are large, and the effects are most pronounced in states with relatively undiversified economies. Consistent with our model, we find the link between economic growth and bank capital within a state weakens with integration, whereas the link between growth and housing prices (a possible proxy for firm capital) tends to increase.

Abstract:
Interstate banking has ambiguous theoretical effects on state business volatility, but the (net) empirical effect has been stabilizing. In theory, bank diversification across states diminishes the impact of bank capital shocks on state activity, but amplifies the impact of firm collateral shocks. Empirically, we find that year-to-year employment growth fluctuations within states fall as banks in that state integrate (via holding companies) with banks in other states. The magnitudes are large. Bank integration matters most significantly in states with very undiversified economies. Consistent with our model, we also find that integration also weakens the correlation between bank capital growth and growth in state employment and bank lending but strengthens the correlation between changes in housing prices and employment and lending.

Abstract:
This paper shows that bank performance improves significantly after restrictions on bank expansion are lifted. We find that operating costs and loan losses decrease sharply after states permit statewide branching and, to a lesser extent, after states allow interstate banking. The improvements following branching deregulation appear to occur because better banks grow at the expense of their less-efficient rivals. By retarding the "natural"evolution of the industry, branching restrictions reduce the performance of the average banking asset. We also find that most of the reduction in banks' costs are passed along to bank borrowers in the form of lower loan rates.

bank, deregulation, loan rates

Abstract:
Concentrated lending declined dramatically between 1992 and 2006. We show that mortgage lenders that concentrate in a few markets behave like informed investors, while diversified lenders behave like uninformed investors. First, concentrated lenders accept and retain more mortgage applications than diversified lenders. Second, they have higher profits than diversified lenders, their profits vary less systematically, and their stock prices fell much less during the 2007-08 credit crisis. Third, when concentrated lenders retain more mortgages, future housing prices tend to appreciate, but retention rates of diversified lenders have no power to explain price changes. Both across markets and over time, the share of concentrated lending - that is, the share of informed lending - is negatively related to the recent housing price run-up. We conclude that inadequate information production helps explain the 2001-2008 real estate bubble and crash.

Bank Lending, Soft Information, Credit Crunch

Abstract:
When the Riegle-Neal Interstate Banking and Branching Efficiency Act went into effect in June 1997, it marked the final stage of a quarter-century-long effort to relax geographic restrictions on banks. This article examines an earlier stage of the deregulatory process-the actions taken by the states between 1978 and 1992 to remove the barriers to intrastate branching and interstate banking-to determine how the lifting of geographic restrictions affect the efficiency of the banking industry. The analysis reveals that banks' loan losses and operating costs fell sharply following the state initiatives, and that the cost declines were largely passed along to bank borrowers in the form of lower loan rates. The authors argue that these efficiency gains arose because better performing banks were able to expand their market share once geographic restraints were erased.

Riegle-Neal, bank branching deregulation

Abstract:
This paper looks at how advances in information and telecommunications technologies have been changing the structure of the financial system by lowering transaction costs and reducing asymmetric information. Households and smaller businesses can now raise funds in securities markets as financial institutions have become better at unbundling risks while financial products can be distributed more efficiently through electronic networks. These changes have reduced the role of traditional financial intermediaries overall efficiency by lowering the costs of financial contracting. Despite these benefits technological progress presents policymakers with some important challenges. First markets for financial products become larger and more contestable, defining geographic and product markets narrowly becomes more problematic. Second, financial consolidation and the trend towards new activities of financial intermediaries require the exploration of new methods to preserve the safety and soundness of the financial system. A combined system of vigilant supervision and constructive ambiguity to deal with failures of larger institutions should be capable of mitigating the potential for increased risk-taking and help preserve the health of the financial system.

Abstract:
I consider banks' role in providing funding liquidity (the ability to raise cash on demand) and market liquidity (the ability to trade assets at low cost), and how these roles have evolved. Traditional banks made illiquid loans funded with liquid deposits, thus producing funding liquidity on the liability side of the balance sheet. Deposits are less important in 21st century banks, but funding liquidity from lines of credit and loan commitments has become more important. Banks also provide market liquidity as broker-dealers and traders in securities and derivatives markets, in loan syndication and sales, and in loan securitization. Many institutions besides banks provide market liquidity in similar ways, but banks dominate in producing funding liquidity because of their comparative advantage in managing funding liquidity risk. This advantage stems from the structure of bank balance sheets as well as their access to government-guaranteed deposits and central-bank liquidity.

Abstract:
This paper investigates what factors determine whether a commercial banker is on the board of a non-financial firm. We consider the tradeoff between the benefits of direct bank monitoring to the firm and the costs of active bank involvement in firm management. Given the different payoff structures to debt and equity, lenders and shareholders may have conflicting interests in running the firm. In addition, the U.S. legal doctrines of "equitable subordination" and "lender liability" could generate high costs for banks which have a representative on the board of a client firm that experiences financial distress. Consistent with high potential costs of active bank involvement, we find that bankers tend to be represented on the boards of large stable firms with high proportions of tangible ("collateralizable") assets and low reliance on short-term financing. The protection of shareholder versus creditor rights under the U.S. bankruptcy doctrines may reduce the role that banks play in corporate governance and the management of financial distress, in contrast to Germany and Japan. We conclude with implications for the current bank regulatory reform debate, such as whether to permit banks to own equity in non-financial firms that, in turn, could allow them to mitigate the conflict.

Abstract:
We report evidence from the equity market that unused loan commitments expose banks to systematic liquidity risk, especially during crises such as the one observed in the fall of 1998. We also find, however, that banks with higher levels of transactions deposits had lower risk during the 1998 crisis than other banks. These banks experienced large inflows of funds just as they were needed -- when liquidity demanded by firms taking down funds from commercial paper backup lines of credit peaked. Our evidence suggests that combining loan commitments with deposits mitigates liquidity risk, and that this deposit-lending synergy is especially powerful during period of crises as nervous investors move funds into their banks.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
A paper summarizing a session of the June 2000 conference "Specialization, Diversification, and the Structure of the Financial System: The Impact of Technological Change and Regulatory Reform," sponsored by the Federal Reserve Bank of New York.

financial conglomerates, securities, banking

Abstract:
This paper investigates the frequency of connections between banks and non-financial firms through board linkages and whether those connections affect lending and borrowing behavior. Although a board linkages may reduce the costs of information flows between the lender and borrower, a board linkage may generate pressure for special treatment of a borrower not normally justifiable on economic grounds. To address this issue, we first document that banks are heavily involved in the corporate governance network through frequent board linkages. Banks tend to have larger boards with a higher proportion of outside directors than non-financial firms, and bank officer-directors tend to have more external board directorships than executives of non-financial firms. We then show that low-information cost firms - large firms with a high proportion of tangible assets and relatively stable stock returns - are most likely to have board connections to banks. These same low-information cost firms are also more likely to borrow from their connected bank, and when they do so the terms of the loan appear similar to loans to unconnected firms. In contrast to studies of Mexico, Russia and Asia where connections have been misused, our results suggest that avoidance of potential conflicts of interest explains both the allocation and behavior of bankers in the U.S. corporate governance system.

Abstract:
This paper examines the key forces behind deregulation in order to assess the relative importance of alternative theories of regulatory entry and exit. We focus on bank branching deregulation across the states which began a quarter century ago and cumulated in federal deregulation in 1994. The cross-sectional and time-series variation of branching deregulation allows us to develop a hazard model to explain the timing of deregulation across the states using proxies motivated by private-interest, public-interest, and political-institutional theories, the public interest approach cannot easily explain our findings that deregulation occurs later in states with relatively more small banks and with a relatively large insurance sector in states where banks can sell insurance. We also find that the ex post consequences of deregulation for the different interest groups are consistent with the ex ante lobbying patterns we infer from the hazard model. Some political-institutional factors also play a role in the process of regulatory change. The same forces that explain the timing of deregulation across the states also explain the pattern of voting in Congress on interstate branching deregulation. We conclude by considering the implications of our results for tyhe future path of deregulation and applications of our research design to other episodes of regulatory entry and exit.

Abstract:
We offer a new explanation of loan syndicate structure based on banks' comparative advantage in managing systematic liquidity risk. When a syndicated loan to a rated borrower has systematic liquidity risk, the fraction of passive participant lenders that are banks is about 8% higher than for loans without liquidity risk. In contrast, liquidity risk does not explain the share of banks as lead lenders. Using a new measure of ex-ante liquidity risk exposure, we find further evidence that syndicate participants specialize in liquidity-risk management while lead banks manage lending relationships. Links from transactions deposits to liquidity exposure are about 50% larger at participant banks than at lead arrangers.

Abstract:
Theory suggests that bank integration (financial integration generally) can magnify or dampen the business cycles, depending on the importance of shocks to firm collateral versus shocks to the banking sector. In this paper, we show empirically that bank integration across U.S. states over the late 1970s and 1980 dampened economic volatility within states. Internationally, however, we find that foreign bank integration, which advanced widely during the 1990s, has been either unrelated to volatility of firm investment spending or positively related to that volatility. The results suggest the possibility that business spending may become more volatile as countries open their banking sectors to foreign entry.

Abstract:
In February 2003, the SEC officially certified a fourth credit rating agency, Dominion Bond Rating Service ("DBRS"), for use in bond investment regulations. After DBRS certification, bond yields change in the direction implied by the firm's DBRS rating relative to its ratings from other certified rating agencies. A one notch better DBRS rating corresponds to a 39 basis point reduction in a firm's debt cost of capital. The impact on yields is driven by cases where the DBRS rating is better than other ratings and is larger among bonds rated near the investment-grade cutoff. These findings indicate that ratings-based regulations on bond investment affect a firm's cost of debt capital.

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Abstract:
Using the September 15, 2008 bankruptcy of Lehman Brothers as an exogenous shock to funding costs, we show that hedge funds act as liquidity providers. Hedge funds using Lehman as prime broker could not trade after the bankruptcy, and these funds failed twice as often as otherwise-similar funds after September 15 (but not before). Stocks traded by the Lehman-connected hedge funds in turn experienced greater declines in market liquidity following the bankruptcy than other stocks; and, the effect was larger for ex ante illiquid stocks. We conclude that shocks to traders' funding liquidity reduce the market liquidity of the assets that they trade.

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Abstract:
We examine whether rating agencies (Moody’s and S&P) reward large issuers of mortgage-backed securities, who bring substantial business, by granting them unduly favorable ratings. We also study whether and when the market begins to realize this incentive. For both AAA and non-AAA rated tranches sold by large issuers, their prices drop more than similar tranches sold by smaller issuers. These differences are concentrated during the market boom years of 2004 through 2006. The initial yield on the tranches sold by large issuers is lower than that on the tranches sold by small issuers during 2000-2003, but these patterns reverse during 2004-2006.

Credit ratings, mortgage-backed securities, conflict of interest, yield

Abstract:
In 1996, Congress passed the Interstate Banking andBranching Efficiency Act, which allowed banks to branch across state lines andto purchase banks in any state.This act contributed to an increase inexpansion-seeking banks.The focus here is on the ways in which thesestructural changes in banking have impacted the availability of bank credit andthe rate of new business creation.A literature review examines the waysthat financing affects business formation, considering other factors such ascompetition and entrepreneurial activity. To determine if the deregulation of banks and the subsequent increase inlending behavior positively impacted business creation, a reduced-form model isutilized. This model determines the extent to which the lending behavior of astate's banks depends on measures of the state's banking environment.Twomarket share variables are the focus of the study:the share of stateassets detained by undercapitalized banks and the share held by weaklycapitalized banks. Following data analysis, the results indicate that the deregulation of banksand the decline in the significance of small banks resulted in an increase inoverall lending, which aided entrepreneurs in creating their ownbusinesses. (AKP)

Herfindahl-Hirschmann Index (HHI), Interstate Banking & Branching Efficiency Act, Interstate commerce, Startup rates, Startups, Access to capital, Banking industry, Bank loans, Clusters, Deregulation, Federal regulations, Financing, Firm growth

Abstract:
Liquidity risk in banking has been attributed to transactions deposits and their potential to spark runs or panics. We show instead that transactions deposits help banks hedge liquidity risk from unused loan commitments. Bank stock-return volatility increases with unused commitments, but only for banks with low levels of transactions deposits. This deposit-lending hedge becomes more powerful during periods of tight liquidity, when nervous investors move funds into their banks. Our results reverse the standard notion of liquidity risk at banks, where runs from depositors had been seen as the cause of trouble.

G18, G21

Abstract:
Legal and institutional differences shape the ownership and terms of bank loans across the world. We show that under strong creditor protection, loans have more concentrated ownership, longer maturities, and lower interest rates. Moreover, the impact of creditor rights on loans depends on borrower characteristics such as the size and tangibility of assets. Foreign banks appear especially sensitive to the legal and institutional environment, with their ownership declining relative to domestic banks as creditor protection falls. Our multidimensional empirical model paints a more complete picture of how financial contracts respond to the legal and institutional environment than existing studies.

Creditor rights, institution, bank loan, collateral, maturity

Abstract:
The literature is divided on the expected effects of increased competition and consolidation in the financial sector on the supply of credit to relationship borrowers. This paper tests whether policy changes fostering competition and consolidation in U.S. banking helped or harmed entrepreneurs. We find that the rate of new incorporations increases following deregulation of branching restrictions, and that deregulation reduces the negative effect of concentration on new incorporations. We also find the formation of new incorporations increases as the share of small banks decreases, suggesting that diversification benefits of size outweigh the possible comparative advantage small banks may have in forging relationships.

Abstract:
Recent papers have argued that both competition and consolidation may reduce small- and new-business lending; competition by weakening incentives to collect private information, and consolidation by destroying existing relationships and marginalizing small banks. This paper uses state-level aggregate data on new business incorporations to examine whether trends toward increased competition and consolidation in the banking sector have reduced entrepreneurial activity. We find just the opposite. Increased competition is associated with higher levels of new incorporations. Consolidation also appears to help entrepreneurs; states with more large banks experience a higher levels of incorporations. This suggests that the diversification benefits of consolidation and greater bank size, which reduce delegated monitoring costs, outweigh possible advantages small banks may have in forging long-term relationships.

Entrepreneurship, small firm finance, banking

Abstract:
E-finance is defined as "The provision of financial services and markets using electronic communication and computation". In this paper we outline research issues related to e-finance that we believe set the stage for further work in this field. Three areas are focused on. These are the use of electronic payments systems, the operations of financial services firms and the operation of financial markets. A number of research issues are raised. For example, is the widespread use of paper-based checks efficient? Will the financial services industry be fundamentally changed by the advent of the Internet? Why have there been such large differences in changes to market microstructure across different financial markets?

E-finance, internet, research

Abstract:
E-finance is defined as "The provision of financial services and markets using electronic communication and computation". In this paper we outline research issues related to e-finance that we believe set the stage for further work in this field. Three areas are focused on. These are the use of electronic payments sys tems, the operations of financial services firms and the operation of financial markets. A number of research issues are raised. For example, is the widespread use of paper-based checks efficient? Will the financial services industry be fundamentally changed by the advent of the internet? Why have there been such large differences in changes to market microstructure across different financial markets?

Abstract:
This paper shows that bank performance improves significantly after restrictions on bank expansion are lifted. We find that operating costs and loan losses decrease sharply after states permit statewide branching and, to a lesser extent, after states allow interstate banking. The improvements following branching deregulation appear to occur because better banks grow at the expense of their less-efficient rivals. By retarding the "natural" evolution of the industry, branching restrictions reduced the performance of the average banking asset. We also find that most of the reduction in banks' costs were passed along to bank borrowers in the form of lower loan rates.

Abstract:
State guaranty funds provide partial protection to life insurance holders in the event of an insolvency, thus creating a moral hazard problem akin to the one associated with deposit insurance in the banking industry. We find that differences across states in the financing of these government guaranty systems affects risk taking by life insurance companies (LICs). In states where taxpayers do not pay for the costs of resolving insolvencies, LICs hold portfolios with lower overall stock market risk. These portfolios, however, are characterized by higher levels of both capital and risky assets. These empirical findings have policy implications for improving monitoring of financial intermediaries receiving government liability guarantees. We also examine the effects of franchise value, size and ownership structure on portfolio risk. We find that larger LICs and LICs with more franchise value take less risk. We also find that risk decreases with insider holdings until insiders own about 25 percent of the firm and increases thereafter.

Abstract:
The moral hazard problem associated with deposit insurance generates the potential for excessive risk taking on the part of bank owners. The banking literature identifies franchise value -- a firm's profit-generating potential -- as one force mitigating that risk taking. In the presence of owner/manager agency problems, managerial risk aversion may also offset the excessive risk taking that stems from moral hazard. Empirical models of bank risk have focused either on the disciplinary role of franchise value or on owner/manager agency problems. We estimate a unified model and find that both franchise value and ownership structure affect risk at banks. More important, we identify an interesting interaction effect: The relationship between ownership structure and risk is significant only at low franchise value banks -- those where moral hazard problems are most severe and where conflicts between owner and manager risk preferences are therefore strongest. Using loans to insiders as an alternative indicator of owner/manager agency problems, we find a similar interaction effect.

Abstract:
During the 1980s, insolvency of individual thrifts and the thrift deposit insurer created severe incentive problems. Lacking cash to close insolvent thrifts, regulators induced nearly $10 billion of private capital to flow into the industry through mutual-to-stock conversions. We test a theory of how regulators encouraged capital-impaired mutual thrifts to convert by permitting them to pay dividends rather than rebuild capital. We estimate the costs of this policy and interpret the 1991 Federal Deposit Insurance Corporation Improvement Act as requiring regulators to impose restraints on depository institutions parallel to debt covenants that prevent capital distributions by non- financial firms experiencing distress.

Abstract:
This paper provides evidence that financial markets can directly affect economic growth by studying the relaxation of bank branch restrictions in the U.S. We find that the rates of real, per-capita growth in income and output increase significantly following intrastate branch reform. We also argue that the observed changes in growth are the result of changes in the banking system. Improvements in the quality of bank lending, not increased volume of bank lending, appear to be responsible for faster growth.

Abstract:
This paper provides evidence that financial markets can directly affect economic growth by studying the relaxation of bank branch restrictions in the U.S. We find that the rates of real, per-capita growth in income and output increase significantly following intrastate branch reform. We also argue that the observed changes in growth are the result of changes in the banking system. Improvements in the quality of bank lending, not increased volume of bank lending, appear to be responsible for faster growth.