The Risk Premium for Minority Banks Altruistic Portfolios in Underserved Communities

Abstract:     
Motivated by behavioural asset pricing theory, we introduce a statistical risk accounting model to characterize the compensating risk premium required to sustain minority banks' (MBs) altruistic motive to provide credit in underserved communities. Our model predicts that increased bank capitalization, and brokered deposit (BD) exceptions, compensate risk when the incremental internal rate of return they induce is negatively correlated with the internal rate of return on extant MB loan portfolios. Thus implying, paradoxically, that loan portfolios levered by increased capital, and brokered deposits, militate against altruistic motives. This suggests that for a given amount of altruism, minority banks are better served by tactical portfolio allocation in an expanded investment opportunity set. Using Federal Reserve Statistical Release (12/2011) on select FFIEC Form 031 ("Call Report") data, we fit a risk-return function for minority banks and estimate the compensating risk premium for return on assets. We provide back of the envelope formula for estimating minority bank profitability based on loan loss ratio, leverage ratio, and operating expense. There, we find that Hispanic and Caucasian Women owned banks are the only profitable ones left after brokered deposits are factored out. We also extrapolate crude estimates of the price of risk for minority banks -- adjusted for loss aversion index extrapolated from the behavioural economics literature. These results have implications for the efficacy of U.S. Dept of Treasury's Community Development Financial Institutions (CDFIs) Fund capacity building and bank capitalization initiatives, and emph{de facto} brokered deposit programs, as compensating risk mechanisms for minority and women owned banks. For they are excepted under Section 29 of the Federal Deposit Insurance Act, enacted through the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) (eff. 1989), and the Dodd-Frank Wall Street Reform and Consumer Protection Act (eff. July 2010) mandatory evaluation of such programs.

Number of Pages in PDF File: 44

Keywords: minority banks, behavioral asset pricing, compensating risk premium, brokered deposits, altruistic motives, statistical risk accounting, price of risk

JEL Classification: D03, D81, G11, G12, G21, G28, G32, M48

working papers series