The Risk Premium for Minority Banks Altruistic Portfolios in Underserved Communities
40 Pages Posted: 16 Sep 2012 Last revised: 29 Nov 2017
Date Written: November 28, 2017
Several countries have banking policies geared towards providing access to credit to ethnic or religious minorities, e.g., India, China, Malaysia, South Africa, United States. In this paper, we characterize the compensating risk premium for such minority bank (MB) policies. Our theory apparatus synthesizes Vasicek’s bond pricing model, and KMV Moody loan portfolio model, with statistical risk accounting. We find that differences in internal rate of return (IRR) and interest rate elasticity of bond prices, for minority (MB) and nonminority (NMB) peer banks, induce an anomalous concave risk return pricing structure for MBs. We show how the concave payoff structure is convexified with compensating risk factors. Our model predicts that increased bank capitalization, and brokered deposit (BD) exceptions, compensate risk when the incremental IRR they induce is negatively correlated with the IRR on extant MB loan portfolios. Thus implying, paradoxically, that loan portfolios levered by increased capital, and brokered deposits, militate against altruistic motives. This implies that for a given amount of altruism, MBs are better served by tactical portfolio allocation in an expanded investment opportunity set. We apply the theory to US minority banks’ (MBs) altruistic motives to provide access to credit in underserved communities. Using Federal Reserve Statistical Release on select FFIEC Form 031 (“Call Report”) data for a sample of US banks, we fit a risk-return function for MBs and estimate the compensating risk premium for return on assets. We extrapolate robust estimates of loss aversion indexes for minority banks, e.g., Hispanic (2.42), Asian (2.78), Black (2.93), Native American (3.17), and Low Income Credit Union (3.56). A rank order of adjusted price of risk show that Low Income Credit Unions are most risk averse, followed by African-American banks, Caucasian Women, Native American, Hispanics and Asian banks.
Keywords: minority banks, behavioral asset pricing, compensating risk premium, loss aversion, altruism, statistical risk accounting, price of risk
JEL Classification: D03, D81, G11, G12, G21, G28, G32, M48
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