Does Capital Market Scrutiny Discourage Banks from Accommodating Distressed Borrowers?

Abstract

To encourage banks to accommodate distressed borrowers during the Covid-19 pandemic,
regulators redacted loan modification activity from each bank’s public regulatory filings so that
banks could modify loans free from capital market scrutiny. This study examines whether capital
market scrutiny does in fact discourage banks from making loan modifications, as posited by bank
regulators. To test this question we exploit the fact that the SEC still required public banks to
disclose the modifications, meaning that the type of bank that faces the most capital market
scrutiny (public banks) had to disclose loan modifications, while the type of bank that faces the
least capital market scrutiny (private banks) faced even less scrutiny of loan modifications due to
lack of disclosure. Using a measure of the extent to which banks delay collection of loan payments,
which we find to be highly correlated with actual modification activity disclosed by public banks,
we do not find significant differences in loan modification activity between public and private
banks during the pandemic. Overall, the results are not consistent with the idea that suppressing
information about loan modifications encourages additional modification activity.

Keywords: banking, lending, troubled debt restructurings, loan modifications, COVID, pandemic, disclosure

JEL Classification: M41, M48, G21