Finance: Research, Policy and Anecdotes

Last week saw the 7th edition of the Emerging Scholars in Banking and Finance conference, in virtual format given circumstances.  I do not have time or space to mention all the interesting papers, so herewith just some highlights:

In Monetary Policy Corporate Debt Maturity, Andrea Fabiani and co-authors show that a loosening of the US monetary policy rate lengthens corporate debt maturity, an effect entirely driven by the adjustments of very large firms. They explain this empirical finding with a theoretical model that combines standard financial frictions of moral hazard with short-termist, yield-oriented investors who rebalance their portfolios towards longer-term securities  when the policy rate and thus short-term rate descends. This effect seems to be driven by corporate bond funds that increase their holdings of corporate bonds in reaction to looser monetary policy and rebalance their holdings towards longer-term debt securities. It is then larger firms that can take advantage of this higher demand by issuing more longer-term bonds. As Andrea discusses in this blog entry, these findings can have quite important policy implications in times of increasing corporate debt and show another channel through which loose monetary policy and the search-for-yield channel affect firm financing patterns.

Leslie Shen presented a very interesting paper (Global Banking and Firm Financing: A Double Adverse Selection Channel of International Transmission) that explores theoretically and empirically global monetary policy transmission through cross-border lending to firms, both on the extensive (global vs. local banks) and the intensive (interest rate) margins. The key mechanism (for which she provides empirical evidence) is that cross-border lending relies more on information on the global dimension of borrowers’ returns, while domestic lending relies more on information on the local dimension of borrowers’ returns. This has important repercussion for the transmission of the monetary policy.  Take as example an increase in US interest rates: this results in more firms at the margin in the euro area switching away from US banks, while it raises (lowers) interest rates for firms that keep borrowing from US (Euro area) banks. This is a very nice paper that uses micro-data to test theories of international finance and links nicely to both the banking and the international macro literatures.

Carola Mueller and co-authors focus on the effectiveness of stress tests in Europe in The disciplining effect of supervisory scrutiny in EU wide stress tests.  Stress tests have been an important tool to test the resilience of banks against tail risk and guide supervisors in their dialogue with banks and setting pillar 2 capital requirements.  Using proprietary data on the EU-wide Stress Test conducted in 2016 by the European Banking Authority and the European Central Bank, the authors provide evidence that supervisory scrutiny that comes with stress testing can have a disciplining effect on bank risk, i.e., banks that received more supervisory scrutiny (as measured by the intensity of communication between banks and supervisors during the stress test exercise)  reduce risk weighted density more than banks that were under less intense scrutiny. On the other hand, there is no significant evidence that higher capital requirements resulting from the stress tests and higher publication requirements resulting in higher market discipline might have resulted in lower risk taking. Overall, this is compelling evidence in support of supervisory discipline. This paper provides complementary evidence to research from the US on the effect of stress tests on banks’ risk-taking (part of a special JFI issue I discussed earlier), but provides more detail on the actual channels through which stress tests work.

Overview