Finance: Research, Policy and Anecdotes

One of the highlights of an editor’s job is to press the Accept button.  Here are some of these highlights of recent months:

Andreas Haufler provides a theoretical explanation of why supervision is easier to centralise in a banking union than bailout decisions in “Regulatory and Bailout Decisions in a Banking Union”. Specifically, in a two-country model with different failure probabilities for banks centralized supervisory decisions will always be efficiency enhancing, as the two countries share a common interest to internalize the cross-border spillovers that arise from both successful and defaulting banks. In contrast, the overall efficiency effects of centralized bailout decision are ambiguous, as centralized bailouts reduce the total costs that arise from failing banks, but also exacerbate banks’ incentives to choose inefficiently high levels of risk-taking. In addition, with cross-country differences in the distribution of failure probabilities, a conflict of interest will necessarily emerge from an equal sharing of all countries in the costs of bank bailouts.  For a simple calibration with foreign ownership shares and rates of returns collected from a sample of large European bank, the author shows that the equilibrium regime will feature a common regulatory policy, but maintain national bailout policies, i.e., exactly what we can currently observe in the European banking union structure.

Adonis Antoniades explores a variation on the bank lending channel of monetary policy in “Monetary Easing And The Lending Concentration Channel of Monetary Policy Transmission”, focusing on bank lending concentration. Specifically, he uses loan-level data on US mortgage loan applications to identify the effect of lending concentration on the pass-through of the 2008 monetary easing to the volume of lending. He finds that lenders eased credit conditions but less so in counties with higher lending concentration, consistent with theories predicting lower monetary pass-through for lenders with higher market power. Furthermore, within a county, the pass-through was lower for lenders with higher local market power. The channel is active also during the 2005 monetary tightening episode, where lending contraction is less in more concentrated counties.

Modestus I. Nnadi and co-authors offer a new test of how political connections affect the costs of external finance in “Political Connections and Seasoned Equity Offerings”. Using a sample of seasoned equity offerings between 2001 to 2018 in the US, the authors find that politically connected issuers enjoy lower cost of seasoned equity issuance than their non-connected counterparts. SEO gross spreads are 36 to 38 percentage points lower when an issuer is politically connected (measured as having at least one board member who had important political offices and was a candidate for such). This result holds after controlling for issuers depending on government contracts and other factors. One wonders whether the benefit of such political connections has increased over time.

Ali Choudhary and Anil Jain explore the relationship between banks’ capital buffer and their willingness to recognise non-performing loans in “Corporate stress and bank nonperforming loans: Evidence from Pakistan”.   Focusing on a sample of borrowers with multiple lender from the Pakistani credit registry, the authors show that banks with lower leverage ratios are both significantly slower and less likely to recognize a loan as overdue than other banks.  This lack of recognition also impedes loan curing, with banks with lower leverage ratios reporting significantly higher final default rates than other banks for the same borrower, even after controlling for differences in loan terms.  This is not due to these banks knowing their client better or trying to help them over bad times, as they reduce their lending to these firms compared to other lenders. Overall, a clear sign of zombie lending, triggered by low capital buffers. Maybe some lessons for Europe as well?

Overview