Finance: Research, Policy and Anecdotes

The Ieke van den Burg Prize, an annual prize to recognise outstanding research conducted by young scholars on a topic related to the ESRB’s mission, awarded by the Advisory Scientific Committee, was this year given to two papers, both of which address very timely topics.

The first one – especially close to my own interest - studies the effects of bank payout restrictions, imposed during the COVID-crisis in 2020 on banks’ risk-shifting incentives. Thomas Kroen uses the fact that only Fed-supervised bank holding companies were subject to the ban on share buy-backs and restrictions on dividend payments in the US. He finds that both equity prices and CDS spreads and bond yields declined for these banks, suggesting that that payout restrictions shift risk from debt towards equity holders. After restrictions were lifted, both effects reverted. Overall, this suggests that pay-out restrictions reduced risk-shifting incentives of banks, in line with the intention of supervisors. Thomas also provides micro-evidence for this effect by considering syndicated lending data and shows that banks increase their non-investment grade lending by 32 % relative to investment-grade lending when the payout restrictions are removed, while the average interest rate spread declines. Finally, he provides back-of-the envelope calculations that the financial safety net guarantee by the government also reduced in the value during the period of payout restrictions, i.e., the amount of bailout resources the government would have to provide in case of bank failure times failure probability. Overall, quite powerful evidence in favour of payout restrictions during extreme crisis situations such as in 2020.  

Antonio Coppola shows the importance of investor base composition for the performance of firms during financial crises. Fire sales by investors might put pressure on firms and their access to external funding. This has raised the focus on long-term investors as safe hands, in contrast to weak- hand investors who are prone to quickly liquidate their investments in times of market-wide distress. Antonio focuses on two investor sectors, insurance companies and mutual funds, which are the most important participants in the corporate bond market. Given that mutual fund clients can redeem capital easily unlike insurance policy holders, mutual funds have a higher propensity to engage in fire sales than insurers.  He finds that this matters for firms.  Specifically, firms whose bonds are owned by mutual fund investors and who are thus less prone to fire sales face relatively better credit conditions: they maintain higher levels of borrowing, pay a lower cost of capital, and have higher real investment rates. He uses large-scale security-level holdings data and introduces issuer fixed effects, i.e., comparing a firm’s bond held by either an insurance company or a mutual fund, to control for endogeneity.  The economic effects are also strong: All else equal, increasing insurance holdings in a bond by 50 percentage points leads to price declines during downturns that are 20 percent shallower; further, firms at the 90th percentile of the distribution of bonds held by insurers have capital expenditure rates higher by 1.5 percentage points than firms at the 10th percentile,  are 25 percentage points more likely to issue new bonds in each of the crisis years, and pay offering yields lower by 120 basis points when doing so.   These findings are important for ongoing macroprudential policy discussions, such as on gating provisions for mutual funds during crisis periods but also the need for a diverse institutional investor base (with mutual funds being able to provide liquidity during normal times but insurers reducing the risk of wide-spread fire sales during crisis situations).

Overview