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«Whatever it takes: The Real Effects of Unconventional Monetary Policy Viral V. Acharya NYU Stern Tim Eisert Erasmus University Rotterdam Christian ...»

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NOVEMBER 5–6,2015

Whatever it takes: The Real Effects of

Unconventional Monetary Policy

Viral V. Acharya

NYU Stern

Tim Eisert

Erasmus University Rotterdam

Christian Eufinger

IESE Business School

Christian Hirsch

Goethe University Frankfurt

Paper presented at the 16th Jacques Polak Annual Research Conference

Hosted by the International Monetary Fund

Washington, DC─November 5–6, 2015 The views expressed in this paper are those of the author(s) only, and the presence of them, or of links to them, on the IMF website does not imply that the IMF, its Executive Board, or its management endorses or shares the views expressed in the paper.

Whatever it takes: The Real Effects of Unconventional Monetary Policy∗ Viral V. Acharya† Tim Eisert‡ Christian Eufinger§ and Christian Hirsch,,, Abstract On July 26, 2012 Mario Draghi announced to do whatever it takes to preserve the Euro. The resulting Outright Monetary Transactions (OMT) Program led to a significant reduction in the sovereign yields of periphery countries. Due to their significant holdings of GIIPS sovereign debt, the OMT announcement indirectly recapitalized periphery country banks by increasing the value of their sovereign bonds. This led to an increased supply of loans to private borrowers in Europe.

We show that firms that receive new loans from periphery banks use the newly available funding to build up cash reserves, but there is no impact on real economic activity like employment or investment.

∗ The authors gratefully acknowledge financial support by CEPR/Assonime Programme on Restarting European Long-Term Investment Finance (RETLIF). Hirsch gratefully acknowledges support from the Research Center SAFE, funded by the State of Hessen initiative for research Loewe. Eufinger gratefully acknowledges the financial support of the Public-Private Sector Research Center of the IESE Business School and the Europlace Institute of Finance. Corresponding author: Viral V. Acharya, Phone: +1-212- 998-0354, Fax: +1-212-995-4256, Email: vacharya@stern.nyu.edu, Leonard N. Stern School of Business, 44 West 4th Street, Suite 9-84, New York, NY 10012.

† New York University, CEPR, and NBER ‡ Erasmus University Rotterdam § IESE Business School Goethe University Frankfurt and SAFE 1 Introduction In the peak of the European Sovereign Debt Crisis in 2010, the European Central Bank (ECB) began introducing unconventional monetary policy measures to stabilize the Eurozone and restore trust in the periphery of Europe. Ultimately, these unconventional monetary policy measures were aiming at breaking the vicious circle between bank and sovereign health, which has led to a sharp decline in economic activity in the countries in the periphery of the Eurozone (Acharya, Eisert, Eufinger, and Hirsch (2015)). It was especially the ECB’s Outright Monetary Transactions (OMT) program, which ECB’s president Mario Draghi announced during his famous “whatever it takes” speech in the summer of 2012, that helped to restore trust in the viability of the Eurozone.

While, according to the ECB, the primary objective of the OMT program was “safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy”, the measure also potentially had an important impact on the stability of banks and their lending behavior. As the OMT program announcement led to a strong decrease in sovereign debt spreads of stressed countries in the periphery of the Eurozone, banks with significant holdings of these sovereign bonds potentially experienced substantial windfall gains due to the increased value of their bond holdings.

However, there is still no conclusive evidence as to whether and how the OMT program has impacted the real economy through the bank lending channel. Therefore, in this paper, we analyze whether (i) the ECB’s OMT program led to a reduction in bank credit risk by increasing the value of the sovereign debt portfolio of banks, (ii) whether this reduction in bank credit risk entailed an increase in the availability of bank funding for borrowing firms, and (iii) whether this potential increase in loan supply led to real economic effects on the firm level.

This sets the structure for our analysis. Our empirical analysis is hence organized into three parts. We start by analyzing the impact of the OMT program announcement on bank health. The sample used in this paper builds on loan information data obtained from Thomson Reuters LPC’s DealScan, which provides extensive coverage of bank-firm relationships throughout Europe, and firm-specific information from Bureau van Dijk’s Amadeus database, which we hand-match to DealScan. The sample includes all private firms from all EU countries for which Dealscan provides loan information. In particular, the sample includes firms from all European countries that were severely affected by the sovereign debt crisis (the GIIPS countries). In addition, we obtain information on bank and sovereign CDS spreads from Markit, bank equity and sovereign bond information from Datastream, bank level balance sheet data from SNL, and data on the sovereign debt holdings of banks from the EBA stress tests, transparency, and capital exercises.

This allows us to determine the extent to which individual banks were affected by the announcement of the OMT program. Our sample period covers the years 2009 until 2013.

1 We first show that GIIPS banks benefited most from the OMT announcement due to their substantial amount of GIIPS sovereign debt holdings. These banks realized significant windfall gains on their sovereign debt holdings due to the decreasing sovereign yields, implying that the OMT program announcement has indirectly recapitalized especially those banks in Europe that contributed significantly to the severe loan supply disruptions during the sovereign debt crisis. Furthermore, we find that bank credit risk decreased significantly on the dates surrounding the OMT announcement dates, a result that is in line with findings in Acharya, Pierret, and Steffen (2015). We use regression analysis on the bank level to confirm that the reduction in bank credit risk is indeed largely driven by a bank’s holding of GIIPS sovereign debt and its resulting windfall gains due to the OMT program.

Second, we document that this reduction in bank credit risk and the resulting improvement in bank health led to an increase in available loans to firms. Building on the methodology of Khwaja and Mian (2008), we find that banks with higher windfall gains on their sovereign debt holdings increased loan supply to the corporate sector by more in the quarters following the OMT announcement than banks with lower windfall gains.

To analyze which type of borrowers benefited most from an increased lending volume in the period after the announcement of the OMT program, we divide our sample into low- and high-quality borrower based on the ability of firms to service existing debt. In particular, a low-quality borrower is defined as having a below country median interest coverage ratio, while borrowers are considered to be of high-quality if their interest coverage ratio is above the median. The results of our lending regressions show that especially low-quality borrower benefited from the increased loan volume in the period following the OMT program announcement. In contrast to this result, high-quality borrower did not benefit significantly from the OMT announcement as the loan volume extended to this subset of firms does not increase in response to the OMT announcement.

Next, we investigate whether the OMT program supported the economic recovery of the Eurozone due to the potential positive impact on firms’ polices and real activity induced by the increased loan supply. To analyze how the OMT announcement has impacted corporate policies of firms through the bank lending channel, we closely follow the approach used in Acharya, Eisert, Eufinger, and Hirsch (2015). In particular, we use a diff-in-diff framework to evaluate the performance and policies of borrowing firms in the post-OMT period. To measure the impact of the OMT program announcement, we construct for each firm a variable that captures how much each firm indirectly benefited by the post-OMT increase in value of the sovereign debt holdings of the banks it is associated with. We provide evidence that borrowers with higher indirect OMT windfall gains (indirectly as they benefited through their banks) increased both their cash holdings and leverage by roughly the same amount, suggesting that they use the majority of cash inflow to build up cash reserves. However, we do not find any changes in real economic 2 activity; neither investment nor employment are significantly affected by a firms’ indirect OMT windfall gains.

To shed more light on the motives behind this finding, we follow the approach of Almeida, Campello, and Weisbach (2004) and use the cash flow sensitivity of cash to analyze whether firms with relationships to banks that benefited from OMT remain financially constrained in the period following the OMT program announcement. Using this measure we, first, document that borrowers with a high exposure to banks that benefited from OMT were financially constrained in the pre-OMT announcement period, a finding which is consistent with prior studies (e.g., Acharya, Eisert, Eufinger, and Hirsch (2015)). Second, we find that, whether a firm that is borrowing from banks that benefited from OMT remains financially constrained or becomes financially unconstrained in the post-OMT period, depends on the quality of the borrower. Low-quality borrower became financially unconstrained, while high-quality borrower remain financially constrained in the period following the OMT announcement. This result is in line with the finding that mostly low-quality borrower obtained new loans.

In line with these results, we document that firms, which received new bank loans from banks that experienced large windfall gains on their sovereign debt holdings due to the OMT program, had a significantly higher propensity to save cash from the proceeds of new loans. One possible interpretation of this result is that low-quality firms used the proceeds from new loans to regain financial stability and build up a buffer after being cutoff from bank lending for a sustained period of time during the sovereign debt crisis.

A possible concern about our empirical methodology is that our results could be driven by the poor macroeconomic environment in GIIPS countries which prevented firms from investing and creating new jobs. We control for the macroeconomic environment in our main specification by including firm as well as interactions between industry, year and country fixed effects to absorb unobserved time-varying shocks to an industry in a given country in a given year. Furthermore, we include foreign bank country-year fixed effects to absorb any unobserved, time-varying heterogeneity that may arise because a firm’s dependency on banks from a certain country might be influenced by whether this firm has business in the respective country. Consider as an example a German firm borrowing from a Spanish bank and a German bank. For this firm, we include a Spain-year fixed effect to capture the firm’s potential exposure to the macroeconomic downturn in Spain during the European Sovereign Debt Crisis. Moreover, we control for unobserved, timeconstant firm heterogeneity and observable time-varying firm characteristics that affect the firms’ corporate policies, loan demand, and/or loan supply.

To further alleviate concerns that our results are driven by the poor economic environment, we show that all results continue to hold if we restrict our sample to non-GIIPS borrower without any subsidiaries in GIIPS countries or to GIIPS borrower that generate a considerable part of their revenues from non-GIIPS subsidiaries. For both of these 3 subsets of firms it is plausible to assume that they were relatively less affected by the economic conditions as, e.g., GIIPS firms operating solely in GIIPS countries.

2 Outright Monetary Transactions In mid-2012 the anxiety about excessive national debt led to interest rates on Italian and Spanish government bonds that were considered unsustainable. From mid-2011 to mid-2012, the spreads of Italian and Spanish 10-year government bonds had increased by 200 basis points and 250 basis points, respectively relative to Germany. As a result, yields on 10-year Italian and Spanish government bonds were more than 4 percentage points higher than yields on German government bonds in July 2012.

This significant increase in bond spreads of countries in the periphery of the Eurozone became a matter of great concern for the ECB as it endangered the monetary union as a whole. In response to the mounting crisis, ECB President Mario Draghi stated on July 26, 2012, during a conference in London: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” On August 2, 2012, the ECB announced it would undertake outright monetary transactions in secondary, sovereign bond markets. The technical details of these operations were unveiled on September 6, 2012.

To activate the OMT program towards a specific country, that is, buy a theoretically unlimited amount of government bonds with one to three years maturity in secondary markets, four conditions have to be met. First, the country must have received financial support from the European Stability Mechanism (ESM). Second, the government must comply with the reform efforts required by the respective ESM program. Third, the OMT program can only start if the country has regained complete access to private lending markets. Fourth, the country’s government bond yields are higher than what can be justified by the fundamental economic data. In case the OMT program would be activated the ECB would reabsorb the liquidity pumped into the system by auctioning off an equal amount of one-week deposits at the ECB. By Summer 2015, the OMT program has still not been actually activated.

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