FREE ELECTRONIC LIBRARY - Dissertations, online materials

Pages:   || 2 | 3 | 4 |

«Kenneth N. Kuttner Federal Reserve Bank of New York Darius N. Palia Rutgers University Are There Bank Effects in Borrowers’ Costs of Funds? ...»

-- [ Page 1 ] --

R. Glenn Hubbard

Columbia University and National Bureau of Economic Research

Kenneth N. Kuttner

Federal Reserve Bank of New York

Darius N. Palia

Rutgers University

Are There Bank Effects in

Borrowers’ Costs of Funds?

Evidence from a Matched Sample

of Borrowers and Banks*

I. Introduction We use a matched sample

of individual loans, bor-

rowers, and banks to in-

Empirical researchers in macroeconomics and corporate

vestigate the effect of finance have long been interested in effects of changes banks’ financial health on in bank loan supply on borrowers’ costs of funds and the cost of loans, control- hence on a variety of investment decisions by borrowers ling for borrower risk and information costs.

(see, e.g., Roosa 1951). This interest has come to the Our principal finding is forefront in policy discussions of the credit crunch in that low-capital banks the United States in 1991 and the capital crunch for tend to charge higher Japanese banks in 1998. To the extent that a borrower loan rates than well- faces switching costs in a relationship with an individual capitalized banks. This effect is primarily associ- bank, bank-specific financial health might affect a bor- ated with firms for which information costs are * We are grateful to David Beim, Charles Calomiris, Douglas likely to be important, Diamond, John Driscoll, Charles Himmelberg, Robert Hodrick, and, when borrowing Mitchell Petersen, Richard Roll, Eric Rosengren, Matthew Shapiro, from weak banks, these Jacky So, Phil Strahan, Suresh Sundaresan, and seminar participants at University of Chicago, Columbia University, University of Flor- firms tend to hold more ida, New York University, Northwestern University, University of cash. The results indicate California, Los Angeles, the Federal Reserve Bank of New York, that many firms face sig- the NBER Summer Institute Programs in Monetary Economics and nificant costs in swi

–  –  –

rower’s cost of funds, even when observable characteristics relating to borrower risk are controlled for. And to the extent that certain borrowers face differentially costly external financing from nonbank as opposed to bank lenders, shifts in the ability or willingness of banks to lend can affect these borrowers’ cost of funds and investment.

Sources of a special role for banks in the credit allocation process have been widely explored. Indeed, the existence of banklike financial intermediaries is generally explained by informational asymmetries that lead to costly frictions in the allocation of capital (see, e.g., Diamond 1984, 1989, 1991;

Ramakrishnan and Thakor 1984). In this line of inquiry, the relative importance of private financing for firms depends on the magnitude of information costs in acquiring external financing.1 That is, the role for financial intermediaries in financing investment is most pronounced when high information costs create a significant wedge between the costs of internal and external financing (see, e.g., Bernanke 1983; Fama 1985). While there are significant bodies of research on effects of firms’ balance sheet positions on firms’ investment decisions and on effects of banks’ balance sheet positions on banks’ lending decisions, empirical work linking bank and borrower variables has been much more limited.

One strand of research offers indirect evidence on the real decisions of bank-dependent borrowers. Using firm-level data for Japan, Hoshi, Kashyap, and Scharfstein (1993) concluded that investment is less sensitive to cash flow for firms that are members of a keiretsu. Also using Japanese data, Gibson (1995) found that firm investment is sensitive to the financial health of the firm’s main bank, holding constant Q and cash flow (as proxies for investment opportunities and costly external financing). Using data on small U.S. firms, Petersen and Rajan (1994) and Berger and Udell (1995) estimated that a close bank relationship increases credit availability for small borrowers. Using data on larger, publicly traded U.S. firms, Houston and James (1995) found that firms that rely on a single bank lender have a much greater sensitivity of investment to cash flow than do firms that have multiple bank relationships or that borrow in public debt markets. They also estimate that firm-level sensitivity of investment to cash flow increases with a firm’s reliance on banks for debt financing.

Another body of research has concluded that replacing banking relationships is costly. James (1987) found that, on announcement of a bank loan, firms earn positive abnormal returns.2 Similar in spirit to this article is that of Slovin,

1. Perhaps less well understood are costs associated with reliance on banks, including regulatory taxes (Fama 1985), information monopoly power (Sharpe 1990; Rajan 1992), and costs of lender control (Diamond 1994).

2. While James (1987) found that all bank loans earn positive abnormal returns, Lummer and McConnell (1989) found that only loan renewals earn positive abnormal returns and that loan initiations do not. However, Slovin, Johnson, and Glascock (1992) showed that differentiating between loan initiations and loan renewals is unnecessary, because both types of loans earn positive abnormal returns (only in the case of small firms, not in the case of large firms).

Accordingly, we control for firm size but not for whether the loan is a renewal or an initiation.

Bank Effects 561 Sushka, and Polonchek (1993), who studied the effects of the de facto failure of Continental Illinois Bank and its subsequent rescue by the Federal Deposit Insurance Corporation (FDIC) during 1984 on the share prices of the bank’s loan customers. In particular, they concluded that the impending failure led to negative excess returns for firms with a lending relationship with Continental (especially for those lacking a relationship with another bank), while the rescue led to positive excess returns for those firms. We employ a larger sample of banks and firms than do Slovin, Sushka, and Polonchek, and, more important, we control for firm characteristics related to borrower-specific operating risk and scope for moral hazard.

We attempt to bridge the gap in existing research by matching data on the terms of individual loans with information on the borrower and bank lender in the transaction. This matching allows us to investigate whether, holding constant proxies for borrower risk and information costs, bank liquidity or capital affects terms of lending. In particular, we focus on measuring the effects of borrower and bank characteristics on the interest rate charged to the borrower.

Our principal findings are five. First, even after controlling for proxies for borrower risk and information costs, the cost of borrowing from low-capital banks is higher than the cost of borrowing from well-capitalized banks. Second, this cost difference is traceable to borrowers for which information costs and incentive problems are a priori important. Third, estimated “weak-bank” effects remain even after controlling for unobserved heterogeneity in the matching of borrowers and banks. Fourth, weak-bank effects are quantitatively important only for high-information-cost borrowers, consistent with models of switching costs in bank-borrower relationships and with the underpinnings of the bank lending channel of monetary policy. Fifth, when we investigate determinants of cash holdings of borrowing firms, we find that firms facing high information costs hold more cash than other firms, all else being equal, and those firms (and only those firms) have higher cash holdings when they are loan customers of weak banks. These results suggest that declines in banks’ financial health can lead to precautionary saving by some firms, a response that may affect their investment spending.

The article is organized as follows. Section II describes the data sets we use to match loan, bank, and borrower characteristics. Our empirical tests are reported in Section III. Section IV concludes and discusses broader implications of our findings.

II. The Data Our interest in isolating effects of borrower and bank characteristics on the cost of funds for investment creates a high data hurdle. We require information on loans, borrowers, and banks for each transaction. Our basic source of data is a sample of 11,621 loan agreements with principal amounts totaling $1,895 billion (with an average loan size of $164 million), covering about 4,840 562 Journal of Business business firms in the United States. The data are taken from the 1993 release of the Dealscan database supplied by the Loan Pricing Corporation (LPC) and cover the period from 1987 to 1992.3 For a given loan, the LPC data record the identity and location of the borrower; the purpose, contract date, type, and amount of the loan;4 the identities of the lenders (for our purposes, U.S. banks) party to the loan at origination; and price and some nonprice terms. Almost all (97%) of the loans are floating-rate. To obtain more information about borrower characteristics, we matched the firms in LPC with those in the Compustat database. To obtain more information about bank characteristics, we match the banks in LPC (i.e., the lead bank for a given loan) with data from the Reports of Condition and Income (Call Reports) compiled by the FDIC, the Comptroller of the Currency, and the Federal Reserve System.5 We use as a measure of the cost of funds the “drawn all-in spread,” or AIS, reported by LPC.6 The AIS is intended to provide a standard measure of the overall cost of the loan, expressed as a spread over the benchmark London interbank offering rate (LIBOR) and taking into account both one-time and recurring fees associated with the loan. The AIS is defined accordingly as the coupon spread, plus any annual fee, plus any up-front fee divided by the maturity of the loan. For loans not based on LIBOR, the LPC converts the coupon spread into LIBOR terms by adding or subtracting a constant differential reflecting the historical averages of the relevant spreads.7 Before investigating empirically the effects of borrower and bank characteristics on the cost of funds, we begin by documenting patterns for loan rates (measured by the AIS), loan maturity, bank size, firm leverage, use of colOther studies using the LPC data for different purposes include Carey (1995a, 1995b); Beim (1996); and Carey, Post, and Sharpe (1998). In general, the loan agreements in the Dealscan database cover a significant fraction of the dollar value of outstanding consumer and industrial loans (see Carey et al. 1998). According to LPC, the great majority of the data were collected from letters of commitment and credit agreements drawn from filings with the Securities and Exchange Commission. (Registered firms are required to disclose information about any financing in excess of 10% of their total assets and, while not required to do so, often choose to include the complete text of the credit agreement as an attachment to their filing.) Especially in the more recent years of our sample, some data were collected from news reports or through LPC’s relationships with major banks.

4. Some of the loan packages, or “deals,” incorporated multiple “facilities” originated by the borrower on that date. Our empirical analysis is at the level of the facility because loan packages with more than one lender do not necessarily involve all lenders in all facilities and because the spread depends on facility-specific attributes.

5. We lose observations when LPC does not report the loan spread or whether the loan is secured and when we cannot match the loan transaction data to the Call Report data or Compustat.

6. An “undrawn all-in spread” on undrawn lines of credit is also reported, but we do not use it in the analysis.

7. The differentials used in the AIS reported in the LPC data set are as follows: 205 basis points for the prime rate, 19 basis points for the commercial paper rate, 125 basis points for the Treasury-bill rate, 25 basis points for the federal funds rate, 12 basis points for the bankers’ acceptance rate, and 9 basis points for the rate on negotiable certificates of deposit.

Carey (1995a) found the loan spread, as measured by the AIS, to be comparable to bond spreads, controlling for differences in maturity and collateral. Replacing these constants with time-varying differentials based on year-specific average spreads has a minimal effect on the results.

Bank Effects 563

–  –  –

lateral, and bank capital-asset ratios across borrower-size groupings (measured by sales). As table 1 shows, smaller borrowers on average pay a higher AIS, obtain shorter-term loans, are more likely to rely on secured financing, and have somewhat lower leverage than larger borrowers. In addition, smaller borrowers tend to be the loan customers of smaller banks; these small banks, in turn, tend to be better capitalized. Through their common dependence on borrower size, therefore, the AIS would appear to be an increasing function of bank capital. Detecting a link between bank financial weakness and terms of lending will therefore require controls for borrower and bank characteristics.

III. Borrower Characteristics, Bank Characteristics, and the Cost of Funds Absent informational frictions, in a competitive loan market, the loan interest rate charged by a bank to a borrower should reflect the bank’s cost of funds and the risk characteristics of the borrower. Changes in borrower risk will affect the risk premium in the loan rate. Bank-specific increases in the cost of funds would not be passed on to loan customers in the absence of informational or competitive frictions; borrowers could simply switch banks. With informational frictions, this simple loan-pricing story changes in three ways.

First, borrower information costs and incentive problems may influence the cost of funds to the borrower. Second, to the extent that the bank-borrower relationship reduces information and incentive costs relative to other forms of financing, borrowers face switching costs in changing lenders; hence an idiosyncratic increase in the bank’s cost of funds (say, from a decrease in capital or balance sheet liquidity) could increase the cost of funds to borrowers.

Pages:   || 2 | 3 | 4 |

Similar works:

«1 FACULTY OF ECONOMICS AND BUSINESS ADMINISTRATION Ogunleye Oyin THE EFFECT OF FOREIGN DIRECT INVESTMENT: CASE STUDY NIGERIA Master‘s Thesis Department of International Business May 2014 2 UNIVERSITY OF OULU Abstract OF THE MASTER'S THESIS Oulu Business School Unit Department of International Business Author Supervisor Ogunleye Oyin Petri Ahokangas (Professor, D.Sc.) Title The effect of foreign direct investment: case study Nigeria Subject Type of the degree Time of publication Number of...»

«DRAFT Guidelines for the Development of the Russian Financial Market in 2016–2018 Moscow Contents Introduction I. Characteristics of the Russian financial market and the results of its development I.1. Russian financial market in the global competition context I.2. Current state of the Russian financial market II. Guidelines for the development of the Russian financial market in 2016–2018 II.1. Financial consumer protection and financial literacy of the population of the Russian Federation...»

«Packaged Mindfulness? Some unpackaged pieces of mind David Zigmond © 2014 Our increasing push-buttoned and systems-managed world has produced myriad losses of human relationship and personal sentience. Can this then be countered by modern packaging of ancient wisdom and practices? Is this our wisest approach? The worse the economy, the better the economists – Alfred Zauberman, Economist 1903-84 Our truest wisdom must be sought and grown, slowly and with difficulty, by each individual afresh....»

«LAW AND FINANCE MEETING Wednesday, July 29, 2009, 1:00 P.M. The Law and Finance Committee met on Wednesday, July 29, 2009, at 1:00 P.M., in the Council Chambers at City Hall. The following people were present: Law and Finance Committee: Mayor Cornelia P. Olive Council Member Steve Brewer Mayor Pro Tem Joseph E. Martin Council Member Mike Stone Council Member Walter McNeil, Jr. Council Member Charles Taylor Council Member James Williams City Clerk Bonnie D. White City Manager Hal Hegwer City...»

«STEUBEN COUNTY FINANCE COMMITTEE Tuesday, January 8, 2013 10:00 a.m. Legislative Committee Room Steuben County Office Building Bath, New York **MINUTES** COMMITTEE: Joseph J. Hauryski K. Michael Hanna Gary B. Roush Scott J. Van Etten STAFF: Mark R. Alger Jack Wheeler Brenda Mori Alan Reed Pat Donnelly Tammy Hurd-Harvey Wendy Flaitz Shawn Corey David Cole David McCarroll LEGISLATORS: Carol A. Ferratella William A. Peoples ABSENT: Larry P. Crossett, Chair Gary D. Swackhamer, Vice Chair OTHERS:...»

«Financing Disruption John Armour* Luca Enriques** June 2015 Preliminary Draft Please do not cite or circulate without authors’ permission Abstract ‘Disruptive’ innovations are powerful forces for reshaping activities and generating growth. Yet by definition, the properties (what they can do) and consequences (whether they disrupt) of innovations are not widely understood when they are first explored and their success is extremely uncertain. Extreme uncertainty, and the related dearth of...»

«WORLDVIEW EVANGELISM: THE SEVEN ESSENTIAL QUESTIONS OF LIFE Dr. David G. Cashin 1 Table of Contents: Introduction... Pages 3-4 Chapter 1: Worldview Evangelism.. Pages 5-8 Chapter 2: Myths of Origin, Power and Destiny.. Pages 9-13 Chapter 3: How do I Know What is True? Chapter 4: How do I Know Right from Wrong? Chapter 5: What Is the Nature of Humankind’s Problem? Chapter 6: What is the Solution to Humankind’s Problem? Chapter 7: How do Different Worldviews answer the questions of origin,...»

«Economic Papers are written by the Staff of the Directorate-General for Economic and Financial Affairs, or by experts working in association with them. The Papers are intended to increase awareness of the technical work being done by staff and to seek comments and suggestions for further analysis. The views expressed are the author’s alone and do not necessarily correspond to those of the European Commission. Comments and enquiries should be addressed to: European Commission...»

«Nassim Nicholas Taleb: To Prevail in an Uncertain World, Get Convex July 16, 2013 by Laurence B. Siegel Investment professionals know the value of a convex bond – it gains more from falling rates than it loses from rising ones. According to Nassim Nicholas Taleb, people and institutions can and should position themselves to be convex. Indeed, they should be antifragile – ready to gain from disorder or uncertainty. That is the theme of the provocative, sometimes playful and often infuriating...»

«Chapter 1 A Tale of Four Moguls: Interviews with Quincy Jones, Karlheinz Brandenburg, Tom Silverman, and Jay L. Cooper Newton Lee MP3 and peer-to-peer file sharing technology single-handedly disrupted the age-old music business. iTunes and YouTube have displaced record stores and MTV. If we take the cue from Netflix which has successfully produced original content, it will not be long before Apple and Google will sign new artists and rival the record labels.1.1 Interview with Quincy Jones...»

«Healthcare Financing: How should Singapore’s Ministry of Health shift costs from private pockets to the public purse? Introduction In early 2013, the Finance and Health Ministers of Singapore announced that the government was reviewing the country’s healthcare financing framework with a view to having the State shoulder a larger share of healthcare costs. 1 In concrete terms, this means that part of the costs (and risks) that are currently borne by individuals and families would shift to...»

«CITY OF TWO RIVERS COUNCIL PROCEEDINGS Monday, August 3, 2015 6:00PM Council Chambers, City Hall Regular Meeting The meeting was called to order by Council President Brad Yaggie at 6:00 PM. President Yaggie led the Council and those present in the Pledge of Allegiance. Roll Call – Present: Bonnie Shimulunas, Patrick Gagnon, Kay Koach, Jack Powalisz, Ruben Reveles, Bonnie Shimulunas, Jim Taddy, David VanGinkel, Brad Yaggie, Vince Alber. Also present were: Dave Buss, Finance Director; Jeff...»

<<  HOME   |    CONTACTS
2016 www.dissertation.xlibx.info - Dissertations, online materials

Materials of this site are available for review, all rights belong to their respective owners.
If you do not agree with the fact that your material is placed on this site, please, email us, we will within 1-2 business days delete him.