Knowledge that Transforms

During a flight to liquidity, investors demand large amounts of governmentbacked safe assets in a rush. The sluggish reaction of the public supply of safe assets opens up a role for government-sponsored shadow banks. We exploit exogenous changes in both demand and supply of safe assets from the 2014 money fund reform and the 2015 debt limit. We find that shadow banks act as a substitute as well as a complement to public supply during a flight to liquidity. Our findings carry over to the dash for cash at the onset of the Covid-19 pandemic. JEL classification: G23, G28, E41.

Using earnings conference calls, we investigate banks’ views of the Troubled Asset Relief Program (TARP) to understand why TARP generated so few loans. We find that banks generally regarded TARP favorably and many mentioned using TARP funds to make loans. However, actual loan growth fell well below expectations based on prior capital ratios, even among banks that publicly committed to lending. Other banks highlighted that the funds would improve their capital ratios. We show that these perspectives are largely unrelated to banks’ ex-ante financial characteristics, but instead reflect the evolving conditions during the crisis period. These shifts are consistent with a large decline in the fraction of banks that commented on the favorable pricing of the preferred stock over time. Our findings suggest that banks primarily used TARP funds to strengthen capital ratios, partly driven by CEO career concerns. Weak loan demand and evolving market conditions also contributed to the sluggish loan growth following the TARP injections.

We construct a novel panel of insider ownership for roughly 600 U.S. bank holding companies from 2003 to 2014 to test whether ownership structure shaped recapitalizations around the Global Financial Crisis (GFC). Insider ownership shows no discrete shift around the GFC. Using a difference-in-differences design with BHC and time fixed effects, we find that, after Q3 2008, banks with higher pre-crisis insider stakes issued significantly less common equity than otherwise similar peers. This effect is more pronounced where insiders enjoy greater private benefits of control, as proxied by insider lending and earnings opacity—consistent with dilution reluctance as the mechanism. The findings hold in propensity score matched regressions and when employing instrumental variables for insider ownership. These results reveal that ownership structure affects banks’ equity issuances in crises, underscoring the importance of accounting for ownership structure in bank stress tests and capital-regulation frameworks.

• How does product market competition affect corporate environmental footprint? • We examine restructuring of U.S. electric utilities, the number one emissions-intensive sector. • Cost-cutting actions are the key driver of changes in operations and emissions of electric plants. • Cost-cutting actions lower environmental footprint when plant technology allows greener production. • Without such technology, competition worsens environmental outcomes. Banks face pressure to integrate a wider range of risks into lending decisions, including both traditional product-market risks and the increasingly important environmental risk. Yet how these two types of risk interact remains unclear. We show that production technology is pivotal in shaping the impact of product-market competition on environmental risk. Focusing on the restructuring of the US electric utility industry, which introduced product-market competition into a highly polluting sector, we find that technological capacity is key. When technology enables cost-saving production decisions that also improve environmental performance, competition reduces environmental footprint. Otherwise, it exacerbates it. These findings suggest that lenders must assess not only individual risk factors of borrowers but also their potential interactions, with firms’ technological capacity playing a crucial role.

We assess issues related to borrower beliefs and mortgage performance using new individual panel data that simultaneously cover borrower expectations, forbearance status during the COVID-19 pandemic, and a wide array of demographic characteristics. First, we establish the determinants of borrower expectations, with local experiences and those of social networks playing important roles. We then show that households who, at origination, were optimistic about future house price appreciation or pessimistic about the possibility of future unemployment were more likely to enter forbearance in 2020. However, by early 2021, appreciation-optimistic borrowers who were in forbearance were likely to have cured or prepaid their loan, while those who expected unemployment were likely to still be in forbearance. We offer three channels by which expectations affect forbearance behavior: choices of initial loan terms, associations with actual future events, and factors related to belief formation that are also plausibly associated with forbearance. Our findings highlight the crucial role borrower expectations play in both leverage choices and mortgage performance.

We examine how banks manage carbon transition risk by selling loans given to polluting borrowers to less regulated shadow banks in securitization markets. Exploiting the election of Donald Trump as an exogenous shock that reduces carbon transition risk, we find that banks engage in regulatory arbitrage and use brown loan securitization to manage their exposure to carbon transition risk. Banks are more likely to securitize brown loans when carbon transition risk is high but keep these loans on their balance sheets when the risk is reduced. In addition, securitization enables banks to offer lower interest rates to polluting borrowers but does not affect the supply of green loans. Our findings are more pronounced among banks with low levels of capitalization, domestic banks, and banks that do not display green lending preferences. We discuss how securitization can weaken the effectiveness of bank climate policies.

Utilizing a unique and novel setting of disclosure mandate threshold under Regulation AB (Reg AB), we investigate the relationship between disclosure and trust in asset securitization. Post-Reg AB enactment, we observe a significant bunching of originators just below the disclosure threshold. Less trustworthy originators are more likely to adjust their portfolio sizes to remain below this threshold, particularly when loan originators and deal sponsors are unaffiliated, which are cases in which disclosure plays a greater role in reducing information asymmetry. Additionally, these originators are more likely to misrepresent loan quality. Our findings reveal a strong relationship between disclosure and trust—trustworthy originators disclose more and originate higher-quality loans, while less trustworthy originators disclose less and produce lower-quality loans.

This paper is based on a panel discussion at the international bank conference on Frontier Risks, Financial Innovation and Prudential Regulation of Banks in Gothenburg, Sweden, June 2–4, 2024. The panelists were Deborah Lucas, Jan Pieter Krahnen, and Magnus Olsson, with Ted Lindblom moderating. This paper contains the panel presentations, along with a unifying discussion by Paolo Fulghieri and Anjan Thakor. The main themes in the paper focus on how society should balance costs and benefits in designing the prudential regulation of banks. Optimal regulation should take into account how banks and markets interact, the dangers of both under-regulation that spawns excessive risk-taking and over-regulation that depresses value-enhancing innovation in financial services, the somewhat fragmented nature of national-sovereignty-constrained European banking and financial markets regulation relative to bank regulation in the US, and how prudential regulation can be improved by more explicitly dealing with interest rate risk.