Knowledge that Transforms

This paper explores the effects of an LTV limit on constrained borrowers using comprehensive loan- and borrower-level data from Brazil. LTV limits entail identification challenges because constrained borrowers are no longer directly observed after the policy is implemented. In this paper, partially observed treatment status is addressed by an adjusted difference-in-difference method, focusing on the average treatment effect on the treated (ATT) borrowers (i.e. those that would violate the LTV limit if unconstrained). In the most affected segment, treated individuals cope with the new LTV limit by making higher down payments and also purchasing more affordable houses. They are also less likely to be in arrears, suggesting that LTV limits are effective macroprudential tools by lowering the risk of some originated housing loans.

This paper combines loan-level administrative data with household-level survey data to analyze the impact of recent macroprudential policy changes in Canada using a microsimulation model of mortgage demand of first-time homebuyers. Policies targeting the loan-to-value ratio are found to have a larger impact on demand than policies targeting the debt-service ratio, such as amortization. In addition, we show that loan-to-value policies have a larger role to play in reducing default than income-based policies.

We use a 2013 Norwegian policy reform to study how banks react to higher capital requirements and how these adjustments transmit to the real economy. Using bank balance sheet data, we document that banks raise capital ratios by reducing risk-weighted assets. Most of the reduction in risk-weighted assets is accounted for by a reduction in average risk weights. Consistent with this reduction in risk, we document a substantial decline in credit supply to the corporate sector relative to the household sector. We also show that banks react to higher requirements by increasing interest rates, consistent with the reduction in corporate credit growth being supply driven. Using administrative loan level tax data, we document a reduction in lending on the firm level. This is robust to controlling for firm fixed effects, thereby accounting for potential firm-bank matching. Finally, we find that the reduction in bank lending has a negative impact on firm employment growth and that this effect is driven by small firms.

We propose and test a new explanation for forced CEO turnover, and examine its implications for the impact of firm performance on CEO turnover. Investors may disagree with management on optimal decisions due to heterogeneous prior beliefs. Theory suggests that such disagreement may be persistent and costly to firms; we document that this induces them to sometimes replace CEOs who investors disagree with, controlling for firm performance. A lower level of CEO-investor disagreement serves to partially “protect” CEOs from being fired, thus reducing turnover-performance sensitivity, which we also document. We also show that firms are more likely to hire an external CEO as a successor if disagreement with the departing CEO is higher. Disagreement declines following forced CEO turnover. Using various empirical strategies, we rule out other confounding interpretations of our findings. We conclude that disagreement, independently of firm performance, affects forced CEO turnover.

We analyze how two types of recently used prudential policies affected the supply of credit in the United States. First, we test whether the U.S. bank stress tests had any impact on the supply of mortgage credit. We find that initiation of the Comprehensive Capital Analysis and Review (CCAR) stress tests in 2011 had a negative effect on the share of jumbo mortgage originations and approval rates at stress-tested banks, whereby banks with worse capital positions were impacted more negatively. Second, we analyze the impact of the 2013 Supervisory Guidance on Leveraged Lending and subsequent 2014 FAQ notice, which clarified expectations on the Guidance. We find that the institution-specific share of speculative-grade term-loan originations decreased notably at regulated banks after the FAQ notice, especially at banks with greater market share for such loans.

The poor performance of credit ratings of structured finance products in the financial crisis has prompted investigation into the role of credit rating agencies (CRAs) in designing and marketing these products. We analyze a two-period reputation model in which a CRA both designs and rates securities that are sold both to investors who are constrained to purchase highly rated securities and investors who are unconstrained. Assets are pooled and senior and junior tranches are issued with a waterfall structure. When the rating constraint is lax, the CRA will include only risky assets in the securitization pool, serving both types of investors without any rating inflation. Rating inflation is decreasing in the tightness of the rating constraint locally. But rating inflation may be non-monotonic in the rating constraint globally, with no rating inflation when the constraint is lax or tight.

We study the efficiency of banking regulation under financial integration. Banks freely choose the jurisdiction where to locate their activities and have private information about their efficiency level. Regulators non-cooperatively offer any regulatory contract that satisfies information and participation constraints of banks. We show that the unique Nash equilibrium of the regulatory game is a simple pooling contract: financial integration is characterized by the inability for regulators to discriminate between banks with different efficiency levels. This result is driven by the endogenous restriction caused by regulatory arbitrage on the capacity of regulators to use several regulatory instruments.

Contingent convertibles (CoCos) are intended to either convert to new equity or be written down prior to failure while a bank is a going-concern. Yet, in the first actual test case, CoCos never converted before its bank failed. We develop a model that predicts that CoCos lead to less (more) extreme stock returns and have yields greater than (similar to) standard subordinated debt yields if investors do (do not) expect them to convert or be written down prior to failure. These predictions are tested using data on CoCos issued by European banks during 2011 to 2017. We find evidence that equity conversion CoCos reduce stock return variance and several other measures of downside risk, consistent with the perception that they are going-concern capital. However, we also provide event study evidence that recent regulatory actions reduced the CoCo–subordinated debt yield spread, which indicates a diminished investor belief that CoCos are going-concern capital.

A unique legal reform in 2004 in Sweden redistributed collateral rights from banks holding floating liens to unsecured creditors without changing the value of assets on firms’ balance sheets. Using a country-wide panel of all incorporated firms, we document that a zero-sum redistribution of collateral rights and the resulting reduction in collateral capacity towards banks contracts the amount and maturity of corporate debt and leads firms to slow investment and forego growth. Altering their allocation of assets, firms reduce particularly those assets with a low collateralizable value for banks and also hoard more cash. However, the reform has no impact on corporate capital intensity or efficiency, suggesting that under these newly binding credit constraints firms simply shrink their operations.

This paper studies bank learning through repeated interactions with borrowers from a new perspective. To understand learning by lending, we adapt a methodology from labor economics to analyze how loan contract terms evolve as banks acquire new information about borrowers. We construct “proxy” variables for this information using data from borrowers’ out-of-sample, future credit performance. Due to the timing of their construction, banks could not have used these variables directly to price loans. We nonetheless find that these proxies increasingly predict loan prices as relationships progress, even after controlling for possible omitted variable bias. Our methodology provides strong evidence that: (a) bank learning affects loan prices, and (b) relationship benefits are heterogeneous. In particular, higher quality borrowers face differentially lower spreads as their relationship with lenders develop – and banks learn about their quality – while lower quality borrowers see loan prices increase and their loan amounts fall. We further find suggestive evidence that banks incorporate CEO-specific information into loan prices.