Knowledge that Transforms

We examine the role of private unlimited deposit insurance as a complement to federal deposit insurance for deposit flows, bank lending, and moral hazard during a crisis. We find that banks whose deposits are federally and privately fully insured obtain more deposits and expand lending, in contrast to banks whose deposits are only federally insured. We also document that privately insured banks remain prudent in the loan origination process during the subprime crisis. Our results offer novel insights into depositor and bank behavior in the presence of multiple deposit insurance schemes with differential design features. They also illustrate how private sector solutions incentivize prudent bank behavior to strengthen the financial safety net.

Funds with performance fees have annual net risk-adjusted returns of 0.50% below other funds, a result mostly due to funds without a stochastic benchmark against which performance is measured and funds with a benchmark that is easy to beat. For other funds, there is no evidence of underperformance. Performance fee funds charge total expenses, including the performance fee, that are substantially higher than those of other funds. Investors are more likely to punish poor performance in funds with performance fees than in other funds. Our results indicate that even when fees are less regulated, investors can generally be relied upon to make the right choices, but that there are a subset of funds where performance fees are employed to extract additional fees from investors.

We assess the effects of board gender quota laws using a sample of banks from 39 countries. We document an increase in both stand-alone and systemic risk post-quota among banks that did not meet the quota pre-reform; the effect is stronger for banks in countries with a smaller pool of women in finance and low gender equality. We find that the propagation of poor governance practices by overlapping female directors and deterioration in the information environment post quota are likely channels driving the results. The evidence is consistent with some banks “gaming” the reform by strategically appointing insiders, which weakens the board's monitoring function. Our results have policy implications and suggest that supply-side factors are key determinants of the outcome of mandated quotas.

Social relationship and business connections create implicit benefits between borrowers and lenders. We model how implicit benefits and repayment enforcement costs influence credit allocation, cost, and renegotiation. The optimal solution illustrates that financing with implicit benefits may achieve lower financing costs, higher managerial effort, and better outcomes for both borrowers and lenders. This result is consistent with the continuing expansion of alternative financing despite formal financial intermediation, the rise of corporate insider debt, and joint ownership of debt and equity. The growing size and complexity of projects and changes in community relationships can explain expansion of financing with standard intermediation.

This paper studies the efficiency of competitive equilibria in economies where the expansion of investment is facilitated by securitization. We show that the use of securitization is generally associated with constrained inefficient aggregate investment, thereby potentially justifying regulatory intervention in markets for securitized assets. We examine the effectiveness of two real-world policy instruments to address this inefficiency: ex-ante capital / leverage requirements, as well as skin-in-the game (retention) requirements. We find that leverage/capital restrictions can increase welfare in our environment, but that forcing originators to hold additional skin-in-the game is not welfare improving.

We evaluate how the liquidity coverage rule affects US banks’ opacity and funding liquidity risk. Banks subject to the rule become significantly more opaque and funding liquidity risk increases by $245 million per quarter. Higher funding liquidity risk is more pronounced among banks that are subject to the rule’s more stringent liquidity buffers, and systemically riskier banks. Rising opacity reflects an increase in banks’ holdings of complex assets whose value is difficult to communicate to investors. The evidence highlights the unintended consequences of liquidity regulation and is consistent with theoretical models’ predictions of a trade-off between liquidity buffers and bank opacity that exacerbates funding liquidity risk.

Are more informative credit ratings always preferred and how should regulators intervene to promote investment efficiency? To answer these questions, we develop a model in which a manager seeks financing for a project. The main frictions are that the manager is privately informed about the project’s quality and cannot commit not to divert resources away from it. This setting gives rise to a feedback effect in which creditors’ beliefs about whether the manager diverts resources can become self-fulfilling. A critical consequence of this feedback effect is that more precise ratings can be detrimental for investment efficiency. Intuitively, by revealing that a firm is of worse quality and increasing its cost of finance, more informative ratings strengthen the manager’s incentive to withdraw resources away from the project and default. We show that the regulation of credit rating agencies should be lenient during good times and strict during bad times.

We document the effects of the COVID−19 pandemic on digital finance and fintech adoption. Drawing on mobile application data from a globally representative sample, we find that the spread of COVID− 19 and related government lockdowns led to a sizeable increase in the rate of finance app downloads. We then analyze factors that may have driven this effect on the demand−side and better understand the “winners” from this digital acceleration on the supply−side. Our overall results suggest that traditional incumbents saw the largest growth in their digital offerings during the initial period, but that “BigTech” companies and newer fintech providers ultimately outperformed them over time. Finally, we drill−down further on the adoption of fintech apps pertaining to both the asset and liability side of the traditional bank balance sheet, to explore the implications that the accelerated trends in digitization may have for the future landscape of financial intermediation.

This paper introduces collateral rehypothecation, a widespread practice in derivatives, swaps, and repo markets, in a general equilibrium model with default. Rehypothecation frees up collateral because it allows lenders to resell or repledge assets pledged by borrowers. The risk that lenders will not return the asset, however, limits gains from rehypothecation. Still, when markets are contractually incomplete or decentralized, rehypothecation can achieve a superior use of scarce collateral. These results have implications for the repo market and suggest that limits to rehypothecation can cause price fragmentation.

Do targeted macroprudential measures impact non-targeted sectors too? We investigate the compositional changes in the supply of credit by Swiss banks, exploiting their differential exposure to the activation in 2013 of the countercyclical capital buffer (CCyB) which targeted banks’ exposure to residential mortgages. We find that the additional capital requirements resulting from the activation of the CCyB are associated with higher growth in banks’ commercial lending. While banks are lending more to all types of businesses, the new macroprudential policy benefits smaller and riskier businesses the most. However, the interest rates and other costs of obtaining credit for these firms rise as well.