Knowledge that Transforms

Despite the prominent role that information plays in the economic theory of credit markets, no direct evidence exists on the causal relationship between the availability of information about loan applicants and loan performance. This paper provides such evidence by exploiting an unanticipated change in the amount of information visible in an online market for loans to measure the impact of lender information on loan outcomes. Conditional on data available in both periods, allowing lenders to access more borrower credit information substantially reduced default rates among high-risk borrowers by 17percentage points on average but had almost no effect on low-risk borrowers. Immediate lender returns increased by about 12percentage points and took 5weeks to decay. Among high-risk loans, returns converged within credit grade bins. Using panel information on lenders, I find that the information improved loan performance in two ways: first, it significantly improved the screening performed by lenders already active on the website. Second, it attracted new lenders who were better at screening loan applicants and earned higher returns. I test whether the reform resulted in selection among loan applicants using data that is unobserved by lenders in both periods. I find that there was no change in unobserved credit quality among loan applicants, but that the information improved lenders’ ability to select the (unobservably) higher quality borrowers from the pool of applicants. I also find suggestive evidence that lenders’ beliefs about loan applicants, as measured by the minimum interest rate at which they were willing to lend, converged.

Using a large sample of block acquisitions, this paper examines the governance role of customers that acquire block ownership in supplier shares. We find that compared to targets acquired by noncustomers, those acquired by customers experience higher abnormal announcement returns, larger increases in post-acquisition long-term operating performance, and higher non-routine turnover of poorly performing CEOs. These results are evident when target managerial agency problems are highly detrimental to the supplier–customer relationship. The results support the view that customers’ nonfinancial claims in targets provide customers strong incentives to monitor target managers above and beyond previously documented monitoring by large shareholders.

We use detailed data on over 350 banks in emerging Europe to analyze how bank ownership and the Vienna Initiative impacted credit growth during the Great Recession. As part of the Vienna Initiative, western European banks signed country-specific commitment letters in which they pledged to maintain exposures and to support their subsidiaries in emerging Europe. We show that while both domestic and foreign banks sharply curtailed credit during the financial crisis, foreign banks that participated in the Vienna Initiative were relatively stable lenders. We find no evidence of negative spillovers from countries where banks signed commitment letters to countries where they did not.

We provide direct evidence on the effect of financial expertise on investment outcomes by analyzing private portfolios of mutual fund managers. We find no evidence that financial experts make better investment decisions than peers: they do not outperform, do not diversify their risks better, and do not exhibit lower behavioral biases. Managers do much better in stocks for which they have an information advantage over other investors, i.e., stocks that are also held by their mutual funds. More experienced managers seem to be aware of the limitations to their investment skills as they increase their holdings of mutual fund-related stocks following poor performance of their portfolios. Our results suggest that there are limits to the value added by financial expertise.

Theoretical and empirical work on banking emphasizes the role of banks in overcoming information asymmetries and agency problems between borrowers and lenders. This paper investigates the importance of bank ownership in determining the sorts of customers that a bank serves, and consequently, the sorts of information problems a bank lender chooses to address. Using survey data for over 16,500 households from 19 emerging economies in Central and Eastern Europe in 2010 this paper is the first to document that information asymmetries in the retail credit market lead foreign banks to cherry-pick financially transparent clients in similar ways as documented previously for enterprise credit. First, a higher market share of foreign banks in a country is associated with a larger gap in credit use between households with and without formal employment. Second, among mortgage borrowers, clients of foreign banks are more likely to be formally employed, are more likely to have personal assets, and are richer than clients of domestic banks. Third, consistent with these results, retail lending techniques of foreign banks rely more on financial information and collateral than those of domestic banks.

Using the entire universe of Bankscope and Amadeus Top 250,000 we construct the portfolios of shareholders who hold equity stakes in publicly traded and privately held European banks for each year over the period 1999–2008. We show that about 62% of banks’ ultimate largest shareholders are diversified investors, holding on average equity investments from thirteen companies in their portfolio. We exploit this heterogeneity to investigate the impact of their portfolio diversification on bank risk-taking. Our results show that banks with more diversified shareholders undertake more risks. This relation is both statistically significant and economically sizeable. Overall, these findings contribute to the literature by studying for the first time a specific channel through which financial development, in the form of bank shareholders’ diversification, affects the banks’ risk-taking decisions.

The use of collateral has become one of the most widespread risk mitigation techniques. While it brings stabilizing effects to the individual cash lender, it may exacerbate systemic risk by accelerating bank deleveraging under funding stress. We show how a liquidity shock to the cash lender may propagate as a solvency shock via liquidity hoarding even if the cash lender remains solvent in all states of nature. Albeit a privately optimal response of the cash lender to a liquidity shock, bank deleveraging may lead to excessive bankruptcy among its borrowing counterparties while, at the same time, triggering contagion across asset classes. To buttress financial system resilience, we lay out a menu of macroprudential policies that deactivate this channel of financial contagion.

The 2007–9 financial crisis began with increased uncertainty over funding conditions in money markets. We show that funding uncertainty can explain diverse elements of commercial banks’ behavior during the crisis, including: (i) reductions in lending volumes, balance sheets, and profitability; (ii) more intense competition for retail deposits (including deposits turning into a “loss leader”); (iii) stronger lending cuts by more highly extended banks with a smaller deposit base; (iv) weaker pass-through from changes in the central bank’s policy rate to market interest rates; and (v) a binding “zero lower bound” as well as a rationale for unconventional monetary policy.

We examine whether short sellers identify firms that have significant changes in default likelihoods and credit rating downgrades. In the month before a rating downgrade, equity short interest is 40% higher than one year prior. Short sellers predict changes in default probabilities that lead to downgrades by focusing on firms with inaccurate or biased ratings. This strategy is profitable for short sellers primarily since downgrades are associated with significantly negative equity returns. Short sellers also facilitate price discovery by reducing abnormal stock returns following downgrades and by leading bond yield spreads.

This paper tests the impact of an imperfect firm–bank type match on firms’ financial constraints using a dataset of about 4500 Italian manufacturing firms. Considering an optimal match of opaque (transparent) borrowing firms with relational (transactional) lending main banks, the possibility arises of firm–bank ‘‘odd couples’’ where opaque firms end up matched with transactional main banks. We show that the probability of credit rationing increases when the mismatch between firms and banks widens. Our conjecture is that ‘‘odd couples’’ emerge either because of organizational changes in the credit market or since firms observe only imperfectly banks’ lending technology.