Knowledge that Transforms

Using a broad range of uncertainty measures, we show that uncertainty dramatically slows down firms’ adjustments toward their optimal capital structure. At the upper bound, the estimated speed of leverage adjustments almost halves when uncertainty is high. High quality institutions (common law legal origin, more disclosure to congress and/or to the public, and higher public sector ethics) and presidential political systems offset some of the adverse effects of uncertainty on leverage adjustments. The financial crisis has altered the relationships among uncertainty, adjustment speeds, and a country's institutions; more so for countries with weak institutions and parliamentary systems.

One aim of post-crisis monetary policy has been to ease credit conditions for borrowers by unlocking bank lending. We find that bank equity is an important determinant of both the bank's funding cost and its lending growth. In a cross-country bank-level study, we find that a 1 percentage point increase in the equity-to-total assets ratio is associated with a four basis point reduction in the cost of debt financing and with a 0.6 percentage point increase in annual loan growth. These findings suggest that greater retention of bank earnings and hence higher bank capital would have aided the transmission of accommodative monetary policy to ease financial conditions faced by ultimate borrowers. In particular, we find that the effects of a monetary tightening are smaller for banks with higher capitalization, which have easier access to uninsured financing. These results suggest that if the banking system as a whole is weakly capitalized, there may be some tension between the monetary policy imperative of unlocking bank lending (i.e., expanding credit) and the supervisory objective of ensuring the soundness of individual banks (i.e., shrinking credit).

We investigate the U.S. experience with macroprudential policies by studying the interagency guidance on leveraged lending. We find that the guidance primarily impacted large, closely supervised banks, but only after supervisors issued important clarifications. It also triggered a migration of leveraged lending to nonbanks. While we do not find that nonbanks use more lax lending policies than banks, we unveil important evidence that nonbanks increased bank borrowing following the guidance, possibly to finance their growing leveraged lending. The guidance was effective at reducing banks’ leveraged lending activity, but it is less clear whether it accomplished its broader goal of reducing the risk that these loans pose for the stability of the financial system. Our findings highlight the importance of supervisory monitoring for macroprudential policy goals, and the challenge that the revolving door of risk poses to the effectiveness of macroprudential regulations.

We present a novel way to examine macro-financial linkages by focusing on the real effects of bank supervisors’ enforcement actions. Exploiting plausibly exogenous variation in supervisory monitoring intensity, we show that enforcement actions in single-market banks trigger temporarily large adverse effects for the macroeconomy by reducing personal income growth, the number of establishments, and increasing unemployment. These effects are related to contractions in bank lending and liquidity creation, and are more pronounced when we consider enforcement actions on both single-market and multi-market banks, and in counties with fewer banks and greater external financial dependence.