Knowledge that Transforms

I use the staggered passage of creditor rights reforms in 13 countries to examine how changes in creditor rights affect (a) bank stability and (b) the bank market power-stability relationship. (a) There is statistically weak evidence that stronger creditor rights enhance bank stability; the result is not robust across specifications. (b) Market power positively affects stability. However, there is asymmetry in the effect of market power on stability, depending on whether there is an increase or a decrease in creditor rights. The market power-stability relationship is stronger when a country weakens its creditor rights vis-á-vis when it strengthens its creditor rights.

According to “Schwartz's conventional wisdom” and what has been called “divine coincidence”, price stability should imply macroeconomic and financial stability. However, in light of the global financial crisis, with monetary policy focused on price stability, scholars have held that banking and financial risks were largely unaddressed. According to this alternative view, the belief in divine coincidence turns out to be benign neglect. The objective of this paper is to test Schwartz's hypothesis against the benign neglect hypothesis. The priority assigned to the inflation goal is proxied by the central banks’ conservatism (CBC) index proposed by Levieuge and Lucotte (2014), here extended to a large sample of 73 countries from 1980 to 2012. Banking sector vulnerability is measured by six alternative indicators that are frequently employed in the literature on early warning systems. Our results indicate that differences in monetary policy preferences robustly explain cross-country differences in banking vulnerability and validate the benign neglect hypothesis, in that a higher level of CBC implies a more vulnerable banking sector.

This paper takes advantage of access to detailed matched bank-firm data to investigate whether and how employment decisions of SMEs have been affected by credit constraints during the European sovereign debt crisis. Variability in banks’ financial health following the 2008 crisis is used as an exogenous determinant of firms’ access to credit. Findings, relative to the Belgian economy, clearly highlight that credit matters. They show that SMEs borrowing money from pre-crisis financially less healthy banks were significantly more likely to be affected by a credit constraint and, in turn, to adjust their labour input downwards than pre-crisis clients of more healthy banks. These results are robust across types of loan applications that were denied credit, i.e. applications to finance working capital, debt or new investments. Yet, estimates also show that credit constraints have been essentially detrimental for employment among SMEs experiencing a negative demand shock or facing strong product market competition. In terms of human resources management, credit constraints are not only found to foster employment adjustment at the extensive margin but also to increase the use of temporary layoff allowances for economic reasons. This outcome supports the hypothesis that short-time compensation programmes contribute to save jobs during recessions.

We propose a model of collateral choice by banks to quantify how changes in the haircut policy of the central bank affect the collateral used by banks and the funding cost of banks. We estimate the model using data on assets pledged to the European Central Bank from 2009 to 2011. Our results suggest that an increase in the haircut on low rated collateral by 5 percentage points would have reduced the use of this collateral by 10% but would have increased the average funding cost spread between high yield and low yield countries by 5% over our sample period.

In this paper, we examine the links among banking supervision, the volatility of financial flows, and economic growth. In particular, we explore whether banking regulation mitigates the adverse effects of capital flows volatility on economic growth. Using cross-country data over four decades, we find that banking supervision promotes economic growth by dampening the negative impact of volatile capital flows. The findings hold for both aggregate capital flows and its various components, and for both its net and gross counterparts, while they are also robust for various indicators of regulatory policies. The results support the argument that bank regulatory policy rules designed to ensure financial stability are beneficial to long-run economic growth.

Unsustainable credit growth leads to financial stability risks, with real repercussions. But what is unsustainable? In this paper we suggest that the balance between the growth in mortgage credit and business credit is a key factor in post-crisis macroeconomic vulnerability. The sample-average rise in credit composition (the share of household mortgage credit in total credit) in 51 economies in the five years before the 2007 global financial crisis is associated with a 2.1% average growth loss in the five years after the crisis. This finding is robust for total-credit growth and for post-crisis fiscal and monetary policy responses. Delving into the channels, we find that larger changes in credit composition before the crisis are linked to less efficient capital reallocation and larger investment cutbacks afterwards.

We establish that the effect of intensified deposit market competition, measured by reduced switching costs, on the probability of bank failures depends critically on whether we focus on competition with established customer relationships or competition for the formation of such relationships. With inherited customer relationships, intensified competition due to lower switching costs destabilizes the banking market, whereas it stabilizes the market if we focus on competition for the formation of customer relationships. We characterize the factors important for evaluating the effects of intensified competition on stability in a market with unattached as well as locked-in depositors.

We investigate the influence of the institutional environment on bank capital ratios. Using a sample of 160 banks operating in the Middle East and North Africa region for the period 2004–2014, we find that, when stock markets have little presence, institutional variables significantly affect risk-weighted regulatory capital ratios but not leverage ratios. Conversely, when stock markets are more developed, only leverage ratios are influenced by institutional factors. Our results also indicate that institutional variables affect non-weighted equity-to-asset ratios of banks that are listed on a stock exchange. Our findings contribute to the bank capital structure literature and have important policy implications for developing countries.

We propose that credit ratings act as an information channel which, combined with more power being given to creditors by countries strengthening creditor rights, leads to an increase in the supply of public debt. From a firm-level dataset covering 51 developed and developing countries for 1989 through 2013, we find that in countries with stronger creditor rights, firms tend to have higher credit ratings. We confirm that in these countries, firms with higher credit ratings exhibit a greater issuance of public debt than that of equity. As further evidence that credit ratings reduce agency costs of debt, we find that improvements in creditor rights and resulting higher credit ratings increase capital expenditures among firms experiencing severe bondholder-shareholder conflicts.

We find that multi-bank holding companies (MBHCs) in the U.S. have lower insolvency risk than single-bank holding companies (SBHCs) at the parent level, but have significantly higher insolvency risk than the latter at the subsidiary level. Our results suggest that MBHC parents tend to benefit from the internal capital market while allowing for more risk-taking at the individual levels. We further find that the higher risk for MBHC affiliates is because of the organizational and geographic complexity at the MBHC parent level. Our results highlight the importance of government regulation on banks at both parent and subsidiary levels.