Lending to unhealthy firms in Japan during the lost decade: distinguishing between technical and financial health
We investigate the misallocation of credit in Japan associated with banks? evergreening loans, distinguishing between two types of firm distress: (perhaps temporary) financial distress and technical distress, which reflects weak operational capabilities, as indicated by low total factor productivity. We show that previous evidence related to firms? financial health is problematic due to the mixing of loan-demand and loan-supply effects. Using a direct measure of operational health, we provide unambiguous, direct evidence of evergreening behavior, as well as confirming evidence based on the ...
Assessing Targeted Macroprudential Financial Regulation: The Case of the 2006 Commercial Real Estate Guidance for Banks
In January 2006, federal regulators issued guidance requiring banks with specific high concentrations of commercial real estate (CRE) loans to tighten managerial controls. This paper shows that banks with concentrations in excess of the thresholds set in the guidance subsequently experienced slower growth in their CRE portfolios than can be explained by changes in bank or economic conditions. Moreover, banks above the CRE thresholds tended to have slower commercial and industrial loan growth but faster household loan growth following issuance of the guidance. The results highlight the ...
Fiscal Stimulus and Commercial Bank Lending Under COVID-19
We investigate the implications of extra-normal government spending under the COVID-19 pandemic for commercial bank lending growth between 2019Q4 and 2020Q4 in a large sample of over 3000 banks from 71 countries. We control for pre-pandemic structural factors, bank characteristics and government debt. To address the likely endogeneity of government assistance under the pandemic, we instrument for extra-normal spending using disparities in pre-existing national political characteristics for identification. Our results indicate that while higher government spending was associated with higher ...
The Effect of the Central Bank Liquidity Support during Pandemics: Evidence from the 1918 Influenza Pandemic
The coronavirus outbreak raises the question of how central bank liquidity support affects financial stability and promotes economic recovery. Using newly assembled data on cross-county flu mortality rates and state-charter bank balance sheets in New York State, we investigate the effects of the 1918 influenza pandemic on the banking system and the role of the Federal Reserve during the pandemic. We find that banks located in more severely affected areas experienced deposit withdrawals. Banks that were members of the Federal Reserve System were able to access central bank liquidity, enabling ...
The Adverse Effect of “Mandatory” Flood Insurance on Access to Credit
The National Flood Insurance Program (NFIP) was designed to reduce household and lender flood-risk exposure and encourage lending. In this post, which is based on our related study, we show that in certain situations the program actually limits access to credit, particularly for low-income borrowers—an unintended consequence of this well-intentioned program.
The Impact of Natural Disasters on the Corporate Loan Market
Natural disasters are usually associated with an increase in the demand for credit by both households and companies in the affected regions. However, if capacity constraints preclude banks from meeting the local increase in demand, the banks may reduce lending elsewhere, thus propagating the shock to unaffected areas. In this post, we analyze the corporate loan market and find that banks, particularly those with lower capital, reduce credit provisioning to distant regions unaffected by natural disasters. We also find that shadow banks only partially offset the reduction in bank credit, so ...
Up on Main Street
The Main Street Lending Program was the last of the facilities launched by the Fed and Treasury to support the flow of credit during the COVID-19 pandemic. The others primarily targeted Wall Street borrowers; Main Street was for smaller firms that rely more on banks for credit. It was a complicated program that worked by purchasing loans and sharing risk with lenders. Despite its delayed launch, Main Street purchased more debt than any other facility and was accelerating when it closed in January 2021. This post first locates Main Street in the constellation of COVID-19 credit programs, then ...
Banking on the Boom, Tripped by the Bust: Banks and the World War I Agricultural Price Shock
How do banks respond to asset booms? This paper examines i) how U.S. banks responded to the World War I farmland boom; ii) the impact of regulation; and iii) how bank closures exacerbated the post-war bust. The boom encouraged new bank formation and balance sheet expansion (especially by new banks). Deposit insurance amplified the impact of rising crop prices on bank portfolios, while higher minimum capital requirements dampened the effects. Banks that responded most aggressively to the asset boom had a higher probability of closing in the bust, and counties with more bank closures ...
Quantitative Easing and Bank Risk Taking: Evidence from Lending
We empirically assess the effect of reserve accumulation as a result of quantitative easing (QE) on bank-level lending and risk taking activity. To overcome the endogeneity of bank-level reserve holdings to banks' other portfolio decisions, we employ instruments made available by a regulatory change that strongly influenced the distribution of reserves in the banking system. Consistent with theories of the portfolio substitution channel in which the transmission of QE depends in part on reserve creation itself, we document that reserves created in two distinct QE programs led to higher total ...
We develop a simple model of relationship lending where lenders have incentives for evergreening loans by offering better terms to less productive and more indebted firms. We detect such lending behavior using loan-level supervisory data for the United States. Low-capitalized banks systematically distort firms’ risk assessments to window-dress their balance sheets. To avoid further reductions in their capital ratios, such banks extend relatively more credit to underreported borrowers. We incorporate the theoretical mechanism into a dynamic heterogeneous-firm model to show that evergreening ...