Book Description

The first essay studies the evidence from statute-driven bank recapitalizations to examine whether they enhance bank safety. Regulators demand that weakly capitalized banks raise additional capital with the goal of reducing the public's exposure to bank risk-taking. It is found that involuntary bank equity issues made from 1995-2008 are associated with significantly negative announcement returns. These negative returns are greatest when the option value of the government's deposit guarantee is most greatly reduced. Consistent with the regulator's policy goal, this implies a wealth transfer from the bank's equity holders to the deposit insurer. However, it is also found that the negative returns are strongly related to the dilution of the insider owners' equity stake. This suggests insider moral hazard may be exacerbated by the equity issue. Consistent with this notion, subsequent declines in operating performance and survival rates are also found to be strongly related to declines in the insider's ownership position. This suggests that capital standards, to some degree, shift bank failure risk from the near term to future periods. The second essay revisits the loan announcement effect with a sample of loans from 2004-2009 and relates it to the core banking function of liquidity provision. Recent criticism of past studies due to selection biases inherent in samples of announced loans is shown to be unfounded and a small but significant positive effect is found despite the adoption of a stratified sampling procedure that adjusts for size and P/B. From an event perspective, it is the announcement of a loan and not its activation that matters to the market. The sample offers strong evidence that the banks which create the most liquidity are also the best monitors. Firms are rewarded by the market for borrowing from such banks, especially when the economy is doing well. Firms also tend to benefit from the presence of more aggressive liquidity creating banks on the lower rungs of the lending syndicate in a recession. Liquidity creating syndicates, in turn, earn higher spreads, as do syndicates that lend to weaker borrowers. However, the distribution of these spread gains is top-heavy within the syndicate. While the market rewards borrowers, it punishes lenders for loans made in a growing economy and/or to weak borrowers. The burden of this market "tax" falls most heavily on the lower ranked lenders in the syndicate but they are spared this tax on loans made in recessions and/or to strong borrowers, hinting at a potential competitive advantage that can be used to drive growth in difficult economic conditions when the leading lenders curtail their advances.