Financial Sector Integrity and Emerging Risks in Banking

Financial Sector Integrity and Emerging Risks in Banking FDIC Conference 2005 João A. C. Santos Federal Reserve Bank of New York The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System.

Comments on: How bank regulation, supervision and lender identity impact loan pricing: A cross-country comparison Hao, Nandy and Roberts Foreign entry and bank competition Sengupta Competition versus agency costs: An analysis of charter values in European banking Jonghe and Vennet 2

How bank regulation, supervision and lender identity impact loan pricing: A cross-country comparison • Objective – • Methodology – • Investigate if bank regulation, supervision and lender identity impact banks’ loan pricing policy Cross country study Main results – – In countries where regulations allow banks to take equity stakes in firms, domestic banks charge lower interest rates on loans while foreign banks charge higher rates The benefits of that link, however, do not hold in countries with concentrated banking markets 3

How bank regulation, supervision and lender identity impact loan pricing: A cross-country comparison Comments • Objective – Banking and commerce literature (Elston (1993) and Weinstein and Yafeh (1998)) • Methodology – International syndicated loan market is not fully integrated (Carey and Nini 2003) – Controlling for firms’ equity stakes in banks – Controlling for banks’ equity stakes in banks (Santos and Wilson 2005) – Controlling for loan covenants – Firm controls (The case of risk) – Clustering • Results – They should be read with caution 4

Foreign entry and bank competition • Objective – Study how foreign entry affect competition in the domestic banking market and funding costs of domestic borrowers • Model – – – Incumbent bank has an information advantage Foreign bank has a funding advantage Two types of borrowers with unlimited access to collateral Pledging collateral is costly Banks compete on interest rates and collateral requirements • Main results – Lower funding costs of foreign banks, stronger legal protection, and lower costs of collateral liquidation facilitate foreign bank entry – The lower the foreign bank’s funding costs the easier it will be for it to attract good borrowers 5

Foreign entry and bank competition • Objective Comments – The paper’s focus on foreign entry • Model – – Borrowers’ unlimited access to collateral Foreign entrants’ cost advantage Costs of collateral liquidation do not vary across domestic and foreign banks Why would foreign banks choose to compete on collateral? • Results – Who demands and who pledges collateral? – Does foreign entry in banking hurt the domestic economy? – “This model can explain the perceived bias that foreign (and large domestic) banks lend more to large firms thereby neglecting small enterprises. ” 6

Competition versus agency costs: An analysis of charter values in European banking • Objective – Investigate the relative importance of competition, market structure, and the efficiency hypothesis on banks’ market value • Methodology – Cross country study – Dependent variable: Adjusted Tobin’s Q – Independent variables: market share, concentration, cost-to-income measure, assets, leverage…… • Main results – Market share and cost-to-income increase Q’, as does leverage up to a certain limit – Concentration does no affect Q’ – Size reduces Q’ 7

Competition versus agency costs: An analysis of charter values in European banking Comments • Objective – Interesting, but quite difficult • Methodology – – – Adjusting the Tobin’s Q Accounting versus market data B ank’s market share does not account foreign activities Size is not a good measure of scope economies Size and market share correlated Need for bank fixed effects? • Results – “Leverage is positively related to performance by reducing the agency problem…. ” – “We find strong. . . evidence for the Relative Market Power hypothesis. ” 8

What is common about the three papers? • The role of concentration in the banking industry on bank performance – Hao, Nandy and Roberts: concentration is beneficial to banks – Sengupta: concentration is beneficial to banks – Jonghe and Vennet: concentration is not beneficial to banks • The role of foreign banks’ competition – Sengupta: foreign banks’ competition affects negatively domestic banks’ profits – Jonghe and Vennet: foreign banks’ competition does not affect domestic banks’ charter values 9

The caveats of cross-country studies • The difficulties of comparing data across countries • Jonghe and Vennet: “The regulatory environment in the European Union is quite harmonized an does not significantly affect banks operating in a particular country. ” 10