changes in the cost of bank equity and the supply of bank ...3f5b523a-ab1f-4204...italian/belgian...

Changes in the Cost of Bank Equity and the

Supply of Bank Credit “When it Rains in Milano or Brussels, Does it Drizzle in Frankfurt?”

Claire Celerier (University of Toronto)

Thomas Kick (Bundesbank)

Steven Ongena (University of Zurich, SFI, KU Leuven and CEPR)

The opinions expressed are those of the authors and do not necessarily represent the opinion of the Deutsche Bundesbank

Motivation

.., When in distress, highly leveraged banks generate negative externalities

.., Reducing leverage by higher capital requirements, however, have negative

effects on bank lending:

Berrospide and Edge (IJCB 2010), Aiyar, Calomiris and Wieladeck (JMCB, 2014),

Fraisse, Le, Thesmar (2015), Behn, Haselmann, Wachtel (JF, 2016), Berrospide, Black, and Keeton (2016), de Jonghe, Dewachter, Ongena (2016), Jimenez,

Ongena, Pedro, Saurina (JPE, 2016), ...

.., An alternative to increasing capital requirements is a decrease in the

relative cost of equity: What is the effect on bank lending?

How to Decrease the Cost of Equity?

Allowance for Corporate Equity (ACE)

.., Definition: Same tax advantage to equity as to debt by deducting a

notional interest on equity from taxes

.., Mechanism:

� A notional interest rate R is defined by the regulator

� R × Book Value of Equity is deducted from income before taxes

Estimation Challenge

.., To measure the effect on lending the shock should:

� Impact only a subset of banks

� Not impact firms!

.

., Solution: look at lending by impacted banks abroad

Peek, Rosengren (AER, 1997, 2000), Ongena, Popov, Udell (JFE, 2013), ...

Findings

ACE leads banks to...

.., Raise their equity ratio

� Between 0.6 to 1 percentage points (pp) depending on the scope of the reform

.., Supply more credit to in Germany

� Variation of more than +50 percent (%)

� Aggregate firm-level borrowing also increases

Road Map

Strategy/Shocks

Data/Methodology

Estimates Capital Structure

Estimates Lending

Conclusion

Identification Strategy

German Firm Italian/Belgian Bank

German (or Foreign) Bank

Tax policy reform shock

Firm Fixed Effects (in a Difference-in-Differences)

Firms and banks in Germany do not drive reform and are not affected by it

Discussion of Identifying Assumptions

• Firms and/or banks in Germany are unlikely to drive reforms in Italy and Belgium • Few firms and/or banks present there • No anecdotal evidence there was foreign meddling (if anything

reforms were driven by domestic competitiveness` considerations in Belgium)

• Reforms do not affect banks in Germany • We will account for cross-border bank asset shares • Will lead to underestimation of the impact (we find)

Discussion of Identifying Assumptions

• Reforms do not affect bank-specific firm demand in Germany E.g., firms in Germany exporting to Italy or Belgium (where also firms have been affected by the reform) do not specifically change their demand for credit from Italian or Belgian banks • Little evidence on firm-bank specific credit demand

Jiménez, Mian, Peydró, Saurina (2014), Degryse, De Jonghe, Jakovljevic, Mulier, Schepens (2016), De Jonghe, Dewachter, Mulier, Ongena, Schepens (2015)

• Export is relatively small compared to domestic sales • We check results for firms using only either Italian or Belgian

banks and similar foreign banks • For «Spanish shocks» we unlikely have firm demand increasing

in Germany • Current work: remove firms in border areas, with exports, ...

Identification Strategy

German Firm Italian/Belgian Bank

German (or Foreign) Bank

Tax policy reform shock

Firm Fixed Effects (in a Difference-in-Differences)

Banks in Italy and Belgium lend more to banks in Germany?

Yes, but impact is consistent in sign (with changes in lending to firms), though often not significant and small (because global interbank market is large?),

and should result in an under-estimation of the changes in the credit supply to firms!

Identification Strategy: Three Shocks to the Cost of Equity

1. Italy, 2000: introduction of an ACE

2. Italy, 2002: end of the ACE

3. Belgium, 2006: introduction of an ACE

Gambacorta, Ricotti, Sundaresan, Wang (2016)

The Fine Print Is Important But ...

... for our application it suffices to benchmark its impact

using the observed changes in the bank equity ratios





Panier, Perez-Gonzalez, Villanueva (JF, 2016), Schepens (JFE, 2016)

Schepens (JFE 2016)

More equal treatment of debt and equity: 1. increases bank capital ratios, 2. driven by an increase in common equity, 3. leads to a significant reduction in risk

(taking) for ex-ante low capitalized banks

ACE in Belgium triggered by removal BCC. But difficult to identify the impact on the supply of bank credit because the firms are also affected by the change.

Robustness: Two Shocks to Required Bank Capital

1. Spain, 2000: introduction of dynamic provisioning

2. Spain, 2005: modification of dynamic provisioning

Jimenez, Ongena, Peydro, Saurina (JPE, 2016)

Three Possible Mechanisms

.., Income Effect: Tax deduction ⇒ additional income that can directly be

lent to firms

.., Cost of Fund Effect: Lower cost of capital ⇒ Lower lending rate

.., Capital Structure Effect: Higher equity ratios ⇒ Fewer

regulatory constraints on the asset side

Road Map

Strategy/Shocks

Data/Methodology


Estimates Lending

Conclusion

Capital Structure

Capital Structure Analysis: Matching

.., Data: Bank data from Bankscope

.., Methodology: Control group of European banks obtained through

propensity score matching (5 closest) based on the value before the shock of:

� Log of total assets

� Return on assets

� Equity Ratio at t , t − 1, and t − 2

� The equity ratio growth rate at t and t − 1

.., Model:

∆ log Equity Ratiob,t = α + βTreatedb,t + γ Postt + ηTreatedb,t × Postt + λYb + Eb,t

Table 2

Bank-Firm Lending

Lending Analysis: German Credit Register Data

.., Quarterly panel of bank-firm pairs (1994-2013)

.., All bank-firm exposures initially above 1.5 million euros

.., Firms that borrowed at least once from banks in two countries are likely large and credit exposure hurdle not so binding

we back-fill exposures to create a balanced panel

e.g., Schertler, Buch, Westernhagen (IEEP, 2006), Hayden, Porath, Westernhagen (JFSR, 2007), Ongena, Tümer-Alkan, von Westernhagen (EER, 2012)

Four-Step Analysis

1. Overall Impact on Bank-Firm Exposures: Benchmark model includes all

bank-firm exposures

2. Intensive Margin: We restrict the sample to

� Firms that borrow at least from one bank exposed to the shock in the pre-period

� Bank-firm exposures that are strictly higher than zero in the pre-period

3. Extensive Margin: The dependent variable is a dummy that equals one

if bank-firm exposure becomes positive and equals zero otherwise

4. Aggregate Borrowing: The dependent variable is the change in firm total

borrowing (across all banks)

Methodology: Differences-in-differences Estimation

.., Two Sub Periods (collapsed): One year before, two years after

Bertrand, Duflo, Mullainathan (QJE, 2004)

.., Model:

∆ logLb,f = αTreatedb,f + βX f + γYb + λRb,f + Eb,f

.., Variables: � Lb,f : Credit exposure of bank b to firm f (average in the pre and post

periods)

� Treated : Dummy indicating if the bank has been treated by the change in equity cost

� Xf , Yb, Rb,f : respectively firm, bank and relationship characteristics (or fixed effects)

Table 2

Road Map

Strategy/Shocks

Data/Methodology


Estimates Lending

Conclusion

Table 3

0.35 pp 1.00 pp -0.30 pp

Equity changes, assets may change ...

Road Map

Strategy/Shocks

Data/Methodology


Estimates Lending

Conclusion





Gambacorta, Ricotti, Sundaresan, Wang (2016)

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1998q2 1999q2 2000q2

Date 2001q2 2002q2

Exposure of German Firms to Italian Banks 2000q1: Introduction of the ACE in Italy

Table 4

Lending by Italian banks increases by half or more When compared to all or foreign banks Especially on the intensive margin Total credit of «affected» firms similarly increases

40

Assets Liabilities

Domestic Loans 99 Deposits 95

Foreign Loans 1 Equity (5%) 5

Assets Liabilities


Foreign Loans 1.37 Equity (5.35%) 5.37

Possible? Yes, if foreign loans are a minor category

41

Assets Liabilities



Assets Liabilities

Domestic Loans 80 Deposits 113.6

Foreign Loans 40 Equity (5.35%) 6.4

Possible? Yes, if bank “scales up” equity concurrently

Impact on lending reacts strongly to fairly small changes in equity. Mainly foreign loans affected because domestically all banks receive ACE?

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2000q1 2001q1 2002q1

Date 2003q1 2004q1

Exposure of German Firms to Italian Banks 2002: Phasing out of the ACE in Italy

Table 5

Lending by Italian banks decreases by half or more

When compared to all or

foreign banks

On both intensive and extensive margin

Total credit of «affected» firms similarly decreases





Panier, Perez-Gonzalez, Villanueva (JF, 2016), Schepens (JFE, 2016)

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2004q1 2005q1 2006q1

Date 2007q1 2008q1

Exposure of German Firms to Belgian Banks 2006: Introduction of the ACE in Belgium

Table 6

Lending by Belgian banks increases by half or more When compared to all or foreign banks On both margins Total credit of «affected» firms increases somewhat

Italian versus Belgian Shocks

Bank equity effect for Belgian shock 3 times as large than Italian shocks (1 versus 0.35 pp) But average (median) Belgian bank almost 10 times as large than Italian bank => very large firms deal with Belgian banks Larger firms borrowing from Belgian banks are affected somewhat less in their total credit than firms borrowing from Italian banks

Robustness: Two Shocks to Required Bank Capital

1. Spain, 2000: introduction of dynamic provisioning

2. Spain, 2005: modification of dynamic provisioning

Jimenez, Ongena, Peydro, Saurina (JPE, 2016)

Source: Jimenez, Ongena, Peydro, Saurina (JPE, 2016), Figure 2

Introduction of Dynamic Provisioning and Bank Lending in Spain

Increases «capital ratio requirement» on average by 0.20 pp

Table 7

Table 8

Introduction and Modification of Dynamic Provisioning in Spain similarly affect Spanish bank lending in Germany Impact is again large So quantity effect (here) and cost effect (earlier) are similar!

56

Assets Liabilities



Assets Liabilities


Foreign Loans 0 Equity (5.20%) 5

Possible?

Shock Equity Ratio

(in pp)

(5) Bank-firm

Credit Supply: After/Before

Share of Wallet

(9) Firm Credit: After/Before

Italy 2000 0.35 2.66*** 35% 1.82***

Italy 2002 -0.30 0.40** 30% 1.05

Belgium 2006 1.00 1.55** 6% 1.13**

Spain 2000 Req: 0.20 0.23*** 10%

Spain 2005 Req: -0.07 ? 5.00** 3%

Summary of Estimates

Road Map

Strategy/Shocks

Data/Methodology


Estimates Lending

Conclusion

.., This paper is the first to study the impact of exogenous changes in the cost of equity on bank lending

.., Lower equity cost leads to more bank lending to firms

.., Future Research: Disentangle which mechanism is at play. Is the effect

bigger for banks with lower/higher binding capital requirements?

Tentative Conclusions

Policy Implications

.., Is an ACE tax reform a solution for financial stability?

.., Do tax revenues resulting from the increase in lending plus the potential

gain in financial stability compensate for the cost of the tax deduction?

changes in the cost of bank equity and the supply of bank ...3f5b523a-ab1f-4204...italian/belgian...

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