Banking

the effect of financial leverage

The bankruptcy rates plotted in figure 2 reinforce the evidence presented in figure 1. Indeed, figure 2 presents average bankruptcy rates for low-leverage (blue line) and high-leverage (green line) firms calculated in the quarters before and after IBBEA deregulation. The average bankruptcy rate for low-leverage firms did not change before and after the increase in banking competition. However, the average bankruptcy rate for high-leverage firms more than doubled after the IBBEA deregulation took place.

In the paper, we further investigate the effects of debt maturity and bank lending on bankruptcy rates. We find that bankruptcy rates of high-leverage firms were particularly exacerbated among firms with high levels of short-term debt.  We also find that, following the IBBEA, syndicated loans for highly leveraged firms decreased. We document that syndicated loans that were taken with the purpose of mergers and acquisitions decreased for such firms after the IBBEA. Our results suggest that this could be damaging for firms’ survival in the long run, as large companies often rely on acquiring small and innovative firms.

Granted that banking competition generally increases economic growth (Jayaratne and Strahan 1996), we highlight some possible drawbacks of increases in banking competition. Concretely, we find that the credit risk of high-leverage firms rises following increases in banking competition. Credit risk is even higher for firms more exposed to rollover risk (i.e., firms with high levels of short-term debt). This finding could be explained by the loss of relationship lending for high-leverage firms during periods of increased banking competition. Our results suggest that to avoid this downside of increased competition, policy makers should work on measures to mitigate the risk of high-leverage firms during episodes of deregulation.

Psssssst :  Question: Can proof of address be a bank statement?

REFERENCES

Boyd, J. and De Nicolo, G. (2005). The theory of bank risk-taking and competition revisited. The Journal of Finance, 60(3):1329–1343.

Chava, S., Oettl, A., Subramanian, A., and Subramanian, K. V. (2013). Banking deregulation and innovation. Journal of Financial Economics, 109(3):759–774.

Hellmann, T. F., Murdock, K. C., and Stiglitz, J. E. (2000). Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough? The American Economic Review, 90(1):147–165.

Jayaratne, J. and Strahan, P. E. (1996). The Finance-Growth Nexus: Evidence from Bank Branch Deregulation. The Quarterly Journal of Economics, 111(3):639-670.

Johnson, C. A. and Rice, T. (2008). Assessing a Decade of Interstate Bank Branching. Washington and Lee Law Review, (1):73–128.

Keeley, M. C. (1990). Deposit Insurance, Risk, and Market Power in Banking. The American Economic Review, 80(5):1183–1200.

Kerr, W. R. and Nanda, R. (2009). Democratizing entry: Banking deregulations, financing constraints, and entrepreneurship. Journal of Financial Economics, 94(1):124–149.

Petersen, M. A. and Rajan, R. G. (1994). The Benefits of Lending Relationships: Evidence from Small Business Data. The Journal of Finance, 49(1):3–37.

Petersen, M. A. and Rajan, R. G. (1995). The Effect of Credit Market Competition on Lending Relationships. The Quarterly Journal of Economics, 110(2):407–443.

Source : blogs.worldbank.org

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