Lending, Investments and the Financial Crisis

Elena Beccalli, Federica Poli, Elena Beccalli, Federica Poli

• Publisher: Palgrave Macmillan
• Year: 2016
• Print ISBN: 9781349564989, 9781137531001
• eBook ISBN: 9781137531018
• Topic: Business
• Subtopic: Business General
• Index: Business

This book features contributions from leading researchers into the effect of the recent financial crisis on lending in the banking sector. They explore the emergence of alternative methods of firm financing, including crowdfunding, firm network financing and venture capital, and analyse the performance of listed European innovative firms. The book discusses related topics such as the role of loan dynamics and structure for Central and Eastern European economic growth, the liquidity policy of the European Central Bank during the Euro crisis, sovereign pensions and social security reserve funds. Lending, Investments and the Financial Crisis addresses the ways in which the strategies of institutional investors have been impacted by the crisis. The study focuses on Western, Central and Eastern Europe, while providing a wider context in terms of comparison with the Chinese banking system.

1

How Difficult Is It to Raise Money in Turbulent Times?

Paola Bongini, Arturo Patarnello, Matteo Pelagatti and Monica Rossolini

1.1 Introduction

Banks finance themselves with a variety of sources, with different maturities and credit risk characteristics. Heavy reliance on short-term wholesale funding in the years preceding the financial crisis, a distinctive characteristic of the Originate to Distribute (OTD) business model in banking, turned out to be a source of subsequent problems.

The subprime crisis, the collapse of the OTD business model and the ensuing regulatory reforms (Basel III), have highlighted the growing importance for banks to rely more on stable, long-term funding sources. However, the financial crisis has led to a repricing of risks, with important effects on the demand side in the markets of long-term debt financing instruments. The supply side is more eager to issue long-term debt than the willingness (or interest) of the demand side to absorb it. Moreover, at least for Euro Area intermediaries, issuance and pricing behaviour has also been affected by the tensions in the markets of government debt.

The aim of this study is to investigate the following questions: (1) how deeply systemic crises (subprime, sovereign crisis) impacted on the cost of bank long-term funding?; (2) were such effects tied to the issue’s characteristics – maturity, rating, volume – or to the issuing bank main specific characteristics – for instance, business model – or were they mainly dependent on the macro conditions of the country in which these banks operate?

In order to answer these questions, we collected information on banks’ long-term debt issuance for the years 2006–12. Our sample includes all bond issues by banks headquartered in Europe, the United States and Japan. We document the impact of the subprime crisis and the subsequent sovereign crisis on the volume, frequency of issuance, nature of instrument and cost of bank bonds.

The analysis is based on a database created using DCM Analytics by Dealogic. Our dataset includes detailed information on about 26,350 debt issuances by banks headquartered in France, Germany, Italy, Norway, Spain, Sweden, Switzerland, the United Kingdom, the United States and Japan, during 2006–12. The dataset represents 80 per cent of all issues in the above-mentioned countries.

After a review of the relevant literature (Section 1.2), Section 1.3 describes the sample while Section 1.4 investigates the effects of the financial crises on the cost of long-term funds. Section 1.5 concludes.

1.2 Review of literature

Recent developments have led to important changes in bank funding models and patterns, namely the financial market turmoil that emerged in the second half of 2007, the severe global financial crisis subsequent to the collapse of Lehman Brothers in September 2008 and finally the unfolding of the financial crisis in the Euro Area into a sovereign debt crisis. Two main trends are nowadays visible around the world, especially in Europe/euro area: a higher cost of funding (both short- and long-term); a different structure of liabilities, characterized by a sensible reduction of senior unsecured debt issuance and wholesale funding and an increasing portion of secured funding. Overreliance on certain types of wholesale funding was a contributing factor to the global financial crisis: nowadays banks have a lower dependence on wholesale markets and are increasingly dependent on customer deposits. This is a clear-cut and global change in funding patterns with respect to the pre-crisis period, though some geographical differences are notable. Indeed, Euro Area banks are less able to attract new customer deposits, since their economies were hit to a greater extent by financial, real and sovereign debt crises; their recourse to central banking funding increased considerably in order to replace their higher pre-crisis dependency on wholesale funding.

Such changes have inspired an increasing array of academic and institutional studies, mainly empirical, highlighting the relevance of liability side issues, beyond bank capital concerns. Thereby, not only capital adequacy is under scrutiny, but also the whole structure of bank liabilities is analysed and assessed. In fact, despite adequate capital ratios, many banks were faced with funding difficulties; moreover, strains in funding markets led to massive interventions by national and supranational authorities as liquidity providers.

In sum, research on bank funding structures concentrates on four main themes:

1.the relationship between bank funding patterns and financial stability/financial integration (ECB, 2012; IMF, 2013; Le Leslé, 2012; Yorulmzer, 2014; ECB, 2011; 2012);

2.the likely effect of key regulatory initiatives on bank funding structures (IMF, 2013; Le Leslé, 2012).

3.the impact of the crisis on bank funding costs (CGFS 2011; Cardillo and Zaghini, 2012; Bongini and Patarnello, 2012);

4.the analysis of funding cost advantaged deriving to (some) banks benefiting from implicit, yet valuable, government guarantees (Schich and Lindh, 2012; Schich and Aydin, 2014; Cariboni et al., 2013; Zaghini, 2014).

Studies are mainly focused on European banking systems, as funding risk has been one of the main problems of Euro Area banks since the starting of the sovereign debt crisis.

Are bank funding structures relevant to financial stability? The answer is positive, according to a study by the IMF (2013), which examined the relationship between bank funding characteristics and bank distress for a broad range of emerging and advanced economies from 1990 through 2012. The results support the view that overall banking-sector stability requires that banking structures be stable, be diversified and involve less leverage. Limiting mismatch between loans and deposits, i.e. reducing the reliance on wholesale funding, is also important. Higher reliance on short-term debt, in particular in the form of wholesale debt, is associated with an increase in bank distress. Lower level of leverage and a higher diversification of funding sources contribute to bank stability.

Since the crisis began, most banks have altered their funding structures to make themselves less vulnerable: decreasing reliance on interbank and wholesale funding and a shift towards more stable funding is deemed to contribute to overall stability. However, policy concerns arise on account of the increasing reliance on secured lending, which in turn increases the level of asset encumbrance. A predominance of secured or collateralized funding may pose limits to bank lending activity and have an impact on the composition of assets on banks’ balance sheets going forward (ECB, 2012).

Recent regulatory reforms prompted by the crisis and aimed at directly changing bank funding structures and loss-sharing rules across funding instruments¹ tend to reinforce a preference for liquid assets and a reinforcement of asset encumbrance that would persistently affect banks’ asset holdings and their funding strategies (IMF, 2013; ECB, 2012).

These reforms are likely to also impact the future cost of bank funding, already hit hard by the financial crisis and the spill-over of the sovereign debt crisis. In particular, some regulatory-driven changes to funding structures (i.e. more equity) combined with the reallocation of losses upon bank failure among debt-holders (i.e. bail-in of creditors in resolution or depositor preference in liquidation) can produce changes of bank funding costs which cannot be easily anticipated. On the one hand, a larger loss-absorbing buffer makes debt safer and potentially cheaper. On the other hand, bail-in powers and the possible introduction of depositor preference laws, combined with high levels of asset encumbrance, magnify the expected losses that unsecured debt-holders will suffer in the event of a bank failure and will likely drive upwards the cost at issuance of this class of debt instruments.

As a matter of fact, banks’ funding costs have faced a steady and substantial rise since 2009. Not only secured and unsecured debt spread have increased, due to perceived higher bank’s probability of default and ensuing expected losses, but also the price of retail deposits have been driven upwards by increased competition in the household segment of retail deposit markets which have made this source of funding more expensive than before. Besides, the linkages between sovereigns and home banking systems affect significantly banks’ cost of funding. Cardillo and Zaghini (2012) and Zaghini (2014), analysing the cost of bank bond at issuance, over the years 2006–11, for a sample of US, Euro Area and UK banks, show that in crisis periods the effects of a deterioration in (perceived) sovereign creditworthiness spill-over to home banks. In a similar vein, the CGFS paper (2011) analysed the impact of sovereign risk on the cost of bank funding for a sample of 534 unsecured fixed rate senior bonds from 114 banks in 14 advanced economies, for the years 2006 and 2010. The main insight of the study is that in normal times the characteristics of the sovereign have virtually no effect on the cost of funding, which instead is closely related to issue-specific and bank-specific factors. In crisis time, however, a large part of the spread at launch on bank bonds – nearly 30 per cent – reflects the conditions of the sovereign. This percentage increases to 50 per cent for countries for which concerns over public finance conditions are most pronounced. Such results imply a significant funding cost advantage for those banks residing in countries with sovereigns of high creditworthiness.

Indeed, the issue of implicit guarantees for bank debt has received much attention since the onset of the global financial crisis. An implicit guarantee represents the expectation by market participants of future bail-outs upon failure of the beneficiary institution. It is ‘implicit’ because the provider of the guarantee does not have to commit to bailing out the firm. In the case of banks, (unwilling) providers of such guarantees are governments and public authorities in general, given the potential disruptive effects of bank failures. Implicit guarantees imply a funding cost advantage for beneficiary banks: this in turn is conducive to competitive distortions and can have important consequences for firms’ risk-taking decisions since beneficiary banks could be induced to take on too much risk (which makes the use of the guarantee, and tax-payers money, more likely). Implicit guarantees also imply an undesirably close link between the value of bank and sovereign debt, including potential negative feedback effects from the value of sovereign debt to ...

Table of contents

• Cover
• Title
• 1 How Difficult Is It to Raise Money in Turbulent Times?
• 2 The ‘Wisdom of the Crowd’ as an Antidote to the Credit Crunch: A Preliminary Analysis of Crowdfunding
• 3 Financing Firms’ Networks: The Italian Case
• 4 The Role of Loan Dynamics and Structure for CEE Economic Growth
• 5 China’s Shadow Banking System and Its Lurking Credit Crunch: Causes and Policy Options
• 6 An Index of Bank Liquidity Creation: An Application to the Banking Systems of the Eurozone and the Liquidity Policy of the ECB during the Euro Crisis
• 7 The Performance of Listed European Innovative Firms
• 8 Investment Strategies of Institutional Investors: An International Comparison of Sovereign Pension and Social Security Reserve Funds
• Index