Regulation and Trust in Financial Stability

Paper Session

Saturday, Jan. 7, 2017 2:30 PM – 4:30 PM

Sheraton Grand Chicago, Chicago Ballroom VIII
Hosted By: American Finance Association
  • Chair: David Thesmar, Massachusetts Institute of Technology and CEPR

Information Sharing and Rating Manipulation

Mariassunta Giannetti
,
Stockholm School of Economics
Jose Liberti
,
Northwestern University and DePaul University
Jason Sturgess
,
DePaul University

Abstract

We show that banks manipulate the credit ratings of their borrowers before being compelled to share them with competing banks. Using a unique feature on the timing of information disclosure of a public credit registry, we disentangle the effect of manipulation from learning of credit ratings. We show that banks downgrade high quality borrowers on which they have positive private information to protect their informational rents. Banks also upgrade low quality borrowers with multiple lenders to avoid creditor runs. Our results suggest that manipulation of credit ratings limits the positive effects of credit registries’ information disclosure on credit allocation.

Which Swiss Gnomes Attract Money? Efficiency and Reputation as Performance Drivers of Wealth Management Banks

Urs Birchler
,
University of Zurich
Rene Hegglin
,
University of Zurich
Michael Reichenecker
,
UBS AG Switzerland
Alexander F. Wagner
,
Swiss Finance Institute and University of Zurich

Abstract

Wealth management constitutes an important aspect of today's banking world, but very little is known about what explains the differences among banks in their ability to attract new assets under management. Using a unique panel database of Swiss private banks, we test the hypothesis that the performance of a bank in attracting new money depends on two input factors: skill and reputation. Relatively skilled banks -- that is, banks that are more cost-efficient than predicted by their input factors -- also perform better in attracting net new money. We also find that negative media coverage (such as in the context of fraudulent business practices related to tax evasion) strongly diminishes the future ability to attract assets under management, especially at small banks. The present value of lost profits is 3.35 (0.73) times the median annual net profit of a small (large) bank. Thus, adding to the explicit fines that many Swiss banks had to pay in the course of the U.S. Department of Justice's investigations, there are substantial implicit and reputational costs to banks of having negative media coverage. Investment performance for clients seems not to explain future net new money growth. In sum, these results underscore the importance of trust in money management.

The Invisible Hand of the Government: ”Moral Suasion” During the European Sovereign Debt Crisis

Steven Ongena
,
University of Zurich
Alex Popov
,
European Central Bank
Neeltje van Horen
,
Bank of England

Abstract

Using proprietary data on banks’ monthly securities holdings, we show that during the European sovereign debt crisis, domestic banks in fiscally stressed countries were considerably more likely than foreign banks to increase their holdings of domestic sovereign bonds during months when the government needed to roll over a relatively large amount of maturing debt. This result is stronger for state-owned and supported banks, and it cannot be explained by concurrent factors such as risk shifting, carry trading, or regulatory compliance. We also find evidence that domestic banks reduced the supply of household credit following months with high government refinancing need.

Equity is Cheap for Large Financial Institutions: The International Evidence

Priyank Gandhi
,
University of Notre Dame
Hanno Lustig
,
Stanford University
Alberto Plazzi
,
University of Lugano and Swiss Finance Institute

Abstract

Equity is a cheap source of funding for large financial institutions. In a large panel of 31 developed and emerging market countries, we find that the stock returns on a country's largest financials are significantly lower than the returns on that country's small financials, after adjusting for risk exposures. In developed countries, the largest banks earn negative risk-adjusted returns, but, in emerging market countries, the anomaly is largest for other financial firms. The large-minus-small, financial-minus-nonfinancial risk-adjusted spread varies across countries with the institutional, policy, and regulatory environment consistent with stock investors pricing in the implicit government guarantees that protect shareholders of large banks. The spread is larger for banks that operate in countries with deposit insurance, backed by fiscally strong governments.
Discussant(s)
Daniel Paravisini
,
London School of Economics and Political Science
Paola Sapienza
,
Northwestern University
Stijn Claessens
,
Federal Reserve Board
Jeffrey Wurgler
,
New York University
JEL Classifications
  • G2 - Financial Institutions and Services