Borrowing Costs Research Articles

Feeling the heat: Climate risks and the cost of sovereign borrowing

This paper empirically examines the link between the cost of sovereign borrowing and climate risk for 40 advanced and emerging economies. We find that vulnerability to the direct effects of climate change matters substantially more for sovereign borrowing costs than climate risk resilience. Moreover, the magnitude of the effect on bond yields is progressively higher for countries deemed highly vulnerable to climate change. Finally, a set of panel structural VAR models indicate that the reaction of bond yields to climate risk shocks become permanent after around 18 quarters, with high risk economies experiencing the largest permanent effects on yields.

Borrowing during periods of policy uncertainty: The role of foreign lenders

Despite the documented detrimental effect of policy uncertainty on borrowing costs, there is no evidence on the potential role of cross border borrowings during such periods. In this study, we test two hypotheses on the potential role of foreign lenders during periods of high policy uncertainty. The first is the common exposure hypothesis, which predicts that domestic lenders pass their uncertainty exposure on to borrowing firms by charging higher loan spreads. Hence, foreign lenders without such exposure could be able to help dispel policy uncertainty. The second is the information cost hypothesis, which predicts that foreign lenders compensate for information asymmetry when lending in host countries by charging high loan spreads, which suggests potential higher costs of foreign borrowing. We find that foreign lenders who are not simultaneously exposed to policy uncertainty charge lower loan spreads than domestic lenders, which supports the common exposure hypothesis. Additional analysis reveals that the two hypotheses complement each other, as the documented effect is particularly pronounced for foreign lenders who are exposed to lower information asymmetry. The findings of the study shed some light on the role of financial market integration during periods of high policy uncertainty.

Coming to Terms: The Politics of Sovereign Bond Denomination

AbstractGovernments interact strategically with sovereign bond market creditors: they make choices not only about how often and how much to borrow, but also under what terms. The denomination of debt, in domestic or foreign currency, is a critical part of these terms. The “original sin” logic has long predicted that creditors have little appetite for developing-country government debt issued in domestic currency. Our novel data, including bond issues by 131 countries in 240,000 primary market transactions between 1990 and 2016, suggest otherwise. Domestic-denominated bonds have come to dominate the market, although domestic-currency issuance often is accompanied by shorter bond maturities. We argue that ideologically rooted policy preferences play an important role in this unexpected trend in denomination. All else equal, right governments choose foreign denomination as a means of mitigating currency risk and thus minimizing borrowing costs. In contrast, left governments opt for the flexibility of domestic denomination, and they are better able to act on their preferences in the presence of risk-mitigating monetary institutions and macroeconomic stability. We find support for our argument that partisanship has a robust and enduring relationship with denomination outcomes, even in a marketplace in which domestic-denominated developing-country sovereign bonds have become the norm.

Admission Control Game with Capacity Borrowing

We study a decentralized admission control problem with capacity borrowing. In this problem, the admission decision is made by each server who is assigned dedicated capacity. However, a server can borrow capacity from other servers if his dedicated capacity is exhausted. The borrower compensates the lender by a payment equal to the ‘‘borrowing cost’’. Hence, the servers share their capacities via borrowing, but they also compete against each other for their pooled capacities. We formulate this problem as a stochastic dynamic game and characterize the equilibrium strategic admission behavior of servers. We show that the critical factors that affect the equilibrium behavior and the system revenue are the magnitude of the borrowing cost, the arrival rate of customers and the revenue difference between different classes of customers. We have identified conditions under which servers maximizing their own payoffs end up making decisions that benefit the system. Our study highlights the important roles that the borrowing cost plays in shaping servers' behavior in service systems and provides concrete guidance for practitioners to design a decentralized admission control system.

Real earnings management and borrowing costs: The moderating effect of the directors’ and officers' liability insurance

Abstract The purpose of this paper is to investigate the effects of real earnings management on firm borrowing cost of public-listed in Taiwanese manufacturing industry during 2010 to 2017, and also examines the moderating effect of the directors’ and officers’ liability insurance (D&O insurance) on real earnings management and borrowing costs. The empirical results show that borrowing cost is positively related to real earning management but negatively related to D&O insurance purchase. Therefore, the firms with D&O insurance than those without have lower borrowing costs, but the higher the D&O insurance amount, the higher the borrowing costs. Furthermore, D&O insurance has a moderating effect between the real earnings management and borrowing costs. Our findings suggest the relationship between D&O insurance and real earning management, which through the D&O insurance purchasing decision to impact on corporate borrowing costs. JEL classification numbers: G22, G32, M41. Keywords: Real earnings management, Directors’ and officers' liability insurance, Borrowing costs, Moderating effect.

U.S. Dollar Currency Premium in Corporate Bonds

We isolate a U.S. dollar currency premium by comparing corporate bonds issued in the dollar and the euro by firms o utside t he U .S. a nd e uro a rea. We make s everal empirical observations that dissect the perceived advantage of borrowing in the dollar. First, while the dollar dominates global debt issuance, borrowing costs in the dollar are more expensive without a currency hedge and about the same with a currency hedge when compared to the euro. This observed parity in currency-hedged corporate borrowing stands in contrast to the persistent deviation from covered interest parity in risk-free rates. Second, we observe a dollar safety premium in relative hedged borrowing costs, found in the subset of bonds with high credit ratings and short maturities, attributes similar to those of safe sovereigns. Finally, we find that firms flexibly adjust the currency mix of their debt issuance depending on the relative borrowing cost between dollar and euro debt. In sum, the disproportionate demand for U.S. dollar debt is reflected in higher issuance volumes that drive up the currency hedged dollar borrowing costs such that at the margin they equate to euro borrowing costs.

Adherence of AS-16 Borrowing Costs by Non- Corporate Entities; A Descendant Note

All organisations whether profit oriented or not need funds either borrowed or owned for investing in its operating assets on a regular basis. Borrowed funds attracts the periodical interest payments and also includes other costs like discounts, finance charges, ancillary costs etc. Proper accounting of such borrowing cost is equally applicable both for the corporate and non-corporate entities in order to report true and fair state of affairs of the business. In this regard, the Accounting Standard – 16 “Borrowing Costs” specifies the criteria for Recognition and Measurement, Presentation and Disclosure of borrowing costs incurred by an entity on its qualifying assets. How far this Accounting Standard is adhered, particularly by the noncorporate entities is a million-dollar question. The present study intends to analyse the treatment of borrowing costs incurred by the non-corporate entities on the qualifying assets. For a deeper analysis of the issue, an enquiry on 30 non-corporate entities was made and analysed the results thereof. The study revealed some interesting facts regarding the issue. Non adherence of AS - 16 among non-corporate entities is evident from the study.

The impact of climate change on the cost of bank loans

We find robust empirical evidence that firms in locations with higher exposure to climate change pay significantly higher spreads on their bank loans. To alleviate the concerns related to using firms' headquarters in determining climate risk exposure, we exploit the economic link between a firm and its customers and find that the exposure of a firm's customers to climate risk also adversely affects that firm's cost of borrowing. In the cross-section, we find that the long-term loans of poorly rated firms drive the effect. Overall, our evidence suggests that lenders increasingly view climate change as a relevant risk factor.

The impact of environmental performance on capital structure and firm performance: the case of Turkey

Purpose The purpose of this study is to investigate the effect of environmental performance on the capital structure and financial performance of Turkish listed firms. Design/methodology/approach This study used data of 49 firms listed on Istanbul Stock Exchange during the period between 2014 and 2019, resulting in 205 firm-year observations. The environmental performance data were drawn from the carbon disclosure project Turkey climate change reports. Ordinary least squares and binary logistic regression models were used to examine whether environmental performance impacts the capital structure and financial performance. Findings The findings of this research revealed that environmental performance significantly positively affects the firm leverage. Findings also showed that environmental performance has a significantly positive impact on return on assets, operating profitability and return on equity, but no significant impact on stock returns. Practical implications Given the increased borrowing costs for Turkish firms after the 2018 currency crisis in Turkey, the findings of this study are very important as they enable managers of Turkish firms to make better decisions related to capital structure and to understand the role of environmental performance in reducing the cost of debt and enhancing financial performance. Originality/value To the author’s knowledge, this research is the first to investigate the effect of environmental performance on capital structure in the Turkish context, and is one of few that explained how environmental performance affects the financial performance of Turkish firms.

A measure of Turkey's sovereign and banking sector credit risk: Asset swap spreads

The existence of the credit derivatives written on the eurobonds such as credit default swaps or asset swaps allows policymakers and investors to monitor the evolvement of credit risk. However, these instruments are mostly available in advanced economies, whereas the market for credit derivatives in emerging market countries, including Turkey, is limited in terms of liquidity and maturity. In this regard, this study aims to construct a proxy for the credit risk of the Turkish Treasury and banking sector in international markets by calculating asset swap spread for US dollar-denominated fixed coupon eurobonds, which requires a robust estimation of the relevant yield curves. The study firstly presents the estimation of the sovereign and banking sector yield curves and then constructs a synthetic asset swap structure to obtain embedded credit risk premia in the eurobond curves. Our findings show that the proposed credit risk indicator is vastly correlated with credit default swap premium. In addition to this, estimated eurobond curves are also useful for monitoring borrowing cost dynamics of the Turkish Treasury and banking sector in international markets.

“When it rains, it pours”: Fiscal policy, credit constraints and business cycles in emerging and developed economies

Fiscal procyclicality, meaning co-movement between government expenditure and macroeconomic fundamentals, is an important feature of business cycle dynamics for emerging and poor economies. I estimate a panel SVAR to investigate the reasons for fiscal procyclicality. The analysis sheds light on the role of external financial constraints in shaping fiscal policy. My findings suggest that the response of emerging governments to output fluctuations is similar to that of developed governments. However, emerging governments curtail spending in response to increases in the sovereign borrowing rate, which forces their consumption expenditure to act more procyclically. Using counterfactual analysis, I show that the key forces behind fiscal procyclicality are the sensitivity of government spending to international borrowing costs and the procyclical nature of these costs for emerging economies.

Trends in Corporate Borrowing

Corporate borrowing has substantially changed over the last two decades. In this article, we investigate changes in borrowing of US publicly listed firms along trends in five key areas: ( a) the funding mix of firms and the importance of balance-sheet versus off-balance-sheet borrowing; ( b) the costs of corporate borrowing; ( c) trends in nonprice loan terms; ( d) the importance of banks versus nonbank institutional investors; and ( e) the purpose for corporate borrowing. We explore these trends graphically over the 2002–2019 period, provide a narrative for these trends based on the theoretical and empirical literature in the respective areas, and discuss some implications for the coronavirus disease 2019 (COVID-19) pandemic. Finally, we document these trends for firms in the Eurozone countries and delineate similarities and differences.

Cost of Loans and Moral Hazard

We document the effects of higher borrowing cost on private firms by exploiting a novel quasi-experiment and a unique and comprehensive dataset from Sweden. In June 2010, the central bank of Sweden increased the repo rate unexpectedly and exposed firms with long term loans maturing right before or after the hike to different cost of borrowing. Consistent with the debt overhang theory, we find that higher cost of borrowing has a significant negative effect on investment, and more for highly levered firms. Contrary to the risk shifting theory, we find no evidence that distressed firms engage in activities that are riskier ex-post.

Antecedents of the service quality for housing loan customers of Indian banks

The purpose of this paper is to explore the influence of the cost of borrowing, processing time and documentation on the service quality of banking institutions in India that sanction housing loans. A research framework was designed to consider the independent variables influencing service quality by unearthing research gaps in the extant literature on housing loans. All research gaps were transformed into a questionnaire, to which 535 useful responses were received. A five-point Likert scale was used, and a structural equation model was formulated using ADANCO 2.0.1 – all hypotheses were tested with ADANCO. The findings clearly indicate the relevance of the service quality in banking sectors in India. There is a significant relationship between the three independent variables (cost of borrowing, processing time and documentation) and service quality. The outcome of banking service quality is measured through initial personal contact, online banking services, the humanitarian approach, provision of information for services, promise of service delivery and field verification, with all these measures having a very strong impact. This study is restricted to India only, but could be extended to other developing countries in South Asia in the future. This study could also be extended to cover other types of banking loans offered by banking institutions in India. The paper concludes that it is time for banking institutions to take action to sanction housing loans with a view to introducing the instant sanctioning of bank loans that come with real-time access, without resorting to bureaucratic policies and procedures for housing loan customers.

Self-fulfilling debt crises, fiscal policy and investment

This paper studies the circular relationship between sovereign credit risk, government fiscal and debt policy, and output. I consider a sovereign default model with fiscal policy and private capital accumulation. I show that, when fiscal policy responds to borrowing conditions in the sovereign debt market, multiple equilibria exist where the expectations of lenders are self-fulfilling. In the bad equilibrium, pessimistic beliefs make sovereign debt costly. The government substitutes borrowing with taxation, which depresses private investment and future output, increases default probabilities and verifies lenders' beliefs. This result is reminiscent of the European debt crisis of 2010–12: while recessionary, fiscal austerity may be the government best response to excessive borrowing costs during a confidence crisis. The extent of this type of crises can be reduced by the intervention of an external official lender committing to provide liquidity, or by policies aimed at sustaining private investment.

Loan syndication under Basel II: How do firm credit ratings affect the cost of credit?

This paper investigates how syndicated lenders react to borrowers’ rating changes under heterogeneous conditions and different regulatory regimes. Our findings suggest that corporate downgrades that increase capital requirements for lending banks under the Basel II framework are associated with increased loan spreads and deteriorating non-price loan terms relative to downgrades that do not affect capital requirements. Ratings exert an asymmetric impact on loan spreads, as these remain unresponsive to rating upgrades, even when the latter are associated with a reduction in risk weights for corporate loans. The increase in firm borrowing costs is mitigated in the presence of previous bank-firm lending relationships and for borrowers with relatively strong performance, high cash flows and low leverage.

The Dollar and Corporate Borrowing Costs

We show that U.S. dollar movements affect syndicated loan terms for U.S. borrowers, even for those without trade exposure. We identify the effect of dollar movements using spread and loan amount adjustments during the syndication process. Using this high-frequency, within loan variation, we find that a one standard deviation increase in the dollar index increases spreads by up to 15 basis points and reduces loan amounts and underpricing by up to 2 percent and 7 basis points, respectively. These effects are concentrated in dollar appreciations. Our results suggest that global factors reflected in the dollar affect U.S. borrowing costs.

Your word and your bond: Central Banks and sovereign lending in civil wars, 1815–1914

All wars are expensive, but civil wars carry heightened stakes. Defeat can mean loss of territory, the dissolution of the sitting government, or the liquidation of the state itself. Even a victorious government may face tremendous crises and pressures in the short-term. A central bank can signal a sovereign’s creditworthiness to potential lenders, but the bank’s independence (or even existence) can be terminated should a government wish to do so. Despite this, lenders not only continue to lend to governments amidst civil wars but also respond to signals of creditworthiness such as the presence of an independent central bank. Using several statistical models and bond yield data from the nineteenth and early twentieth centuries, I demonstrate that the presence of a central bank reduces sovereign borrowing costs for a state amidst a civil war. This confirms the institution’s ability to secure cheap wartime capital under suboptimal conditions.

Does the charter form lead to lower borrowing costs? Examining the case of California local governments

AbstractIn this paper, we examine the impact of the charter form of government on the borrowing costs of local governments. A substantial amount of research has been undertaken to date in which scholars have investigated the determinants of borrowing costs for governments. However, little research has been conducted hitherto on the impact that the particular form of government – a key issuer characteristic – has on determining its specific borrowing costs. We hypothesized that a chartered government is more likely to be able to reduce its borrowing costs when it is benefiting from the municipal bond market; a government's flexibility and professionalism is desirable. We tested this hypothesis by using city and county government bond data from California that dates from 2003 to 2015. In our findings, we show that the financial flexibility that is afforded by a charter helps local governments to improve their credit ratings and to lower their borrowing costs.

Does a Company’s Environmental Performance Influence Its Price of Debt Capital? Evidence from the Bond Market

Previous studies suggest that a higher level of corporate social responsibility (CSR) is associated with a lower cost of equity capital. However, there are very few studies on the link between CSR and the cost of debt, particularly on the effects of the environmental aspect of CSR on the cost of debt. As one of the first attempts to study the effects of corporate environmental performance on the cost of debt, this article contains an analysis of a sample of 5,260 bonds issued in the EU and US markets over the 2016–2018 period. The findings suggest a negative association between environmental performance and the cost of debt, proxied as coupon rates, which means that higher environmental performance helps reduce the cost of debt financing through bond issuance. Such effect is consistent across bond maturities. <b>TOPICS:</b>ESG investing, fixed income and structured finance, developed markets, performance measurement <b>Key Findings</b> ▪ Environmental performance is negatively associated with the cost of debt, meaning that the lower the corporate environmental performance, the higher the cost of debt. ▪ The integration of environmental factors into investment processes and decision-making is apparent along each debt maturity. ▪ Assigning bonds specifically to green projects or activities by firms may not necessarily lower the cost of borrowing.