Large Loans Research Articles

Small is beautiful: the efficiency of credit markets in the late medieval Holland

In this paper, we analyse the functioning of private capital markets in Holland in the late medieval period. We argue that in the absence of banks and state agencies involved in the supply of credit, entrepreneurs’ access to credit was determined by two interrelated factors. The first was the quality of property rights protection and the extent to which properties could be used as collateral. The second was the level of interest in borrowing money at the time as well as such borrowing compared with the interest rates on risk-free investments. For our case study, the small town of Edam and its hinterland, De Zeevang, in the fifteenth and sixteenth centuries, we demonstrate that properties were used as collateral on a large scale and that interest rates on both small and large loans were relatively low (about 6 percent). As a result, many households (whether headed by men or women) owned financial assets and/or debts, and the degree of financial sophistication was relatively high.

Misguided Policy? Following Venture Capital into Clean Technology

In a search for Schumpeterian solutions, the Obama Administration has made venture capital a cornerstone of its Clean Technology policy, adopting a strategy of providing large loan guarantees to a few venture capital-financed firms. This article argues that three key conditions are necessary for venture capital to successfully open new economic spaces and then it applies them to assess the viability of venture capital investment in clean technology. The article concludes that large loan guarantees are unlikely to be effective. Other government policies such as SBIR grants, university R&D support, certain (de)regulatory actions, large-scale demonstration projects, and/or procurement decisions can better encourage both incremental and Schumpeterian innovation without distorting the turbulent dynamics of new market creation. This analysis can also be applied to other sector- and market-specific innovation policies.

The International Economic Crisis and the 2010 Presidential Elections in Ukraine

The international financial crisis of 2007–9 had a significant impact upon the context, agenda and outcome of the 2010 Ukrainian presidential elections. Among the main reasons for Viktor Yanukovych's success in winning the election were his business-friendly policies, his advocacy of stability and his pro-Russian orientation. His platform chimed with the sentiments of large numbers of voters who were taking a defensive posture in the face of a year-long recession. Yuliya Tymoshenko was treated – and punished – because as the incumbent prime minister she failed to utilize the resources available to her government, including a large IMF loan, to bring the recession to a halt and stimulate a recovery. Viktor Yushchenko was rejected by the electorate because he was increasingly regarded as a president incapable of co-operative relations either with his own government or with the Russian government. These capacities in a president were seen by the electorate as indispensable for tackling the crisis.

Are South Indian farmers adaptable to global change? A case in an Andhra Pradesh catchment basin

Global changes are already having an impact on South Indian farmers. Climate change is affecting the agricultural sector since it is dependent on climatic conditions and water resource availability. The impacts tend to be greater in semi-arid hard rock areas with few water resources. Furthermore, South India area is experiencing a profound agrarian crisis, which is linked, among others, to debt and credit problems. The study reported in this paper aims to develop a methodology to compare and rank farmers according to their ability to adapt to global change. The definition of adaptive capacity is based on a livelihood assets approach. Indicators are evaluated through individual surveys among farmers, then, weighted using the analytic hierarchy process and aggregated via compromise programming. The result is a standardized score measuring the distance of each farmer from an ideal adaptive capacity. Farmers are ranked according to this distance, which allows a comparison of their relative ability to adapt. At the basin scale, it shows that the geographic position of farmers is a significant factor in adaptation performance. The proximity of an administrative center contributes to an increase of their adaptive capacity. Small farming areas limit the adaptive capacities of marginal and small farmers while the largest farmers are constrained by economic factors such as large loans. These study findings offer interesting indications on the variability of farmers’ weaknesses and are bringing a better understanding of the causes of poor performance.

Crossing the threshold: A positive analysis of IBRD graduation policy

According to World Bank policy, countries remain eligible to borrow from the IBRD until they are able to sustain long-term development without further recourse to Bank financing. Graduation from IBRD is not an automatic consequence of reaching a particular income level, but rather is supposed to be based on a determination of whether the country has reached a level of institutional development and capital-market access that enables it to sustain its own development process without recourse to Bank funding. This paper takes a positive approach to IBRD graduation policy, investigating what income and non-income factors appear to have influenced graduation status in recent decades, based on panel data for 1982 through 2009. Explanatory variables include the per-capita income of the country, as well as measures of institutional development and market access that are cited as criteria by the graduation policy, and other plausible explanatory variables that capture the levels of economic development and vulnerability of the country. We find that the observed correlates of Bank graduation status are generally consistent with the stated policy. Countries that are wealthier, more creditworthy, more institutionally developed, and are less vulnerable to trade, financial, and other shocks are more likely to be graduates. Predicted probabilities generated by the model conform closely to the actual graduation and de-graduation experiences of Trinidad and Tobago and Korea, among other countries, and suggest that Hungary and Latvia may have graduated prematurely—a prediction subsequently borne out by the large loans that they later received from the IBRD in the wake of the global financial crisis.

Clawbacks and Cronyism: Evidence from China

This paper is the first to examine the long‐term impact on bank lending policy of clawbacks in executive compensation contracts. Using a hand‐gathered database of Chinese business lending, we find evidence of reduced cronyism at the Big Four Chinese banks during the period after the introduction of a clawback program, marking a shift from earlier studies covering earlier time periods that find evidence of widespread cronyism at the Big Four banks. Politically connected borrowers received fewer and smaller loans relative to non‐Big Four banks, consistent with a backlash against cronyism at the Big Four banks. In contrast, we find that cronyism persisted (i.e., politically connected borrowers received more and larger loans) at non‐Big Four Chinese banks where the clawback policy was not effective.

Information Asymmetries in Consumer Credit Markets: Evidence from Payday Loans

This paper tests for incentive and selection effects in a subprime consumer credit market. We estimate the incentive effect of loan size on default using sharp discontinuities in loan eligibility rules. This allows us to estimate the magnitude of selection from the cross-sectional correlation between loan size and default. We find evidence of advantageous incentives and adverse selection. For a given borrower, we estimate that a $100 increase in loan size decreases the probability of default by 3.7 to 4.2 percentage points, a 20 to 23 percent decrease from the mean default rate. The incentive effect is more than o ffset by adverse selection into larger loans. Borrowers who choose $100 larger loans are 6.9 to 8.0 percentage points more likely to default than borrowers who choose smaller loans. Taken together, our results are consistent with the idea that information frictions lead to credit constraints in equilibrium.

Modeling Ultimate Loss Given Default on Corporate Debt

Loss given default (LGD) is a critical parameter in various facets of credit risk modeling. This study empirically investigates the determinants of LGD and builds alternative predictive econometric models for LGD on bonds and loans using an extensive sample of most major U.S. defaults in the 1985–2008 period. The authors build simultaneous equation models in the beta-link generalized linear model (BLGLM) class, identifying several that perform well in terms of the quality of estimated parameters as well as overall model performance metrics. This extends prior work by modeling LGD both at the firm and the instrument levels. In a departure from the extant literature, the authors find the economic and statistical significance of firm-specific debt and equity market variables. In particular, they find that information from either the equity or the debt markets at around the time of default (measures of either cumulative equity returns or distressed debt prices, respectively) have predictive power with respect to the ultimate LGD, which is in line with recent prior recovery and asset pricing research. They also document a new finding: Larger firms have significantly lower LGDs while larger loans have higher LGDs. <b>TOPICS:</b>VAR and use of alternative risk measures of trading risk, big data/machine learning, credit risk management

Why Do Firms Form New Banking Relationships?

AbstractUsing a large loan sample from 1990 to 2006, we examine why firms form new banking relationships. Small public firms that do not have existing relationships with large banks are more likely to form new banking relationships. On average, firms obtain higher loan amounts when they form new banking relationships, while small firms also experience an increase in sales growth, capital expenditure, leverage, analyst coverage, and public debt issuance subsequently. Our findings suggest that firms form new banking relationships to expand their access to credit and capital market services, and highlight an important cost of exclusive banking relationships.

Modeling Ultimate Loss Given Default on Corporate Debt

Loss given default (LGD) is a critical parameter in various facets of credit risk modeling. This study empirically investigates the determinants of LGD and builds alternative predictive econometric models for LGD on bonds and loans using an extensive sample of most major U.S. defaults in the 1985–2008 period. The authors build simultaneous equation models in the beta-link generalized linear model (BLGLM) class, identifying several that perform well in terms of the quality of estimated parameters as well as overall model performance metrics. This extends prior work by modeling LGD both at the firm and the instrument levels. In a departure from the extant literature, the authors find the economic and statistical significance of firm-specific debt and equity market variables. In particular, they find that information from either the equity or the debt markets at around the time of default (measures of either cumulative equity returns or distressed debt prices, respectively) have predictive power with respect to the ultimate LGD, which is in line with recent prior recovery and asset pricing research. They also document a new finding: Larger firms have significantly lower LGDs while larger loans have higher LGDs.

Are Commercial Mortgage Defaults Affected by Tax Considerations?

We study whether tax considerations are an important determinant of commercial mortgage default. We also study whether large lenders are better informed, or better at interpreting information for lending purposes, and hence have lower foreclosure rates; whether lenders have more information on larger borrowers than smaller borrowers, and hence have lower foreclosure rates on larger loans; and whether commercial mortgage defaults are related to debt service coverage and loan-to-values, both initial and contemporaneous. The paper's main findings are fourfold. First, holding all else equal, there is evidence that tax considerations influence investors' decisions about when to "put" assets to lenders. The results are consistent with the argument of Constantinides (1984). Second, the evidence suggests that large lenders are especially knowledgeable about commercial mortgage borrowers and commercial property markets, in that they have lower foreclosure rates than smaller lenders. Third, on the question of whether lenders have more information on larger borrowers than smaller borrowers, we find that larger loans have, on average, lower default rates than smaller loans. Fourth, the findings suggest that lower default rates are associated with higher debt service coverage ratios, both initial and contemporaneous.

The voluntary adoption of International Financial Reporting Standards and loan contracting around the world

Using a sample of non-U.S. borrowers from 40 countries during 1997–2005, this paper investigates the effect of the voluntary adoption of International FinancialReporting Standards (IFRS) on price and non-price terms of loan contracts and loan ownership structure in the international loan market. Our results reveal the following. First, banks charge lower loan rates to IFRS adopters than to non-adopters. The difference in loan rates in excess of a benchmark rate between the two groups is about 20 basis points for all loans and nearly 31 basis points for London Interbank Offered Rate (LIBOR)-based loans. Second, banks impose more favorable non-price terms on IFRS adopters, particularly less restrictive covenants. We also provide evidence suggesting that banks are more willing to extend credit to IFRS adopters through larger loans and longer maturities. Finally, IFRS adopters attract significantly more foreign lenders participating in loan syndicates than non-adopters.

Financial Innovations, Credit Default Swaps, and Syndicated Loans

Loan syndication suffers from two types of agency problems – an adverse selection problem (lead arrangers pass on bad loans to the participants) and a moral hazard problem (lead arrangers shirk on their costly monitoring duties). Therefore, a lead arranger has to take a big share of the loan to certify the quality of borrower and to credibly commit to its monitoring duty. I argue that the invention of the CDS provides an instrument to reduce these agency problems when participant lenders purchase CDS protections from lead arrangers, which then allows lead arrangers to take smaller shares of loans. The interest rate on loan and the premium on CDS can serve as a reconciliation mechanism to reduce adverse selection problem because if a lead arranger bluffs the quality of a borrower and under-charge loan interest rate and CDS premium, the lead arranger will suffer two immediate losses – lower interest and CDS incomes, which will not be a feasible long term strategy for institutions willing to maintain their reputations. In the event of borrower default and physical settlement is used, lead arrangers have to take the loans back and pay the face values of loans to participants. The monetary interest can provide lead arrangers enough incentives to monitor borrowers. Therefore, besides explicitly managing risk, participant lenders can use CDSs to “trade” the monitoring duty back to lead arrangers. Using the credit derivatives data from Y-9C and more than 10,000 loan facilities, I found strong evidence supporting the syndicate expansion hypothesis that CDS plays a significant role in expanding loan syndicates, reducing lead arrangers’ capital contributions in the syndicates resulting in large loans for borrowers. The paper thus provides empirical evidence to show how financial innovations can profoundly impact banking practices.

Trust in Public Institutions over the Business Cycle

This paper estimates the amount of tightening in bank commercial and industrial (C&I) loan rates during the financial crisis. After controlling for loan characteristics and bank fixed effects, as of 2010:Q1, the average C&I loan spread was 66 basis points or 23 percent above normal. From about 2005 to 2008, the loan spread averaged 23 basis points below normal. Thus, from the unusually loose lending conditions in 2007 to the much tighter conditions in 2010:Q1, the average loan spread increased by about 1 percentage point. I find that large and medium-sized banks tightened their loan rates more than small banks; while small banks tended to tighten less, they always charged more. Using loan size to proxy for bank-dependent borrowers, while small loans tend to have a higher spread than large loans, I find that small loans actually tightened less than large loans in both absolute and percentage terms. Hence, the results do not indicate that bank-dependent borrowers suffered more from bank tightening than large borrowers. The channels through which banks tightened loan rates include reducing the discounts on large loans and raising the risk premium on more risky loans. There also is evidence that noncommitment loans were priced significantly higher than commitment loans at the height of the liquidity shortfall in late 2007 and early 2008, but this premium dropped to zero following the introduction of emergency liquidity facilities by the Federal Reserve. In a cross section of banks, certain bank characteristics are found to have significant effects on loan prices, including loan portfolio quality, capital ratios, and the amount of unused loan commitments. These findings provide evidence on the supply-side effect of loan pricing.

Information Asymmetries in Consumer Credit Markets: Evidence from Two Payday Lending Firms

This paper tests for incentive and selection effects in a subprime consumer credit market. We estimate the incentive effect of loan size on default using sharp discontinuities in loan eligibility rules. This allows us to estimate the magnitude of selection from the cross-sectional correlation between loan size and default. We find evidence of advantageous incentives and adverse selection. For a given borrower, we estimate that a $100 increase in loan size decreases the probability of default by 3.7 to 4.2 percentage points, a 20 to 23 percent decrease from the mean default rate. The incentive effect is more than o ffset by adverse selection into larger loans. Borrowers who choose $100 larger loans are 6.9 to 8.0 percentage points more likely to default than borrowers who choose smaller loans. Taken together, our results are consistent with the idea that information frictions lead to credit constraints in equilibrium.

Global Banking and International Business Cycles

This paper incorporates a global bank into a two-country business cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007-09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the US and the Euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis.

SEL versus SUL: managing seismic risk in commercial real estate investments

AbstractTwo common scenario loss ratios are used when calculating Probable Maximum Losses from earthquakes: Scenario Expected Loss (SEL) and Scenario Upper Loss (SUL). Analyses of seismic loss ratios prepared by five seismic consulting firms, four loan pools securitized in the capital markets, two very large loans with many properties, two large hospitality portfolios and a general account portfolio indicate that use of SUL rather than SEL would yield significantly larger numbers of loans with loss ratios in excess of 20%. When using SEL, the percentage of loans in the four large pools exceeding a 20% loss ratio was 3.8%. When SUL was used on this same data set, 47.8% of these properties had SUL values above 20%. Common industry practice has been to use SEL. Some of the implications of tightening seismic underwriting standards to apply a 20% threshold to the SUL, rather than SEL, may include: lower loan production, properties may lose value, properties may be costlier and more difficult to finance, existing loan portfolios may appear more seismically risky, and demand for insurance and seismic retrofit could go up. Equally undesirable effects could be that seismic consultants and lenders who do more rigorous analysis will be less competitive than those who do not. Copyright © 2010 John Wiley &amp; Sons, Ltd.

Borrowing from Yourself: The Determinants of 401(K) Loan Patterns

This paper explores the determinants of people’s decisions to take 401(k) loans. We argue that 401(k) plans do not simply represent retirement saving, but they also provide a means of saving for precautionary purposes. We model factors that rationally would induce people to borrow from their pension plans, and we explain why people do not often use 401(k) loans to replace their more expensive credit card debt. Next we test our hypotheses using a rich dataset and show that people who are liquidity-constrained are more likely to have plan loans, while the better-off take larger loans when they do borrow. Plan characteristics such as the number of loans allowed also influence borrowing and loan size in interesting ways, while loan interest rates have only a small impact.

A factor analysis approach to measuring European loan and bond market integration

By using an existing and a new convergence measure, this paper assesses whether bank loan and bond interest rates are converging for the non-financial corporate sector across the euro area. Whilst we find evidence for complete bond market integration, the market for bank loans remains segmented, albeit to various degrees depending on the type and size of the loan. Factor analysis reveals that rates on large loans and small loans with long rate fixation periods have weakly converged in the sense that, up to a fixed effect, their evolution is driven by common factors only. In contrast, the price evolution of small loans with short rate fixation periods is still affected by country-specific dynamic factors. There are few signs that bank loan rates are becoming more uniform with time.

Value-Driving Activities in Euro-Zone Banks

We develop and test accounting-based valuation models for commercial banks. We extend Begley et al.'s framework (2006) and propose a valuation model where goodwill is generated by virtually all commercial and investment banking activities. Key features of our model are: the development of a relation between future cash flows from fee income and the bank value that depends on lending, borrowing and off-balance sheet business; and the inclusion of proprietary investment and trading as value-driving activities. Empirical tests on a sample of Euro-zone banks from 1998 to 2006 provide the following evidence. Unrealised expected cash flows from fee income are the most important source of unrecorded goodwill. This is consistent with the increasing importance of revenue from the sale of financial services to banks' income. The contribution of fee income to goodwill is higher for banks with large deposits and new loans. Equity securities are a source of unrecorded goodwill, but the introduction of fair value accounting, with the adoption of the International Financial Reporting Standards (IFRS), reduces their valuation role. Yet equity securities remain positively associated with unrecorded goodwill after IFRS adoption, suggesting that the fair value standards do not fully capture market expectations about future cash flows of investment assets.