Loan Liquidity Research Articles

Using the Z-score to analyze the Financial Stability of Conventional Commercial Banks in Bangladesh

This paper aims to measure and identify the determinants of financial stability of conventional commercial banks of Bangladesh listed on the Dhaka Stock Exchange. In the first step, the researcher calculates an accounting-based Z-score to measure the financial stability of the 23 sample banks over the period 2013-2022. In the second phase of the study, panel data regression analysis is conducted to identify the bank-specific determinants of financial stability. The exogenous variables include return on asset, income diversity, bank size, non-performing loan liquidity, capital adequacy, and management efficiency. The endogenous variable is the financial stability measured by z-score. The study provides empirical evidence of the bank-specific factors affecting the solvency of conventional commercial banks in Bangladesh.

Less Bank Regulation, More Non-Bank Lending

Bank deregulation in the form of the repeal of the Glass-Steagall Act facilitated the entry of non-bank lenders into the market for syndicated loans during the pre-2008 credit boom. Institutional investors disproportionately purchase tranches of loans originated by universal banks able to cross-sell loans and underwriting services to firms (as permitted by the repeal). A shock to cross-selling intensity increases loan liquidity at origination and over time. The mechanism is that non-loan exposures ensure monitoring even when banks retain small loan shares. Our findings complement the conventional view that regulatory arbitrage caused the rise of non-bank lenders.

Bank Capital and Loan Liquidity

We expand the bank liquidity creation concept from its current focus on bank portfolios to include providing liquidity to secondary markets for financial assets. We test opposing theories of the effects of bank capital on secondary market liquidity of syndicated loans. We find that higher bank capital significantly increases secondary market loan liquidity, consistent with risk absorption theory. The data also support the loan riskiness and bank balance sheet quality channels behind this theory. We use the exogenous capital shock from the 2012 JPMorgan Chase ‘London Whale’ incident to help establish causality. Our findings have important research and policy implications.

Loan Ownership and Liquidity in the Secondary Loan Market

We find some support for theories predicting that the presence of informed investors adversely affects liquidity: When arrangers retain a share in the loan this impacts negatively liquidity. We find strong evidence that investor diversity is beneficial to liquidity: Loans with larger syndicates; syndicates with higher investor turnover, more investor types, and lower investor-types’ loan share concentration have lower bid-ask spreads. These findings are robust and do not appear to be driven by investors’ borrower/loan selection. We find that not all investors contribute positively to loan liquidity. While an increase in the number of hedge funds in a syndicate lowers the loan’s bid-ask spread, an increase in the number of banks in the syndicate has the opposite effect, consistent with existing beliefs that asset managers are active traders but banks follow buy-and-hold investment strategies.

The joint determinants of cash holdings and debt maturity: the case for financial constraints

We examine the joint choices of cash holdings and debt maturity for a large sample of firms for the 1985–2013 period. We find that there is a positive relation between debt maturity and cash holdings. Our results hold after taking into account endogeneity among leverage, debt maturity, and cash holding. We posit that this positive relationship will be found among firms facing financial constraints and we find support for this hypothesis. Our results are robust after we control for agency problems, international taxation, bank loan liquidity covenants and default risk.

Do Transactional Loans Behave Differently from Relationship Loans? Evidence from the Secondary Loan Market

Using primary and secondary loan market data, we identify a group of lenders specializing in syndicating tradable loans (referred to as transactional loan originators, “TLOs”). We compare TLOs with relationship lenders (“RLs”) by examining the probability of loan resale, the institutional participation in TLO-led loans versus RL-led loans. In addition, we also investigate the post-loan issuance operating performance and creditworthiness of borrowers borrowing TLO-led loans versus those borrowing RL-led loans. We find that TLO-led loans are more likely to be resold on the secondary loan market and involve a greater number of non-bank institutional lenders than RL-led loans. We also show that borrowers borrowing TLO-led loans experience worse operating performance and severer creditworthiness deterioration after a loan origination compared with those borrowing RL-led loans. We conclude that while TLOs may have helped improve loan liquidity, they may also have reduced incentives to monitor borrowers. Our paper provides first hand empirical evidence on the implications of relationship-based banking versus transactional-orientated activities in the secondary loan market.

Banks' Liability Structure and Mortgage Lending During the Financial Crisis

We examine the impact of banks' exposure to market liquidity shocks through wholesale funding on their supply of credit during the financial crisis. We focus on mortgage lending since a comparison across heterogeneous categories of credit could be easily tainted by confounding demand factors. We exploit the time variation in market liquidity and the cross-section variation in wholesale funding by banks to study relative changes in bank rejection rates using comprehensive loan-level data on mortgage applications while controlling for bank, borrower, and regional characteristics. Banks that were more reliant on wholesale funding curtailed their credit significantly more than retail-funded banks during the crisis. The demand for mortgage credit, on the other hand, declined evenly across wholesale and retail banks. We also exploit the discrete fall in loan liquidity of jumbo loans (loans that cannot be purchased by the GSEs) and show that the relative decline in the supply of credit by wholesale banks was significantly more pronounced above the jumbo cutoff. This and several other robustness checks, including a matching exercise in which we eliminate imbalances in observable applicant characteristics between these banks, provide strong evidence that the crisis has led to a sharper contraction in the supply of credit by wholesale funded banks and highlight the role of liquidity conservation. We explore the aggregate implications of our findings by exploiting the heterogeneity in mortgage funding across U.S. MSAs and find that wholesale funding was a strong and significant predictor of a sharper decline in overall mortgage credit at the MSA level.

Liquidity Risk, Credit Risk and Interbank Competition

This paper examines the impact of interbank competition on liquidity risk and on the interaction between liquidity and credit risks. We first show that financial intermediation with deposit insurance may increase the impact of liquidity risk, so that intermediated loans may carry higher liquidity premia for borrowers than market-financed loans. Second, with negligible interbank competition, higher credit risk may reduce liquidity risk, so a bank's need for liquidity may also induce it to take on additional credit risk. Third, we show that Bertrand competition among banks in the loan market, introduced by outside lenders purchasing the relationship-specific liquidation skilll of the incumbent lender, has two potential effects: (i) it can improve loan liquidity, and (ii) it can make credit and liquidity risks comonotonic, thereby reducing the inclination of banks to take on excessive credit risk to cope with their liquidity needs. However, interbank competition improves loan liquidity only under some conditions. We identify conditions under which greater interbank competition increases loan liquidity and reduces each bank's overall risk, which includes credit and liquidity risks.