Essays in financial economics

Abstract

Banks play a special role in the financial system. According to classical banking theory, they help reduce informational asymmetries and serve as liquidity providers. Banks can, at least partially, lower transaction costs that result from information frictions between investors and firms and thereby alleviate firms’ funding constraints (Diamond, 1984). Moreover, banks create liquidity on their balance sheets by financing comparably illiquid assets with relatively liquid liabilities (Diamond and Dybvig, 1983). Integrating credit and liquidity provision functions, banks have been the object of numerous studies on financial intermediation. A particular focus in recent years has been on banks’ behavior as well as on the con- sequences of their actions for the real economy when hit by adverse shocks. Following the global financial crisis, financial shocks that originate from within the financial sec- tor have received wide attention (Cingano et al., 2016; Chodorow-Reich, 2014; Khwaja and Mian, 2008; Paravisini, 2008; Paravisini et al., 2015; Schnabl, 2012). However, banks are also subject to numerous non-financial shocks, which are the focus of this thesis. Paper 1 investigates how banks change their credit supply after a shock to the salience of transition risk that arises from moving to a greener and more sustainable economy.1 Following an increase in public awareness of firms’ transition risks, financial market participants may update their prevailing perceptions of these risks and act accordingly. We show that lending changes in the aftermath of such an event depending on whether firms can benefit or lose from stricter environmental regulations as well as on the ex-ante stringency of the regulatory landscape the borrowers operate in. Stringency proxies for heterogeneous expectations about future environmental regulation across countries as well as the materiality of the financial risks (benefits) that firms are exposed to (Carbone et al., 2021; Ehlers et al., 2021; Krueger et al., 2020). Only in countries in which existing environmental regulations are relatively stringent, banks supply more 1For a detailed definition of transition risk, see Basel Committee on Banking Supervision (2021). funding to firms that will benefit from them. Conversely, firms that are likely hurt by regulation receive more credit if located in less stringent environments or if linked to banks with a portfolio tilted toward lending to negatively impacted firms. Thus, the effect of transition risk on banks’ lending depends on the interaction of how firms will be affected by regulation, the existing regulatory landscape the firms operate in, and banks’ own exposure to firms’ regulatory risks via their loan portfolios. Paper 2 studies how banks’ management of transition risk interacts with corporate loan securitization. After a political event that lowered the risk of new environmental policies being introduced, we find that banks alter the securitization of loans granted to firms that exhibit higher transition risks. While these loans were more likely to be sold off before, they become more likely to remain on banks’ balance sheets after the shock. This effect is more pronounced if banks impose covenants in the loan contract. This could suggest that banks consider that political circumstances may change in the future altering the performance of these loans. Evaluating which banks engage in lower securitization of higher transition risk loans, we identify that it is, in particular, banks that have low or no preferences for sustainable lending as well as domestic lenders that are likely to respond more strongly to local political events. Papers 1 and 2, thus, contribute to the discussion on the role of banks in the transi- tion toward a greener and more sustainable economy. Banks are seen as critical for this process given their central position in allocating resources through their intermediation function as well as their ability to impose costs via quantity and price adjustments. Pa- per 1 sheds light on whether and how banks account for transition risk in their lending decisions. Paper 2 highlights an alternative channel of how banks manage transition risk, i.e. securitization. This channel is of relevance as banks may be limited in their willingness to account for transition risk in their lending terms and securitization mar- kets are of very large sizes. Moreover, it is crucial for regulators and supervisors to know, who in the financial system ultimately carries the risk. This knowledge is a pre- condition for designing appropriate policies to address climate-related risks to financial stability. Both papers have in common that they draw attention to how different bank characteristics influence the management of transition risk. A finding that should be taken into consideration when future regulatory actions are mapped out. Moving away from shocks in the context of the green transition, Paper 3 analyses how banks adjust lending in response to the dismantling of trade barriers. Increased im- port competition adversely affects non-financial corporations (e.g., Autor et al., 2013) and subsequently feeds through to banks via their lending relationships. This work shows that banks reduce lending the more they are affected by the liberalization of trade. Importantly, it uncovers large heterogeneity in banks’ reactions depending on their sectoral specialization. Banks shield the industries in which they specialize. While I find evidence that banks’ reductions in credit in response to the trade shock have ad- verse real effects, lending specialization dampens the negative impact on firm outcomes. These findings provide valuable input for accounting the gains from trade liberalization and therefore allow for a more informed design of such policies. Moreover, they shed light on the complex implications of lending specialization. All three papers use the same data as their main foundation: syndicated loan data provided by Thomson Reuters LPC’s DealScan. This dataset is rich enough to answer pressing questions in the fields of corporate finance and banking. In combination with its commercial availability, it has therefore been employed by a whole array of highly influential papers. They explore fundamental topics such as asymmetric information and loan pricing (Ivashina, 2009; Sufi, 2007), the nature and determinants of rela- tionship lending (Bharath et al., 2011; Schwert, 2018), as well as the effect of credit market shocks on firm outcomes (Chodorow-Reich, 2014; Correa et al., 2021). A key feature of the usage of this database is the multitude of options to define sample and lending outcomes. This feature does not only leave the researcher with a large degree of discretion regarding which option to take but also raises many questions on how to make appropriate sampling and definition decisions. Therefore, Paper 4 scrutinizes the results of an established empirical setting across a variety of DealScan specifications, which we identified to be the most commonly used in the literature. The results paint a somewhat positive picture. Estimates are robust across many choices while we highlight modifications that appear to be especially relevant for the conclusions drawn. In this vein, this study corroborates the sampling choices made in Papers 1 to 3 but also provides insights to other researchers on how specific data decisions might affect coefficient estimates as well as presents structured guidance on possible scrutiny tests.