2019 Community Banking in the 21st Century Research and Policy Conference

Research Papers, Authors and Key Findings

Research Paper Session 1
Small Business Lending

Who's Holding the Bag? Regulatory Compliance Pressure and Bank Risk-Shifting

Authors: Lamont Black, Driehaus College of Business, DePaul University Chicago, Illinois; John Hackney, University of South Carolina, Darla Moore School of Business

Key Findings: This paper finds evidence that compliance pressures from the Community Reinvestment Act (CRA) lead to an increase in small business lending by small banks but not by large banks. Specifically, small banks increase origination volumes of their smallest business loans by 19 percent during CRA exam years. The paper also finds that these loans are more likely to be funded with Small Business Administration (SBA) government guarantees. These loans, however, demonstrate higher default rates. They are also less likely to be a revolving loan. These two factors suggest some risk-shifting onto the government during CRA exam years. The paper concludes that more CRA-induced lending leads to a short-term increase in employment for local small businesses but it also results in a long-term decrease in employment as the increased risk of the loans made in CRA exam years is realized. 

To Ask or Not to Ask? Bank Capital Requirements and Loan Collateralization

Authors: Artashes Karapetyan, ESSEC Business School, Paris; Hans Degryse, KU Leuven, Flanders, Belgium; Sudipto Karmakar, Bank of Portugal

Key Findings: This paper examines the impact of higher capital requirements on a bank’s decision to offer collateralized, rather than uncollateralized, loans. The authors analyze the 2011 European Banking Authority (EBA) capital exercise, which required some banks to increase regulatory capital but not others. This exercise made secured lending more attractive (versus unsecured lending) for the affected banks since secured loans require less regulatory capital. The authors show that banks more frequently require loans to be collateralized, but less so for relationship borrowers.

Is There a Benefit from Reduced Regulation on Small Banks?

Authors: Francesco Vallascas, University of Leeds; Abhishek Srivastav , University of Edinburgh

Key Findings: The authors in this paper show that reduced regulations on small bank holding companies (BHCs) in the U.S., implemented in 2015, boosted small business lending at the BHCs’ affiliated commercial banks without affecting risk-taking or transparency. Increases in small business lending were stronger when the parent BHC was significantly below the 2015 regulatory asset threshold ($1 billion). Further, the regulatory relief that was granted in 2015 shows positive implications for the funding opportunities of the affiliated commercial banks and has a real impact on local economies.

Moderator and Discussant Response

Small Business Lending: Moderated Q&A

Research Paper Session 2
Local Shocks and Spillover Effects

Capital Mobility and Regulation Frictions: Evidence from U.S. Lottery Winners

Author: Carlos Parra, Pontifical Catholic University of Chile

Key Findings: This paper analyzes how banks reallocate capital across lending markets following funding shocks. Funds are transmitted across markets, but allocations are five times greater in the state in which the positive funding shock occurred. The paper also shows how banking regulation can negatively affect fund mobility and loan performance. The paper concludes that state boundaries matter for capital mobility in part because of regulatory distortions.    

Natural Disasters, Loan Loss Accounting and Subsequent Lending

Authors: Rajesh Vijayaraghavan, University of British Columbia, Columbia Sauder School of Business, Vancouver; Sandra Chamberlain, University of British Columbia; Yuxiang Zheng, University of British Columbia

Key Findings: This paper examines the relationship between loan loss accounting policies and a bank’s ability to respond to an increase in local demand for loans. The authors first examine how natural disasters impact loan losses and find that a natural disaster shock on loan loss provisioning is negligible. However, at large banks, there is an increased weight on loan loss indicators during the four quarters that encompass a natural disaster. The paper suggests that smaller banks, which have policies of over-reserving for loan losses, exhibit greater responses to increased loan demand in the year of a disaster, which is consistent with the theory that loan loss provisioning can influence a bank’s ability to lend in the face of demand shocks for loans.

Bank Branching Networks and Geographic Contagion of Oil Price Shocks

Author: Teng Wang, Board of Governors of the Federal Reserve System

Key Findings: This paper studies the role of bank branch networks of U.S. regional banks in transmitting commodity price shocks across the economy. Oil price collapses have adversely affected regions with high concentrations of their workforce in the oil and gas industry, which contributes to a higher rate of loan defaults and lower deposit inflows into local bank branches. The author also shows that smaller regional banks operating in counties most affected by an oil price collapse were forced to sell their liquid asset holdings and contracted their credit to small businesses and mortgage borrowers in counties that were not affected by falling oil prices. The paper also shows that banks with exposure to a negative oil price shock contract lending more in counties with more opaque borrowers suggesting that these borrowers could be disproportionally affected in times of liquidity scarcity.

Local Shocks and Spillover Effects: Moderated Q&A

Research Paper Session 3
Responses to Changes in Regulation or Supervision

Risk-shifting, Regulation and Government Assistance

Author: Padma Sharma, Federal Reserve Bank of Kansas City

Key Findings: This paper examines the moral hazard effects of less stringent regulatory and resolution standards on thrift institutions in the midst of the Savings and Loan (S&L) crisis. In the aftermath of the failure of the industry deposit insurer (the FSLIC) in 1989, thrift institutions became subject to more enhanced regulation and oversight. The paper finds that, following the implementation of the enhanced regulatory regime, thrifts with a high probability of failure increased their composition of safe assets and reduced the share of high-risk loans on their balance sheets relative to thrifts with a low probability of failure, thereby providing evidence of moral hazard incentives within the thrift industry in the previous regime. The paper provides specific evidence of risk-shifting from equity-holders of stock thrifts toward debt-holders prior to the 1989 reforms by comparing the changes in the composition of the balance sheets of stock thrifts with those of mutual thrifts. The paper further demonstrates that in future crises, shareholder expectations around government assistance will be crucial for the policies aimed at reducing moral hazard (such as the Orderly Liquidation Authority under Title II of the Dodd-Frank Act) to succeed.

Deregulation, Market Structure and the Demise of Old School Banking

Authors: Stefan Lewellen, Pennsylvania State University ; Emilio Bisetti, Hong Kong University of Science and Technology; Stephen Karolyi, Office of the Comptroller of the Currency (OCC)

Key Findings: The authors construct a new measure of regulatory “intensity” that allows them to separately identify the effects of deregulation on competition and investment. The authors find that increased competition leads to higher deposit funding costs and reduces bank net interest margins and overall profitability. In response to increased competitive pressures, banks increase their risk-taking, shift their business models toward new sources of non-interest income, and increase the likelihood that they’ll be acquired by another bank. The paper’s findings support the idea that reductions in bank charter values lead to increases in bank risk-taking.

Reliance on Third Party Verification in Bank Supervision

Authors: Yadav Gopalan, Indiana University, Kelley School of Business ; Andrew Imdieke, University of Notre Dame; Joseph Schroder, Indiana University; Sarah Stuber, Texas A&M University

Key Findings: This paper examines how internal controls regulation affects bank supervision by exploiting a change in size thresholds for internal control audits required under the Federal Deposit Insurance Corporation Improvement Act (FDICIA). The authors demonstrate that banks that became exempt from the internal control audit requirements increased their reported level of non-performing loans compared to banks that were not exempt. However, the increase in reported nonperforming loans is not accompanied by increases in past due loans. This suggests that the newly exempted banks were being more forthcoming in their reporting rather than experiencing operational deterioration. Furthermore, the authors find evidence that bank examiners increased regulatory scrutiny on the newly exempted banks. The authors conclude that third-party verification is an imperfect substitute for bank supervision and efforts to rely upon externally generated attestations may heighten bank risk.

Responses to Changes in Regulation or Supervision: Moderated Q&A

Research Paper Session 4
Technology and Banking

Small Bank Lending in the Era of Fintech and Shadow Banking: A Sideshow?

Authors: Kandarp Srinivasan, D'Amore-McKim School of Business, Northeastern University, Boston, Mass.; Taylor Begley, Washington University in St. Louis

Key Findings: This paper finds that the share of mortgage lending by the four largest U.S. banks dropped (30% to 23%) from 2009 to 2013 in the aftermath of the financial crisis. Aggregate patterns suggest the gap was filled by nonbank lenders (increasing from 26% to 37%). Despite the rise in nonbank lending, the authors show that small banks were twice as responsive as nonbanks in filling the mortgage credit gap. The authors find consumer preferences for dealing with small banks (over nonbanks) and institutional features such as securitization explain their finding. The authors conclude that small banks remain vital sources of mortgage credit despite the rise of shadow banks and fintech firms.

What is Fueling the Fintech Lending Revolution? Local Banking Market Structure and Fintech Market Penetration

Authors: John Hackney, University of South Carolina, Darla Moore School of Business; Allen Berger, Darla Moore School of Business, University of South Carolina; Tetyana Balyuk, Emory University

Key Findings: Fintech marketplace lenders are providing credit where commercial banks have left voids in credit supply, but it is unclear which voids they are primarily filling. This paper looks at the allocation of small business credit and finds that small business lending by fintech firms has primarily penetrated areas in which small bank market shares are low, suggesting that fintech firms are filling the void created by the loss of small banks. The paper also demonstrates that fintech lending matters primarily for the very smallest firms, while small banks matter for small businesses more generally.

Bank Technology: Productivity and Employment

Authors: Zhonghua Wu, Florida International University; Zifeng Feng, Florida International University

Key Findings: This paper examines the impact of technology investment on bank production and employment. The authors show that technology input, on average, contributes more than 12% to the net output of U.S. commercial banks over the period of 2000-2017. They also find that the contribution of technology input became stronger after the financial crisis, suggesting technology plays a more important role in improving bank productivity in recent years. Moreover, bank employment and total tasks are found to be positively correlated with their lagged technology spending, supporting the task-based framework in Acemoglu and Restrepo (2018). The paper concludes that technology investment is highly productive for U.S. banks and that the use of technology generally increases employment for the commercial banks during the sample period, which is likely due to the creation of new tasks through adoption of advanced technologies.

Technology and Banking: Moderated Q&A