Highlight conflicts of interest in banking relationships. Highlight conflicts of interest in banking relationships

Highlight conflicts of interest in banking relationships.

• Highlight conflicts of interest in banking relationships.

• Key feature is pre-existing relationships (or financial claims) between banks and borrowers before the banks’ lending decisions.

• Approach

• Part 1: Loan announcement effect in the stock

• market. (empirical investigation)

• Part 2: Loan announcement effect in the stock

• market. (theory)

• Part 3: Banks’ lending decisions (empirical).

Exogenous selection and matching and the transfer of loans in their entirety.

• Exogenous selection and matching and the transfer of loans in their entirety.

• No personnel were transferred from the closed banks to the acquiring banks (purchase and assumption).

• Distinctions between the closed banks and the acquiring banks.

• - BIS ratios: 5.32% vs. 9.64%

• - Non-performing loans: 9.08% vs. 3.01%

• - Market shares: 6.95% vs. 30.96%

• Firms’ pre-existing relationships with the acquiring banks are identified.

• Overall effect on firm value in the stock market: positive

• Loss of the relationship-specific advantage with the closed banks is outstripped by the gain from good quality of the acquiring banks.

• Effect of the pre-existing relationships on the positive valuation: negative

• Informational advantage from the pre-existing relationships is more than offset by banks’ incentives to misuse the information.
• The larger the size of pre-existing loan, the more negative the effect of pre-existing relationships.

Firm’s abnormal stock returns to estimate the net gain for the firm may not tell the whole story .

• Firm’s abnormal stock returns to estimate the net gain for the firm may not tell the whole story .

• For example, the market’s reactions to the event may be inconsistent with the actual behavior of loan officers of the acquiring banks.

• Examine directly how the pre-existing relationships between banks and borrowers affect the banks’ lending decisions.

• whether the lending relationship is maintained.
• how the size of loans changes.

Banks tend to continue relationships with firms that have prior relationships even when their market values are lower.

• Banks tend to continue relationships with firms that have prior relationships even when their market values are lower.

• Evidence for conflicts of interest

• Bank is aggressive in expanding loans to firms that have no prior relationships once the new relationships are continued.

• Value of bank relationship to its client firms decline over time.
• Bank quality does not necessarily conveys risk classes of its client firms.

• Investigates in great detail the effect of pre-existing relationship between banks and borrowers

• on banks’ lending decisions and market’s reactions to the lending decisions.

• Sheds light on the fundamentals of bank-borrower relationships,

• especially the dark sides of banking relationships:
• conflicts of interest.

• Underscores the importance of the specific mechanisms employed to replace failed banks – the liquidation of banks followed by transfers of their loans to better banks can make client firms better off.

• Mitigates the policy-maker’s concerns about potential negative effects of banking sector restructuring on the values of sound client firms of failed banks.

• Suggests that the intensity of firms’ pre-existing relationships with acquiring banks is important in understanding how successful a bank consolidation is in speeding up the resolution of financially distressed firms.