This paper empirically examines how capital affects a bank’s performance (survival and market share), and how this effect varies across banking crises, market crises, and normal times that occurred in the U.S. over the past quarter century. We have two main results. First, capital helps small banks to increase their probability of survival and market share at all times (during banking crises, market crises, and normal times). Second, capital enhances the performance of medium and large banks primarily during banking crises. Additional tests explore channels through which capital generates the documented effects. Numerous robustness checks and additional tests are performed.

How Does Capital Affect Bank Performance During Financial Crises

This article investigates the effect of bank lending frictions on employment outcomes. I construct a new data set that combines information on banking relationships and employment at 2,000 nonfinancial firms during the 2008–9 crisis. The article first verifies empirically the importance of banking relationships, which imply a cost to borrowers who switch lenders. I then use the dispersion in lender health following the Lehman crisis as a source of exogenous variation in the availability of credit to borrowers. I find that credit matters. Firms that had precrisis relationships with less healthy lenders had a lower likelihood of obtaining a loan following the Lehman bankruptcy, paid a higher interest rate if they did borrow, and reduced employment by more compared to precrisis clients of healthier lenders. Consistent with frictions deriving from asymmetric information, the effects vary by firm type. Lender health has an economically and statistically significant effect on employment at small and medium firms, but the data cannot reject the hypothesis of no effect at the largest or most transparent firms. Abstracting from general equilibrium effects, I find that the withdrawal of credit accounts for between one-third and one-half of the employment decline at small and medium firms in the sample in the year

/pdf/the-employment-effects-of-credit-market-disruptions-firm-49jiyxa9r3.pdf

The Employment Effects of Credit Market Disruptions: Firm-level Evidence from the 2008–9 Financial Crisis

How does capital affect bank performance during financial crises

The recent financial crisis has raised several questions with respect to the corporate governance of financial institutions. This paper investigates whether risk management-related corporate governance mechanisms, such as for example the presence of a chief risk officer (CRO) in a bank’s executive board and whether the CRO reports to the CEO or directly to the board of directors, are associated with a better bank performance during the financial crisis of 2007/2008. We measure bank performance by buy-and-hold returns and ROE and we control for standard corporate governance variables such as CEO ownership, board size, and board independence. Most importantly, our results indicate that banks, in which the CRO directly reports to the board of directors and not to the CEO (or other corporate entities), exhibit significantly higher (i.e., less negative) stock returns and ROE during the crisis. In contrast, standard corporate governance variables are mostly insignificantly or even negatively related to the banks’ performance during the crisis.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1942896_code362677.pdf?abstractid=1942896&rulid=5417022&mirid=1

Risk Management, Corporate Governance, and Bank Performance in the Financial Crisis

/pdf/risk-management-corporate-governance-and-bank-performance-in-3ohska63sh.pdf

Risk management, corporate governance, and bank performance in the financial crisis

We investigate whether a bank’s performance during the 1998 crisis, which was viewed at the time as the most dramatic crisis since the Great Depression, predicts its performance during the recent financial crisis. One hypothesis is that a bank that has an especially poor experience in a crisis learns and adapts, so that it performs better in the next crisis. Another hypothesis is that a bank’s poor experience in a crisis is tied to aspects of its business model that are persistent, so that its past performance during one crisis forecasts poor performance during another crisis. We show that banks that performed worse during the 1998 crisis did so as well during the recent financial crisis. This effect is economically important. In particular, it is economically as important as the leverage of banks before the start of the crisis. The result cannot be attributed to banks having the same chief executive in both crises. Banks that relied more on short-term funding, had more leverage, and grew more are more likely to be banks that performed poorly in both crises.

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance During the Recent Financial Crisis

Are some banks prone to perform poorly during crises? If yes, why? In this paper, we show that a bank's stock return performance during the 1998 crisis predicts its stock return performance and probability of failure during the recent financial crisis. This effect is economically large. Our findings are consistent with persistence in a bank's risk culture and/or aspects of its business model that make its performance sensitive to crises. Banks that relied more on short-term funding, had more leverage, and grew more are more likely to be banks that performed poorly in both crises.

/pdf/this-time-is-the-same-using-bank-performance-in-1998-to-mre8f75g44.pdf

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis

Despite the importance of banks' role as delegated monitors, little is known about how non-price terms of loan contracts are structured to optimize information production in a lending relationship. Using a large sample of corporate loans, this paper examines the effect of relationship lending on covenant choice. Consistent with information asymmetry theories, covenant tightness is relaxed over the duration of a relationship, especially for opaque borrowers. In contrast, the effect of lending relationship intensity on the number of covenants included in a loan follows an inverted U shape. I discuss potential explanations for this finding.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2772120_code604752.pdf?abstractid=2023791&mirid=1&type=2

Why Do Loans Contain Covenants? Evidence from Lending Relationships

From 1973 to 2014, the common stock of U.S. banks with loan growth in the top quartile of banks over a three-year period significantly underperforms the common stock of banks with loan growth in the bottom quartile over the next three years. The benchmark-adjusted cumulative difference in performance over three years exceeds twelve percentage points. The high growth banks also have significantly higher crash risk over the three-year period. This poor performance is explained by fast loan growth as asset growth separate from loan growth is not followed by poor performance. These banks reserve less for loan losses when their loans grow quickly than other banks. Subsequently, they have a lower return on assets and increase their loan loss reserves. The poorer performance of the fast growing banks is not explained by merger activity and loan growth through mergers is not accompanied by the same poor loan performance. The evidence is consistent with fast-growing banks, analysts, and investors failing to properly appreciate the extent to which the fast loan growth results from making riskier loans and failing to charge for these risks correctly.

Robert Prilmeier

Papers

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance During the Recent Financial Crisis

This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis

Why Do Loans Contain Covenants? Evidence from Lending Relationships

Why Does Fast Loan Growth Predict Poor Performance for Banks

Why do loans contain covenants? Evidence from lending relationships