Which Financial Frictions? Parsing the Evidence from the Financial Crisis of

Transcription

1 Which Financial Frictions? Parsing the Evidence from the Financial Crisis of Tobias Adrian Paolo Colla Hyun Song Shin February 2013

2 Adrian, Colla and Shin: Which Financial Frictions? 1 An Old Debate Do financial frictions operate through demand for credit? Shocks to borrower net worth, NPV of project, collateral value of assets Bernanke and Gertler (1989), Kiyotaki and Moore (1997) Or, do financial frictions operate through supply of credit? Bank lending channel Kashyap, Stein and Wilcox (1993)

3 Adrian, Colla and Shin: Which Financial Frictions? 2 This Paper Examine evidence for crisis, pointing to: Inelastic demand for credit by firms Sharp contraction in supply of intermediated credit Shortfall made up by sharp increase in demand for direct credit

4 Adrian, Colla and Shin: Which Financial Frictions? 3 This Paper Examine evidence for crisis, pointing to: Inelastic demand for credit by firms Sharp contraction in supply of intermediated credit Shortfall made up by sharp increase in demand for direct credit Question: why is one dollar of credit through the banking system so different from one dollar of credit that flows directly? Focus on behavior of banks Checklist of stylized facts

5 Adrian, Colla and Shin: Which Financial Frictions? 4 This Paper Examine evidence for crisis, pointing to: Inelastic demand for credit by firms Sharp contraction in supply of intermediated credit Shortfall made up by sharp increase in demand for direct credit Question: why is one dollar of credit through the banking system so different from one dollar of credit that flows directly? Focus on behavior of banks Checklist of stylized facts Model of direct and intermediated credit from checklist

6 Adrian, Colla and Shin: Which Financial Frictions? 5 Trillion dollars Corporate bonds Commercial paper Other loans and advances 2.0 Bank loans n.e.c Q1 1991Q3 1993Q1 1994Q3 1996Q1 1997Q3 1999Q1 2000Q3 2002Q1 2003Q3 2005Q1 2006Q3 2008Q1 2009Q3 2011Q1 2012Q3 Total mortgages Figure 1. Credit to US non-financial corporate sector (US Flow of Funds, table L102)

7 Adrian, Colla and Shin: Which Financial Frictions? Millions 120 Bond change Loan change Q2 2009Q4 2008Q2 2006Q4 2005Q2 2003Q4 2002Q2 2000Q4 1999Q2 1997Q4 1996Q2 1994Q4 1993Q2 1991Q4 1990Q2 Figure 2. Changes in outstanding corporate bonds and loans to US non-financial corporate sector. Loans are defined as sum of mortgages, bank loans not elsewhere classified (n.e.c.) and other loans (US Flow of Funds, table F102)

8 Adrian, Colla and Shin: Which Financial Frictions? 7 other loans and advances depository institution loans n.e.c commercial mortgages multifamily residential mortgages construction loans on one-tofour family homes home mortgages Non-corporate business sector total borrowing (trillion dollars) 2012Q3 2011Q1 2009Q3 2008Q1 2006Q3 2005Q1 2003Q3 2002Q1 2000Q3 1999Q1 1997Q3 1996Q1 1994Q3 1993Q1 1991Q3 1990Q1 Figure 3. Credit to US non-corporate business sector (US Flow of Funds, table L103)

9 Adrian, Colla and Shin: Which Financial Frictions? 8 18 Percent of liabilities Percentage points Expected year-ahead defaults at t-12 (left axis) 10-year high-yield corporate bond spread at t (right axis) Figure 4. Risk premium versus expected default probability (Source: Egon Zakrajsek, based on Gilchrist and Zakrajsek (2012))

10 Adrian, Colla and Shin: Which Financial Frictions? 9 Lending rate Bank credit supply Bond credit supply Aggregate credit supply Credit demand Total credit Figure 5. Bank and bond credit supply before crisis

11 Adrian, Colla and Shin: Which Financial Frictions? 10 Lending rate Bank deleveraging Credit demand Total credit Figure 6. Bank and bond credit supply following deleveraging by banking sector

12 Adrian, Colla and Shin: Which Financial Frictions? 11 Lending rate Bond financing Bank financing Total credit Figure 7. Bank and bond credit supply following deleveraging by banking sector

13 Adrian, Colla and Shin: Which Financial Frictions? 12 Figure 8. Evidence from UK: Cumulative gross issuance of bonds by UK private non-financial corporations (Source: Bank of England Asset Purchase Facility Quarterly Report, 2012 Q3)

14 Adrian, Colla and Shin: Which Financial Frictions? 13 Corporate Finance of Banking A L Equity Assets Debt

15 Adrian, Colla and Shin: Which Financial Frictions? 14 A L A L Assets Equity Debt Assets Equity Debt

16 Adrian, Colla and Shin: Which Financial Frictions? 15 A L A L Assets Equity Debt Assets Equity Debt

17 Adrian, Colla and Shin: Which Financial Frictions? 16 Change in Equity & Changes in Debt (Billions) Investment Banks (1994Q1-2011Q2) y = x y = x Equity Debt Change in Assets (Billions) Figure 9. Scatter chart of {( )} and {( )} for changes in assets, equity and debt of US investment bank sector consisting of Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley between 1994Q1 and 2011Q2 (Source: SEC 10Q filings)

18 Adrian, Colla and Shin: Which Financial Frictions? Commercial Banks (Call Reports) 1984Q1-2010Q2 Change in Equity & Changes in Debt (Billions) y = x y = x Equity Debt Change in Assets (Billions) Figure 10. Scatter chart of {( )} and {( )} for changes in assets, equity and debt of US commercial bank sector between 1984Q1 and 2010Q2 (Source: FDIC call reports).

19 Adrian, Colla and Shin: Which Financial Frictions? BNP Paribas: annual change in assets, equity and debt ( ) 400 y = x R 2 = Change in equity and debt (billion euros) Debt Change Equity Change Asset change (billion euros) Figure 11. BNP Paribas: annual change in assets, equity and debt ( ) (Source: Bankscope)

20 Adrian, Colla and Shin: Which Financial Frictions? Societe Generale: annual changes in assets, equity and debt ( ) Annual change in equity and debt (billion euros) y = 0.996x R 2 = Debt change Equity change Annual asset change (billion euros) Figure 12. Société Générale: annual change in assets, equity and debt ( ) (Source: Bankscope)

21 Adrian, Colla and Shin: Which Financial Frictions? 20 1,000 Barclays: 2 year change in assets, equity, debt and risk-weighted assets ( ) 2 year change in equity, debt and risk-weighted assets (billion pounds) y = x R 2 = yr RWA Change 2yr Equity Change 2yr Debt Change -1,000-1, ,000 2 year asset change (billion pounds) Figure 13. Barclays: 2 year change in assets, equity and debt ( ) (Source: Bankscope)

22 Adrian, Colla and Shin: Which Financial Frictions? 21 Societe Generale: 2 year changes in assets, risk-weighted assets, equity and debt ( ) year change in risk-weighted assets, equity and debt (billion euros) y = x R 2 = y = x yr debt change 2yr equity change 2yr RWA change year asset change (billion euros) Figure 14. Société Générale: 2 year change in assets, equity and debt ( ) (Source: Bankscope)

23 Adrian, Colla and Shin: Which Financial Frictions? 22 Book Equity or Market Cap? Book equity = Value of bank s portfolio of claims value of liabilities Example: repo haircut Market capitalization = Discountedvalueoffreecashflows 6= Marked-to-market value of book equity We are interested in bank s portfolio decision (lending and other claims). Hence, book equity is the appropriate concept.

24 Adrian, Colla and Shin: Which Financial Frictions? 23 Two Hypotheses Hypothesis 1. forriskpremium Net worth (of the borrower or bank)is sufficient statistic Hypothesis 2. As well as net worth, leverage of the intermediaries determines risk premium

25 Adrian, Colla and Shin: Which Financial Frictions? Q2 Leverage ( =(total liabilities + equity)/equity) Q Q1 2011Q1 2010Q1 2009Q1 2008Q1 2007Q1 2006Q1 2005Q1 2004Q1 2003Q1 2002Q1 2001Q1 2000Q1 1999Q1 1998Q1 1997Q1 1996Q1 1995Q1 1994Q1 1993Q1 1992Q1 1991Q1 1990Q1 Figure 15. Leverage of US Securities broker dealer sector (Source: Federal Reserve Flow of Funds)

26 Adrian, Colla and Shin: Which Financial Frictions? 25 Checklist for the Banking Sector Bank lending changes dollar-for-dollar through change in debt, with equity sticky Equivalently, bank chooses leverage given pre-determined equity Implication: banking sector leverage is procyclical

27 Adrian, Colla and Shin: Which Financial Frictions? 26 Micro Evidence Sample: U.S. public firms Intersection between Compustat Loan Pricing Corporation (LPC) Dealscan database Securities Data Corporation (SDC) New Bond Issuances database 3,896 firms with new financing between 1998 and 2010 (out of 11,538 in Compustat sample)

28 Adrian, Colla and Shin: Which Financial Frictions? 27 Total Credit bln USD New debt: Total amount bps New debt: Cost Time Time From Q2:2007 to Q2:2009: total amount 1/2, spread 4x

29 Adrian, Colla and Shin: Which Financial Frictions? 28 Split between Loans and Bonds bln USD Loan financing: Total amount bln USD Bond financing: Total amount Time Time From Q2:2007 to Q2:2009: loans 1/4, bonds 2x

30 Adrian, Colla and Shin: Which Financial Frictions? 29 Pricing bps Loan financing: Cost bps Bond financing: Cost Time Time From Q2:2007 to Q2:2009: loans 4x, bonds 3x

31 Adrian, Colla and Shin: Which Financial Frictions? 30 Firms with Access to Both Loans and Bonds Follow Denis and Mihov (2003) and Becker and Ivashina (2011). Firms with access to both types of credit can be used to identify demand and supply shocks Rated New issuer Crisis Q2:2005 (July 2007) Q3:2005 Q2:2007 Q3:2007 Q2:2009 Sorting New debt (cum.) Before crisis New debt (cum.) Crisis To qualify: obtained credit during crisis, positive assets before crisis, non-missing firm characteristics Sorting (rating and firm characteristics) based on Q2:2005

32 Adrian, Colla and Shin: Which Financial Frictions? 31 One Dimensional Sorts Panel A: Amount Total Loan Bond Relative to Before Crisis t-stat Before Crisis t-stat Before Crisis t-stat median Crisis Crisis Crisis Size Below ** *** Above *** *** Tobin s Q Below *** *** Above *** *** (more...)

33 Adrian, Colla and Shin: Which Financial Frictions? 32 Panel B: Cost Total Loan Bond Relative to Before After t-stat Before After t-stat Before After t-stat median Crisis Crisis Crisis Crisis Crisis Crisis Size Below *** *** *** Above *** *** *** Tobin s Q Below *** *** *** Above *** *** *** Tangibility Below *** *** *** Above *** *** *** Rating Below *** *** *** Above *** *** *** (more...)

34 Adrian, Colla and Shin: Which Financial Frictions? 33 Large Firms' New Loans Before After Frequency More New loans ($ Billions) Figure 16. New loans to large firms (upper tercile) before and after the crisis

35 Adrian, Colla and Shin: Which Financial Frictions? 34 Large Firms' Bond Issuance Frequency Before After More Bond Issuance ($ Billions) Figure 17. Bond issuance by large firms (upper tercile) before and after the crisis in billions of dollars

36 Adrian, Colla and Shin: Which Financial Frictions? 35 One Dimensional Sorts: Main findings Flow of new credit: no change overall (!) New loans: sharp reduction; New bonds: sharp increase. Spreads: sharp increase.

37 Adrian, Colla and Shin: Which Financial Frictions? 36 Logit Analysis for Bond Issuance Determinants of new loans and bonds in regression framework (Denis and Mihov 2003, and Becker and Ivashina 2011). Details: Sample: new issuers, rated the quarter prior to issuance Dependent variable: =1if bond issued during quarter, and=0if loan (robust to exclusion of simultaneous issuers, 191 obs.) Independent variables: firm characteristics (as before) Specification: logit model

38 Adrian, Colla and Shin: Which Financial Frictions? 37 Loan supply proxy Crisis BD EBP leverage Panel A: logit regressions (dependent variable: bond issuance) Size 0.337*** 0.366*** 0.354*** (0.042) (0.042) (0.042) Tobin s Q (0.075) (0.076) (0.075) Tangibility (0.203) (0.206) (0.211) Rating 0.052*** 0.045** 0.039* (0.019) (0.019) (0.020) Profitability *** *** *** (2.506) (2.503) (2.538) Leverage 1.007*** 0.798*** 0.796*** (0.255) (0.263) (0.259) Loan supply proxy 0.621*** *** 0.591*** (0.087) (0.001) (0.046) Observations 4,276 4,276 4,153 Pseudo R-squared Panel B: changes in implied probabilities Loan supply proxy

39 Adrian, Colla and Shin: Which Financial Frictions? 38 Model Checklist 1. Direct and intermediated credit 2. In downturn, new loans contract but bond issuance increases 3. Spreads increase on both loans and bonds 4. Bank lending increases or decreases dollar for dollar with an increase or decrease in debt, with equity being sticky 5. Bank leverage is procyclical

40 Adrian, Colla and Shin: Which Financial Frictions? 39 Model of Direct and Intermediated Finance Ultimate Borrowers Intermediated Credit Banks Claim Ultimate Creditors Directly granted credit Banking sector Mean-variance investors who hold portfolio of (i) cash (ii) bank liabilities (iii) risky loans

41 Adrian, Colla and Shin: Which Financial Frictions? 40 Bank Credit Supply Notation for balance sheet of bank Bank E 1 r C L 1 f

42 Adrian, Colla and Shin: Which Financial Frictions? 41 Credit Risk Vasicek (2002) model, backbone of Basel capital requirements. Project succeeds when 0, where = Φ 1 ( )+ + p 1 Φ ( ) c.d.f. of standard normal, and { } independent standard normals ³ p Pr ( 0) = Pr + 1 Φ 1 ( ) = Φ Φ 1 ( ) =

43 Adrian, Colla and Shin: Which Financial Frictions? 42 Bank diversifies away idiosyncractic risk Conditional on, defaults are independent. Keep fixed but diversify: increase number of borrowers, reduce face value of individual loans In the limit, realized value of assets is function of only ( ) (1 + ) Pr ( 0 ) ³ p = (1+ ) Pr + 1 Φ 1 ( ) ³ Φ 1 ( ) = (1+ ) Φ 1 (*)

44 Adrian, Colla and Shin: Which Financial Frictions? 43 density over realized assets ρ = 0.3 ε = 0.3 ε = 0.2 ε = z density over realized assets ε = 0.2 ρ = 0.3 ρ = 0.01 ρ = z Figure 18. The two charts plot the densities over realized assets when (1 + ) =1. The left hand charts plots the density over asset realizations of the bank when =0 1 and isvariedfrom0.1to0.3. The right hand chart plots the asset realization density when =0 2 and varies from 0.01 to 0.3.

45 Adrian, Colla and Shin: Which Financial Frictions? 44 Turning Credit Risk Model on Its Head Turn credit risk model on its head and think of it as credit supply model Fix. Determine credit supply = 1 1+ (0 1) 1+ ( ) is ratio of notional liabilities to notional assets to be derived below.

46 Adrian, Colla and Shin: Which Financial Frictions? 45 From (*), the c.d.f. of is ( ) = Pr( ) = Pr 1 ( ) = Φ 1 ( ) µ µ 1 = Φ Φ 1 ( )+ p µ 1 Φ 1 (1 + ) Common risk factor determines shape of the density, with larger implying fatter tail. Value-at-Risk (VaR) rule: probability to 0 keep enough equity to limit insolvency

47 Adrian, Colla and Shin: Which Financial Frictions? 46 Bank credit supply determined from Pr ( (1 + ) ) =Φ Ã Φ 1 ( )+ 1 Φ 1 (1+ )! (1+ ) = Notional liabilities Notional assets = µ (1 + ) Φ 1 (1 + ) = Φ ( ) Φ 1 ( ) 1 (1) where ( ) Φ ³ Φ 1 ( ) Φ 1 ( ) 1

48 Adrian, Colla and Shin: Which Financial Frictions? 47 Supply of Credit by Bank Credit supply and demand for funding is obtained from (1) and balance sheet identity = + = = Aggregation holds due to proportionality Leverage = Risk premium is well-defined Risk premium =(1 )(1+ ) 1

49 Adrian, Colla and Shin: Which Financial Frictions? 48 r 1 f 1 C r / E 1 1 f Supply of credit Credit Supply

50 Adrian, Colla and Shin: Which Financial Frictions? 49 Mean-Variance Investors Loans are packaged into bonds that diversify away idiosyncratic risk. Demand for bonds (supply of credit) by mean-variance investor with risk tolerance [(1 )(1+ ) 1] 2 (1 + ) 2 where 2 is variance of ( ). There are mean-variance investors, and =. Aggregate supply of credit from mean-variance sector is = [(1 )(1+ ) 1] 2 (1 + ) 2 We need to work out 2.

51 Adrian, Colla and Shin: Which Financial Frictions? Normalized leverage 0.10 Variance of asset realization α = normalized leverage φ ρ =0.3 ρ =0.1 variance σ ρ =0.1 ρ = default probability ε default probability ε Figure 19. Left hand panel plots the normalized leverage ratio as a function of. plots the variance 2 as a function of epsilon for two values of. The right hand panel

52 Adrian, Colla and Shin: Which Financial Frictions? 51 Market Clearing is risk premium, given by (1 )(1+ ) 1 Credit market clears when total demand for credit is met by direct and intermediated credit {z 1 } + (1 )2 2 (1 + ) 2 {z } = ( )

53 Adrian, Colla and Shin: Which Financial Frictions? 52 Bank Iso-Lending Curves Points in ( )-space with constant ( ) = µ 1 1 ( ) 1 (2) Slope of the iso-lending curve tends to + as 0 µ 0 ( ) = ( )+ 1 (3) since 0 ( ) as 0

54 Adrian, Colla and Shin: Which Financial Frictions? 53 Iso lending curves for banks Iso lending curves for bond investors 1.0 α = 0.01 ρ = 0.3 E = 1 C B = α = 0.01 ρ = 0.3 T = 2 risk premium π C B =2 risk premium π C H = C B = C H = default probability ε default probability ε Figure 20. Iso-lending curves in ( )-space for banks (left panel) and bond investors (right panel). Parameter values are as indicated in the boxes.

55 Adrian, Colla and Shin: Which Financial Frictions? 54 Two Main Results Proposition. Under mild regularity conditions, risk premium is increasing in. Excess bond premium goes up in recessions Proposition. For demand for credit not too elastic, an increase in is associated with a contraction of banking sector assets, both in absolute terms and as a proportion of the total credit received by borrowers. In recessions, bank lending contracts but bond lending expands.

56 Adrian, Colla and Shin: Which Financial Frictions? 55 risk premium π α = 0.01 ρ = 0.3 E = 1 T = 10 Bank iso lending curve, C B = 10 Region A Region D Region C Bond investor iso lending curve, C H = Region B default mprobability ε Figure 21. Crossing point for the iso-lending curves of banks and households.

57 Adrian, Colla and Shin: Which Financial Frictions? 56 Back to Our Main Question Why is one dollar of credit through the banking system so different from one dollar of credit that flows directly? Answer: Size of banking sector proxies for banking sector risk-taking. Procyclical behavior of banking sector drives the risk premium over the cycle. Economic activity (esp. investment) sensitive to risk premium. Spike in excess spreads is followed by decline in economic activity (Gilchrist, Yankov and Zakrajsek (2009), Gilchrist and Zakrajsek (2011))

58 Adrian, Colla and Shin: Which Financial Frictions? 57 Checklist for Macro Models Reconcile procyclical leverage with standard dynamic portfolio choice Incorporate explanatory power of balance sheet variables for asset pricing (Adrian, Moench and Shin (2012)) Explore quantitative impact of shifting composition of credit...

59 Adrian, Colla and Shin: Which Financial Frictions? 58 But How Does Leverage Affect Real Economy? Kahle and Stulz (2012) 1 for crisis Firms with no debt cut capital expenditure as much (sometimes more) as firms with debt We have shown that during crisis there was: Sharp contraction in supply of intermediated credit Shortfall made up by increase in direct credit Cost of both types of financing rise sharply 1 Kahle and Stulz (2012) Access to Capital, Investment and the Financial Crisis

60 Adrian, Colla and Shin: Which Financial Frictions? 59 How Does Leverage Affect Real Economy? Total quantity of credit (bank and bond) may not be good indicator of financial conditions Composition of credit matters - i.e. bond market relative size of banking sector to Bank deleveraging leads to spike in lending rates in both bank loans and bonds Spike in spreads is followed by economic downturn (Gilchrist and Zakrajsek (2012))

61 Adrian, Colla and Shin: Which Financial Frictions? 60 Core and Non-Core Bank Liabilities Core: Liabilities to domestic household and non-financial claim holders Non-Core: Liabilities to financial intermediaries and foreign creditors Ratioofnon-coretocoreliabilitiesis: Procyclical Mirrors lowering of credit standards

62 Adrian, Colla and Shin: Which Financial Frictions? 61 Borrowers Banking Sector Domestic Depositors

63 Adrian, Colla and Shin: Which Financial Frictions? 62 New Borrowers Borrowers Banking Sector Foreign Creditors Domestic Depositors

64 Adrian, Colla and Shin: Which Financial Frictions? 63 Trillion Euros Dec trillion IE_8.9.12,13,14 Other loans to households and nonprofits IE_8_9.11 Credit for purchase of consumer durables IE_8_9.10 Credit for homeownership billion Dec _9.9-9_9.10 Home improvement credit IE_8_9.7 Loans for real estate financing IE_8_9.5 Credit for construction funding 8_9.6-8_9.7 Credit financing services (non real estate) IE_8_9.4 Credit financing industry (excluding construction) IE_8_9.3 Credit for financing agriculture, hunting, forestry and fishing Figure 22. Spain: banking sector total domestic credit (Source: Bank of Spain)

65 Adrian, Colla and Shin: Which Financial Frictions? 64 Trillion Euros Dec 1998 IE_8_2.5 Other bank liabilities (deposits > 3m, securities and repos) held by households, nonfinancial corporations and non-profits billion IE_8_2.1 Cash and deposits (<3m) held by households, nonfinancial firms and non-profits Dec-11 Dec-10 Dec-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04 Dec-03 Dec-02 Dec-01 Dec-00 Dec-99 Dec-98 Dec-97 Dec-96 Dec-95 Figure 23. Spain: Core liabilities of banking sector (Source: Bank of Spain)

66 Adrian, Colla and Shin: Which Financial Frictions? 65 Trillion Euros Private crossborder liabilities (total credit - core liabilties - Eurosystem LTRO Eurosystem Long term refinancing operations Core Liabilities to residents Dec-11 Dec-10 Dec-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04 Dec-03 Dec-02 Dec-01 Dec-00 Dec-99 Figure 24. Spain: funding gap of Spanish banks (Source: Bank of Spain)

67 Adrian, Colla and Shin: Which Financial Frictions? 66 Billion Euros Private crossborder liabilities (total credit - core liabilties - Eurosystem LTRO Eurosystem Long term refinancing operations 0 Mar-12 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03 Mar-02 Mar-01 Mar-00 Mar-99 Figure 25. Spain: funding gap of Spanish banks (Source: Bank of Spain)

68 Adrian, Colla and Shin: Which Financial Frictions? 67 Insights on Current Conjuncture Bond markets have thawed But credit conditions faced by SME borrowers in Europe are still tight Conjunction of the two explained by peculiarity of banks Opening channel from bond market to bank credit (e.g. covered bonds) may improve credit conditions