Macroprudential Bank Capital Regulation in a Competitive Financial System

Transcription

1 Macroprudential Bank Capital Regulation in a Competitive Financial System Milton Harris, Christian Opp, Marcus Opp Chicago, UPenn, University of California Fall 2015 H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

2 Introduction Motivation 1 Debate about stricter bank capital regulation Channel I: Incentives Higher capital requirements More skin in the game Usually an argument to increase bank capital requirements Channel II: Balance sheet effects Capital requirements may affect credit supply Usually an argument to decrease bank capital requirements 2 Missing: A tractable framework that 1 allows us to understand how these channels interact in GE 2 accounts for public markets as alternative source of firm credit Empirical importance: Becker/Ivashina (2014) + Adrian et al. (2012) H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

3 Introduction Substitution between banks and public markets Corporate bonds Commercial paper Other loans and advances Bank loans n.e.c. Total mortgages Billion Dollars Q1 2010Q1 2009Q1 2008Q1 2007Q1 2006Q1 2005Q1 2004Q1 2003Q1 2002Q1 2001Q1 2000Q1 1999Q1 1998Q1 1997Q1 1996Q1 1995Q1 1994Q1 1993Q1 1992Q1 1991Q1 1990Q1 Change in corporate bonds Change in loans rporate Pattern: sector Contraction (left hand of bank panel) lending and changes Increasein inoutstanding public lending ncial Source: corporate Figure 2 in Adrian, sector Colla, and (right Shin (2012) hand panel). The left panel is from el is from table F102. Loans in right panel are defined as sum H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

4 Introduction Contribution 1 A tractable (and flexible) framework to understand the systemwide, real effects of capital requirements featuring 1 Heterogeneous firms 2 Heterogeneous financiers (banks vs. public markets) 3 Deposit insurance and capital regulation for intermediaries 4 Public signals on borrower characteristics available for regulation 2 Model predictions: 1 Effiency increase of public markets caps rents that banks can extract from good borrowers risk-taking (reaching for yield) 2 An increase in equity-ratio requirements 1 implies less inefficient risk-taking if bank capital is in excess 2 may cause banks to increase risk-taking if bank capital is scarce 3 Optimal government regulation crucially depends on development of public markets, distribution of firm types, and signals of risk H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

5 Introduction Graphical illustration of model mechanics Example i) Two equi-probable macro states s {L, H} ii) 10,000 firm types with heterogeneous state-contingent cash flows iii) Special case of model: Firms have identical agency rents B Bank loans to all firms are subject to same equity ratio requirements e Banks cannot finance all firms with inside equity only Banks outside equity raising cost (prohibitively) high H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

6 Introduction 3 2 e = 0 NPV=0 NPV=B Π = e = 0.1 CH(f) 1 CH(f) C L(f) 3 e = C L(f) Bank financing Public financing 3 e = 0.7 CH(f) 2 1 CH(f) C L(f) C L(f) Non-monotonic effects of capital requirements e H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

7 Introduction Literature GE framework of Holmstrom and Tirole (1997) adds heterogeneous firms (different quality and risk) adds deposit insurance / asset substitution incentives regulation Banks specialness: Asset side: Diamond (1984) Liability side: Diamond & Dybvig (1983), Gorton & Pennachi (1990) Competition and banking: Rajan and Petersen (1994, 1995), Petersen (1999), Rajan (1992) Capital requirements: Pre-crisis: Kareken and Wallace (1978), Keeley (1990), Repullo (1994, 2004), Pennacchi (2006) Post-crisis: DeAngelo, Stulz (2013), Plantin (2014), Allen, Carletti, and Marquez (2011), Admati et al. (2013), Strebulaev (2013), Thakor (2014), Harris and Raviv (2014), Mehran et al. (2013) H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

8 Introduction Model essentials A single-period, discrete-state model with risk-neutrality and a storage technology There are four types of agents: 1) A continuum of entrepreneurs with firms with varying cash flow distributions and agency rents. 2) A continuum of perfectly competitive banks that can monitor firms are subject to an outside equity-financing friction can issue insured deposits 3) A continuum of perfectly competitive public investors 4) A government/ regulator that sets equity ratio requirements based on risk signals H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

9 Introduction Firms Cashless firms require outside financing from banks or public markets Investment I at time 0 and produces cash flows C s (q e) at time 1. Cash flows depend on observable quality type q (f ) and unobservable effort e (f ) {0, 1} Shirking (e = 0) yields private benefit of B unless monitored by banks Assumptions B (q) + E[C s ( q e = 0)] I < 0 Shirking socially wasteful C s ( q e = 0) < I s Outside financing requires high effort NPV (q) = E[C s ( q e = 1)] I. H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

10 Introduction Public markets Competitive investors with sufficient wealth to finance all firms Investment opportunity set 1) securities issued by firms 2) bank deposits and bank equity 3) storage technology with zero interest equilibrium expected return on all investments is zero Firm IC and investor IR constraint under (optimal) debt contract E [max {C s FV, 0} e = 1] B (q) + E [max {C s FV, 0} e = 0] E [min {C s, FV } e = 1] I Firm f has access to public markets if NPV (f ) B (f ) H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

11 Introduction Banks Competitive banks with total wealth E I (book value of inside equity) Banks monitor (at zero cost) eliminate firm moral hazard Outside financing decisions to finance assets A = E I + E O + D Deviations from Modigliani-Miller: (microfounded in Appendix model) 1) Insured deposits D total payouts to security-holders increase in D A Microfoundation: deposits are subject to runs (Diamond & Dybvig) Feature needed to generate risk-taking incentives 2) Outside equity costly relative to inside equity, cost c (E O ) 0 Microfoundation: non-deposit financing induces inefficient cash flow diversion of bankers (Calomiris & Kahn) Feature needed to generate balance sheet channel Market value of equity: E M = E [max {(1 + ra) s A D (1 + r D ), 0}] H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

12 Introduction Regulator Cannot condition regulation on firm quality, but can use signals ρ f Risk signals generate a partition of firms: think of 24 S&P ratings Regulatory tools inspired by existing regulation (e.g., Basel I-III) Full deposit insurance to avoid runs, deposit rate satisfies r D = 0 Equity-ratio requirement constraint on banks with loan portfolio {x f } e = E A x f e (ρ f ). f Think of e (ρ f ) = rw (ρ f ) e so that rw (ρ f ) is risk-weight H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

13 Analysis Analysis Roadmap 1 Equilibrium given capital requirements 1 Individual bank problem 2 Capital allocation & surplus division in a competitive financial system 2 Comparative statics of capital requirements 3 Predictions H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

14 Analysis Individual bank problem Individual bank problem Define banker s levered ROE and objective function [ { f x f r s }] f r E (e, x) = E max, 1 e [ ] E I,M = E I + max (E I + E O ) max r E (e, x) c E (E O ) E O e,x Individual banks take loan returns for firm f, rf s, as given Upon bank default, government transfers A ( ra s e) to depositors Total ex-post payouts to securityholders (violation of MM) Competing depositors pass on ex-ante value E ( A max { ra s e, 0}) banks go to regulatory leverage constraint choose loan portfolios with correlated downside risks H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

15 Analysis Competitive financial system Competitive financial system Competitive public investors price public debt to break even Banks have 2 competitive advantages: monitoring & insured financing Bank funding of firm f generates total private surplus Π (f ) = NPV (f ) 1 B(f )>NPV (f ) + E (max {I (1 e (ρ f )) C s (f ), 0}) }{{}}{{} Social advantage: monitoring Private advantage: deposit insurance General equilibrium effect: To extract maximum financing subsidy banking sector is endogenously segmented Risky Greek banks do not want to hold safe German Bunds Safe German banks do not want to hold Greek sovereign debt H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

16 Analysis Competitive financial system Π vs. NPV Π = 0 NPV=0 NPV=B 2 CH(f) C L (f) Definition Given e (ρ), bank capital is scarce if E I < I f :Π(f )>0 e (ρ f ) df. H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

17 Analysis Competitive financial system Proposition (Bank capital not scarce) 1) Banks fund all borrowers with Π (f ) > 0 2) Public markets fund remaining firms if NPV (f ) B (f ) 3) Funded firms extract all rents in the economy Π (f ) + NPV (f )1 NPV (f ) B(f ) Public bond yield (y P ) vs. bank loan yield (y) pricing: [ { E min y P (f ), C }] s (f ) I = 0 I [ { { E max min y (f ), C } }] s (f ) I, e (ρ f ) = 0 I Signals (Ratings) matter for equilibrium prices (H 2 O, 2013; GP, 2011) H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

18 Analysis Competitive financial system Scarce bank capital If bank capital scarce, banks cannot finance all firms in the economy Profit maximization drop firms with lowest profitability per unit of required capital (Profitability ranking = Social ranking!) PI (f ) = Π (f ) I e (ρ f ) Define PI (f M ) of marginal firm funded without outside equity PI EI : E I = I e (ρ f ) df. f :PI (f ) PI EI H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

19 Analysis Competitive financial system Proposition (Scarce bank capital) 1) No bank raises equity if c (0) PI EI. Otherwise, EO is the unique solution to E I + EO = I i:pi (f )>c (EO) e (ρ f ) df. 2) Banks fund all firms with PI (f ) > r E = min {PI E I, c (E O )} 3) Public markets fund remaining firms if NPV (f ) B (f ) 4) Funded firms extract { Π (f ) max 1 r E } PI (f ), 0 + NPV (f )1 NPV (f ) B(f ) Firms funded by scarce banks now need to give up a fraction r E PI (f ) of Π H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

20 Analysis Comparative statics of capital requirements Comparative statics of capital regulation Corollary Without equity ratio requirements, bank capital is not scarce 1) all firms are funded at a yield of y (f ) = 0, and, 2) ex-ante welfare is given by W = f Ω f NPV (f ) df. Capital requirements operate via two channels: 1 Incentives Channel: inefficient financing subsidy reduced 2 Balance sheet channel: potential credit crunch Proposition Let e (ρ f ) = rw (ρ f ) e and consider comparative statics in e 1) If bank capital is not scarce, a marginal increase in e increases surplus. 2) If bank capital is scarce, a marginal increase in e decreases surplus if the marginal funded firm, f M, satisfies, B(f ) > NPV (f ) > 0. H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

21 Examples Example: Balance sheet effects Example Two state economy with s {L, H} and two firm types i) Fraction π g good & safe borrowers producing R > I in both states ii) Fraction π b bad, risky borrowers produce R in s = H and 0 otherwise iii) Regulator sets equity ratio requirements e and uses no signals iv) Assume that raising outside equity is prohibitively costly v) For all firms B > NPV no public market financing H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

22 Examples Example: Balance sheet effects Incentives channel Π Π(g,e) Π(b,e) W Welfare ê 1 e Balance sheet channel e Idf f:π(f)>0 eπ g 0 ê 1 e Loan yields y(f) Good firms Bad firms EI 0 0 ê 1 e 0 0 ê e 1 H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

23 Conclusion Predictions Long-run trend in public market finance competition As public markets become more efficient, B (f ), Π Fraction of private surplus creation Π due to risk-taking Example: deregulation in Japan allows firms to bypass banks risk-taking by banks (Kashyap & Hoshi) Optimal regulatory action: capital requirements Cyclicality of optimum capital requirements depends on which variables move most with the business cycle Level of bank capital Pro-cyclical capital requirements Firm profits ambiguous. Depends on whether majority of firm types becomes so profitable in good times that NPV B, procyclical move from NPV < 0 to 0 < NPV < B in good times, countercyclical Countercyclical variance of firm TFP shocks. (Bloom et al., 2015) countercyclical H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24

24 Conclusion Conclusion We develop a tractable framework to analyze systemwide effects of capital requirements Key ingredients: Firms are heterogeneous according to cash flow distribution and access to public markets Robust insight: An increase in capital requirements increases welfare as long as bank capital is not scarce if capital is scarce, it is unclear which firm types are credit rationed Regulatory policies require macroprudential perspective. Our framework provides a tool to gauge the aggregate effects of distribution of firm types public markets as a substitution channel the quality of risk signals H 2 O (Chicago, UPenn, UC) Macroprudential Bank Capital Regulation Fall / 24