Bank Profitability, Capital, and Interest Rate Spreads in the Context of Gramm-Leach-Bliley and Dodd-Frank Acts MUJTBA ZIA a,* AND MICHAEL IMPSON b a Assistant Professor of Finance, Rankin College of Business, Southern Arkansas University, 100 E University St, Slot 27, Magnolia AR 71753, USA. Tel: +1 (870) 235 4307, E-mail address: mujtabazia@saumag.edu b Associate Professor of Finance, College of Business, University of North Texas, 1155 Union Circle #311160, Denton, TX, 76203-5017, USA. Tel: +1 (940), 565 3055, E-mail address: impson@unt.edu This Draft Version: January 15, 2018 Abstract Over the past two decades, interest rates in the United States fluctuated considerably. During the same period, two major financial regulatory acts passed aiming reforms in the US banking and financial industries, the Gramm-Leach-Bliley Financial Modernization Act of 1999 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. We also experienced the worst financial recession since the Great Depression. We examine bank profitability, capital and risk in response to interest rate fluctuations since 1992 in five sub periods, the pre-gramm-leach-bliley Act period, the Gramm-Leach-Bliley Act period, the Great Recession period, the post-great Recession period and the Dodd-Frank Act period. We find that bank capital, risk and interest rate spread fluctuations have variable implications for bank profitability across sub-periods. JEL Classification: G18; G21; G28 Keywords: Banks; Financial Crisis; Banking Regulation * Corresponding author 1
Bank Profitability, Capital, and Interest Rate Spreads This Draft Version: January 15, 2018 Abstract Over the past two decades, interest rates in the United States fluctuated considerably. During the same period, two major financial regulatory acts passed aiming reforms in the US banking and financial industries, the Gramm-Leach-Bliley Financial Modernization Act of 1999 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. We also experienced the worst financial recession since the Great Depression. We examine bank profitability, capital and risk in response to interest rate fluctuations since 1992 in five sub periods, the pre-gramm-leach-bliley Act period, the Gramm-Leach-Bliley Act period, the Great Recession period, the post-great Recession period and the Dodd-Frank Act period. We find that bank capital, risk and interest rate spread fluctuations have variable implications for bank profitability across sub-periods. JEL Classification: G18; G21; G28 Keywords: Banks; Financial Crisis; Banking Regulation 2
1. Introduction Interest rates fluctuated considerably in the United States over the past two decades. These fluctuations were either due to business cycles or the Federal Reserve System s intervention in financial markets, or both. During the same period, two regulatory acts passed affecting the banking and financial industries. These acts are the Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLB Act) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). The purpose and scope of the acts were different from each other. While the first act aimed at reducing the restrictions on banking firm activities imposed by the Glass-Steagall Act of 1933, the second act sought greater regulation and reform in the US banking and financial industries. Due to the different nature of the acts, banks faced two very different regulatory environments bringing about opportunities as well as challenges in their profitability, capital and risk level. The GLB Act had a positive effect on bank profitability as it allowed banks to engage in more profit maximizing activities, but it may have had a negative effect on bank capital as banks could offer more innovative financial products to manage liquidity without having to maintain a higher level of capital. 1 The GLB Act is also believed to have led to increased risk in the banking industry [Akhigbe and Whyte (2004), Mamun, Hassan and Maroney (2005), and Filson and Olfati (2014)]. The Dodd-Frank Act, on the other hand, has negatively affected bank profitability while increasing bank capital and decreasing bank risk [Akhigbe, Martin and Whyte (2016)]. 1 One of such financial innovations was to offer money market investment accounts while at the same time allowing account holders to write checks on these accounts. Such financial service was prohibited before the GLB Act. 3
The Great Recession of 2007 and 2008 also brought about challenges for the banking industry. During the Great Recession, the Federal Reserve System (the Fed) intervened in financial markets, created emergency lending facilities and provided an unprecedented amount of funds to banking firms and other financial institutions. The intervention of the Fed in financial markets resulted in dramatic interest rate changes. For instance, the Fed Funds rate fell from 6.5% in early 2000 s to 0.25% in late 2008. The fluctuations in interest rates in the past two decades along with the changes in economic conditions and regulatory environment have implications for bank profitability, capital and risk. Like other for profit entities, banks are concerned with profitability or return for its shareholders while managing risk. The traditional banking model defines banks as institutions that accept deposits and make loans. On the other hand, deposits and loans are highly dependent on interest rate levels, hence interest rates play a central role in bank profitability. Although banks have evolved out of the traditional model and engage in a variety of financial activities beyond just accepting deposits and making loans, nonetheless, interest rates remain one of the most important factors in determining bank profitability. While the determinants of bank profitability have been studied extensively [Albertazzi and Gambacorta (2009), Athanasanoglou, Brissimis and Delis (2008), Demirgüç-Kunt and Huizinga (1999) and Entrop et. al. (2015)], bank profitability in response to interest rate fluctuations under the GLB and Dodd-Frank regulatory environments, as well as during the Great Recession has not been adequately investigated. We aim to fill this literature gap in the banking research literature. The primary purpose of this paper is to investigate how US banks adapted to major interest rate fluctuations and regulatory policy changes since 1992. We set four hypotheses to 4
test the implications of bank capital, bank risk, interest rate fluctuations and regulatory environment changes for bank profitability. These hypotheses are the capital relevancy hypothesis, the risk relevancy hypothesis, the interest rate spreads relevancy hypothesis and the regulatory environment relevancy hypothesis. The rest of this paper is organized as follows. In section 2, we review previous studies. In section 3, we present hypotheses. In section 4, we discuss data and methodology. In section 5, we discuss the results and in section 6, we provide a summary and conclusion. 2. Literature Review Bank interest rate margins 2 have perhaps the greatest impact on bank profitability and losses. Fluctuations in the levels of interest rates therefore have significant implications for bank interest rate margins. Ho and Saunders (1981) are among the first researchers who model and analyze bank interest rate margins and their determinants. They extend the hedging hypothesis 3 and utility maximization hypothesis 4 of banking firms to analyze determinants of bank interest margins. They find four main determinants for bank interest margins: the degree of bank management risk aversion; the market structure in which banks operate; the size of banks; and the variance of interest rates. Hanson and Rocha (1986) study the determinants of interest rate margins using data for 29 countries over the period 1975-1983 and determine bank profitability 2 Interest rate margin is defined as the difference of interest rates banks charge on loans and interest rates banks pay to finance the loans. 3 The hedging hypothesis of banking model views banks as firms trying to match the maturity of assets and liabilities to hedge against refinancing risks. 4 The expected utility maximizing hypothesis is based on microeconomic structure of firms that views bank as firms trying to maximize expected wealth or utility of wealth. 5
and losses to be highly dependent on inflation, scale of economies and market structures. Demirgüç-Kunt and Huizinga (1999) study the determinants of bank interest rate margins across 80 countries and find that interest rate margins vary across countries and reflect a variety of determinants such as macroeconomic conditions, deposit insurance regulation and taxation. Saunders and Schumacher (2000) study a panel of banks from 7 OECD countries between 1988 and 1995 and find that bank interest rate margins vary widely across countries and more importantly, the size of the margins changes over time. Entrop et al (2015) study the impact of maturity transformation on interest rate margins of German banks between 2000 and 2009 and find that bank interest rate margin is mainly priced based on the asset side of bank balance sheet. Other related studies on interest rate margins, bank capital, profitability and losses are conducted by Athanasoglou, Brissimis and Delis (2008), Albertazzi and Gambacorta (2009), Bolt et al (2012), Gambacorta and Mistrulli (2014), Saghi-Zedek and Tarazi (2015) and DeAngelo and Stulz (2015). The consensus is that bank profitability depends on many factors including regulatory environment, tax codes, and economic conditions such as financial crises. While these valuable studies contribute to the banking research literature and address important questions, how US bank profitability adapted to interest rate fluctuations has not been adequately investigated. We intend to fill this literature gap in banking research. 3. Hypotheses Capital Relevancy Hypothesis: Bank profitability is correlated with bank capital level. Maintaining higher levels of capital imposes costs on banks as holding more capital would imply foregone investment opportunities and therefore, lower profits. 6
Risk Relevancy Hypothesis: Bank profitability is correlated with bank risk levels. Theory suggests that under normal circumstances, higher risk taking activities of banks result in higher profits. Therefore, we would expect bank profitability to be positively correlated with risk levels. Interest Rate Spreads Relevancy Hypothesis: Interest rate fluctuations impact bank profitability. Interest rates fluctuate due to economic conditions and/or the Fed s intervention in financial markets. These fluctuations may have implications for bank profitability if bank interest rate returns are fixed by contract. Since banks have access to cheaper credit markets than consumers or corporations, a widening interest rate spread would positively affect bank profitability whereas a narrowing interest rate spread would negatively impact profitability. We would expect fluctuations in interest rate spreads to affect bank profitability. Regulatory Environment Relevancy Hypothesis: Regulatory environment alters bank profits as it may impose additional costs or reduce existing costs. Due to differences in their nature, the Gramm-Leach-Bliley and Dodd-Frank Acts had different implications for bank profitability, bank capital, and bank risk level. If this hypothesis holds, we would expect to observe changes in correlation signs and significance levels across sub-periods, especially from the GLB period to the Dodd-Frank period. We notice that this hypothesis can only be jointly tested with the above hypotheses. 4. Data and Methodology Data on bank capital and financial ratios comes from the Reports of Condition and Income (Call reports) and is available from the Federal Financial Institutions Examination Council (FFIEC) and Federal Deposit Insurance Corporation (FDIC). Data on interest rates 7
comes from the Federal Reserve System. Security data is from the Center for Research in Security Prices (CRSP). The period of our study is from the third quarter of 1992, when the data on bank capital (Tier 1 capital) was first reported, to the last quarter of 2015. Our sample consists of unbalanced panel data of of 37,936 total quarterly observations. We use two measures for bank capital, Tier-1 capital and cash ratio. Tier-1 capital is based on Basel Accords 5 and reflects banks ability to absorb losses; whereas, cash ratio reflects the ultimate liquid capital level of a bank. To measure bank profitability, we use return on equity. 6 The interest rate benchmarks we use are the Fed Funds rate, the prime rate, the 48-month consumer loan rate and the 30-year mortgage rate. Although the interest rate benchmarks differ from each other, they are highly correlated. For technical efficiency reasons and to take correlations of interest rate benchmarks into account, we analyze interest rate changes in terms of spreads among them since they are not as correlated as the benchmarks themselves. For instance, the correlation between the prime rate and the fed funds rate is 0.9994 and the correlation between the 30-year mortgage rate and fed funds rate is 0.8919, while the correlation between the prime-fed funds and 30-year mortgage-fed funds is 0.3980. We use three major interest rate spreads in our analysis. These interest rate spreads are the prime rate and the Fed Funds rate, 48-month consumer loan rate and prime rate, and 30-year 5 The Basel Accords refer to Basel I, Basel II and Basel III accords, which are set of recommendations prescribed by the Bank for International Settlements in an attempt to standardize bank regulations across countries. 6 Another measure of bank profitability could be return on assets. However, because banks typically have better access to short-term and long-term funds including funds from the Federal Reserve System and operate with higher levels of liabilities than non-bank firms, return on assets does not reflect bank profitability as well as return on equity does. 8
mortgage rate and prime rate. Using interest rate spreads, rather than interest rates also reveals additional information regarding bank capital and profitability trends as spreads can be considered interest rate margins. A larger spread may allow banks to better absorb some interest rate fluctuations. Table 1 summarizes correlations among the interest rate benchmarks and their spreads. [Insert Table 1 about here] While adapting to interest rate fluctuations and different market conditions, banks may increase their risk taking behavior. Following Saunders, Strock and Travlos (1990) we use three measures of risk, debt ratio measured as total liabilities divided by total assets, market beta and total volatility measured by the standard deviation of returns. 7 Given the importance of large banks 8 in the US banking industry, we also separately conduct our analysis on large banks. We define large banks as banks ranking in the top 10% by their total assets. 7 Saunders, Strock and Travlos (1990) also use the z-score as a measure of risk. The components of the z-score are returns on assets, capital to asset ratio and the volatility of returns on assets. However, the z-score is more relevant to firms with higher levels of fixed assets such as manufacturing firms. Ratios in our paper are similar to the components of the z-score but they are more relevant to banking firms. These ratios are return on equity, rather than return on assets, Tier 1-capital, rather than total capital and total volatility of returns. 8 The phenomenon of too-big-to-fail banks often arises in banking research literature. While some of the large banks in our sample may be considered too-big-to-fail, we refrain from analyzing these banks from the too-bigto-tail perspective as the phenomenon relates to agency problems. The agency problem in banks is outside the scope and purpose of our paper. 9
We analyze bank capital, profitability and risk in five sub-periods. These periods are :the pre-glb period: 1992q3-2000q1, the GLB period 9 : 2000q2-2007q3, the Great Recession period: 2007q4-2009q2 10, the post-great Recession period: 2009q3-2011q4, and the Dodd-Frank period: 2012q4-2015q4 11. Table 2 provides summary statistics of our sample. [Insert Table 2 about here] 5. Results and Discussion 5.1. General trends in bank profitability, capital, risk, and interest rate fluctuations While interest rates benchmarks are highly correlated to each other, interest rate spreads are not as strongly correlated as the benchmarks. This may be due to a lag in time for one benchmark to reflect the changes in another benchmark and the lag may be different for each benchmark. For instance, a sudden change in the Fed Funds rate due to the Fed s intervention in financial markets may take two months to reflect on the prime rate and one year to reflect on consumer loan rates. Panel A of Table 1 shows that the correlation between the Fed Funds rate and the prime rate is 0.9994 and that of 48-month consumer loan rate and the Fed Funds rate is 0.8905. Whereas, Panel B of Table 1 shows that the correlation between their spreads is -0.2606. Table 1 summarizes the correlations among the interest rate benchmarks and their spreads. 9 Gramm-Leach-Bliley Financial Modernization Act was signed on November 12, 1999 to become effective in 120 days. https://www.congress.gov/106/plaws/publ102/plaw-106publ102.pdf, last accessed on June 12, 2017. 10 We are using the Great Recession period defined by the National Bureau of Economic Research (NBER), retrieved from http://www.nber.org/cycles/cyclesmain.html on June 17, 2017. 11 Although the Dodd-Frank Act passed on July 21, 2010, it took more than18 months for all its provisions to become effective. 10
Bank profitability fluctuated considerably with a mean of 9.28% and standard deviation of 83.28% for the period of study from 1992q3 to 2015q4 as shown in Table 2, Panel A. It remained relatively stable from the pre-glb period (1992q3-2000q1) at 11.94% to the GLB period (2000q2-2007q3) at 11.55%, representing a 3% decrease. Bank profitability suffered during the Great Recession and fell dramatically to -5% from 11.55%, representing 143% decrease. The ratio recovered in the post crisis period and reached 10.78% on average. The ratio decreased by 24% to 8.19% average in the Dodd-Frank period. Bank Capital, on the other hand, has been stable at around 11.20%. The ratio increased slightly from the pre-glb period to the GLB period by 2%, while the cash ratio has decreased by 8% in the same period from 6.16% to 5.69%. It implies that banks were able to decrease cash holdings while increasing their Tier-1 capital ratio during the GLB period. During the crisis period, it remained relatively stable at 11.12% while the cash ratio fell to its lowest level of 4.58%. In the post-great Recession and the Dodd-Frank periods Tier-1 capital ratio increased to 12.37% and 13.33%, while cash ratios increased to 6.96% and then fell to 6.21%, respectively. Except during the Great Recession, both Tier-1 capital and cash ratios have generally increased over the time period considered. Bank risk measured by debt ratio increased by 27% from the pre-glb period to the GLB period while beta and total volatility measures decreased by 11% and 22%, respectively. The decrease in beta and total volatility from the pre-glb period to the GLB period is contrary to expectations. Debt ratio reached 11.38% during the Great Recession period and then decreased to 8.47% and 6.15% in the post-great Recession and Dodd-Frank periods, respectively. The result that debt ratio increased by 27% while beta and total volatility decreased in the GLB period suggests that while banks became riskier in terms of debt ratio, they could diversity their 11
earnings by engaging in other financial activities previously prohibited by the Glass-Steagall Act of 1933. For instance, banks were not allowed to issue securities or sell insurance. 5.2. Regression analysis of bank profitability To understand whether bank profitability depends on bank capital, risk level and interest rate fluctuations, we conduct the following model to analyze bank profitability. (Model 1) for Where, ROE is return on equity, Cap is Tier-1 capital ratio, Cash is cash ratio as percentage of assets, Debt is debt ratio as percentage of assets, Beta is market beta calculated over a 52-week period using a single index market model based on S&P500 index, Vol is total volatility measured by the standard deviation of returns, PrFF is the prime-fed fund spread, ConsPr is the consumer-prime rate spread, and MorFF is the 30-year mortgage-fed fund spread. Table 3 summarizes the regression results. [Insert Table 3 about here] Table 3 shows that, except during the Great Recession period, well capitalized banks generally experienced lower profitability. The coefficient of Tier-1 capital ratio is negative and statistically significant at the 5% level for the entire study period, the pre-glb period, the post- Great Recession period and the Dodd-Frank period. During the GLB period, the coefficient is still negative, but not significant. During the Great Recession the coefficient becomes positive 12
and significant at the 0.1% level. This result implies that during the Great Recession well capitalized banks experienced better profitability. There are also differences in how bank capital affects bank profitability between large banks and other banks (small to medium banks). Panel A of Table 3 shows that capital ratio is not significantly correlated with bank profitability for large banks, while it is for small and medium banks at the 5% level. The capital ratio coefficient is not significant for large banks in the pre-glb, Great Recession, and Dodd-Frank periods. The coefficient for small and medium banks is positive and significant during the Great Recession period, but negative and significant during the post-great Recession and Dodd-Frank periods. The results suggest that high capital ratios shield profits in recessionary periods for small and medium banks, but not for large banks. This contrasting result may also imply that maintaining higher levels of capital for small and medium banks is costlier than for large banks. The most notable difference in how bank capital affects profitability for large banks versus small and medium banks is in the post-great Recession period. The coefficient of Tier-1 capital for large banks is positive and significant at the 0.1% level, while the coefficient for small and medium banks is negative and significant at the 5% level. These contrasting results imply that Tier-1 capital affects profitability for both large and small bank, though not in the same manner across all periods. The results provide evidence in support of the capital relevancy and regulatory environment hypotheses. The bank risk measure of debt ratio had different implications for bank profitability across periods. For all banks in the sample, it is only significant during the GLB and the Dodd- Frank periods with different signs. During the GLB period, it is negatively significant at the 1% level but during the Dodd-Frank period, it is positive and significant at the 5% level. Banks with 13
higher debt ratios experienced worse profitability in the GLB period but better profitability during the Dodd-Frank period. This difference is likely due to the different nature of regulatory environments. Higher debt levels negatively impact profitability for small and medium banks in the two sub-periods prior to the Great Recession (the pre-glb and GLB periods). It has positively affected bank profitability in the Dodd-Frank period. For large banks, the only period debt ratio is correlated with profitability is the Dodd-Frank period with a positive coefficient, significant at the 5% level. Other measures of risk, beta and total volatility, seem to be inconsistently correlated with bank profitability. Panel A of Table 3 shows that, for the entire study period, beta is irrelevant of bank profitability and total volatility is negatively correlated with profitability for large banks only. For the pre-glb period, beta is positively and significantly correlated with profits for small to medium banks and insignificant for large banks, while total volatility is negatively correlated with profits for both groups of banks. Panel C of Table 3 shows that, during the GLB periods, beta and total volatility coefficients are significant for both group of banks but with different signs. The beta coefficient is negative for large banks but positive for small banks, both significant at the 0.1% level. The negative sign for large banks implies that higher systematic risk levels impacts profitability inversely while the positive sign for small banks suggests higher systematic risk levels positively affect profitability. Total volatility is consistently negatively affecting profitability for large banks in all sub-periods but negatively affecting profitability for smaller banks only in the pre-glb, GLB, and the Great Recession periods. It becomes irrelevant in the post-great Recession and Dodd-Frank periods. The beta and total volatility risk measures are more relevant to larger banks than smaller ones. The overall evidence supports the risk relevancy hypothesis. The results also jointly support the regulatory environment hypothesis. 14
Panel B of Table 2 shows that interest rate benchmarks differed considerably among subperiods and their spreads are correlated with bank profitability. For the entire study period, the prime-fed fund and 30-year mortgage-fed funds spreads are relevant to bank profitability for large banks. None of the spreads are relevant to profitability for smaller banks. However, Panel B of table 3 shows that the prime-fed funds spread is negatively correlated with profitability, while the 30-year mortgage-fed funds spread is positively correlated with profitability for smaller banks during the pre-glb period. Both coefficients are significant at the 0.1% level. The 48- month consumer loan and prime rate spread is only a relevant factor of profitability in the Great Recession period for both groups of banks. A widening spread during the period positively affected bank profitability. This result is expected as the prime rate during the period fell from 4.33% in the GLB period to 3.25% in the Great Recession period, a decrease of 25%, whereas, the 48-month consumer loan rate fell by only 13% for the same period. In the aftermath of the Great Recession in the post-great Recession period, the 48-month consumer loan and prime rate spread negatively affected profitability for large banks, while it was statistically insignificant for smaller banks. A closer comparison of the interest rate spreads in the GLB period versus the Dodd-Frank Period shown in Panel C and F of Table 3 reveals that while the 30-year mortgage-fed funds spread was the only relevant spread for bank profitability in the GLB period, none of the spreads was relevant to bank profitability in the Dodd-Frank period. The overall results suggest that interest rate spreads, specially the 48-month consumer loan-prime rate spread, are correlated with bank profitability, though the correlation is not consistent across sub-periods. The results weakly support the interest rate spreads relevancy hypothesis, but provides stronger support for the regulatory environment hypothesis. 15
6. Summary and Conclusion We investigate bank profitability, capital and risk in response to interest rate fluctuations and regulatory and economic environment changes since 1992. We conduct our analysis in five sub-periods: the pre-gramm-leah-bliley Act of 1999 (pre-glb) period from the 1992q3 to 2000q1, the Gramm-Leach-Bliley (GLB) period from 2002q2 to 2007q3, the Great Recession period from 2007q4 to 2009q2, the post-great Recession period from 2009q3 to 2011q4 and the Dodd-Frank period from 2012q4 to 2015q4. We set up four hypotheses to analyze bank profitability: the capital relevancy hypothesis, the risk relevancy hypothesis, the interest rate spread relevancy hypothesis and the regulatory environment hypothesis. The results indicate that bank capital has significant and different implications for bank profitability in different regulatory environments. Higher capital level corresponds to lower profitability during the Gramm-Leach-Bliley period but becomes irrelevant in the Dodd-Frank period for large banks. For smaller banks, a higher capital level is irrelevant in the GLB period, but becomes positively correlated to profitability in the Dodd-Frank period. Bank capital ratios are statistically significant for different periods. These results support the capital relevancy hypothesis as well as the regulatory environment hypothesis. Bank risk levels are also correlated to bank profitability and the correlations change across the sub-periods and between large and smaller banks. Interest rate spreads impact bank profitability for large and smaller banks alike, but the effects differ across different regulatory environment. These results provide evidence in support of the capital relevancy, risk level relevancy, interest rate spreads relevancy and the regulatory environment hypotheses. 16
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Table 1. Correlations matrices of interest rate benchmarks and their spreads for the period: 1992q3-2015q4 Panel A. Correlation matrix for interest rate benchmarks Fed Funds Fed Funds 1 Prime Prime 0.9994 1 48-Month Consumer 48-Month Consumer 0.8905 0.8878 1 30-Year Mortgage 30-Year Mortgage 0.8919 0.8884 0.9267 1 Panel B. Correlation matrix for the spread of interest rate benchmarks Prime-Fed Funds 1 Prime- Fed Funds 48M Consumer-Prime 30Y Mortgage- Fed Funds 48M Consumer-Prime -0.2606 1 30Y Mortgage- Fed Funds 0.3980 0.1923 1 19
Table 2. Summary Statistics. The table summarizes the quarterly data for all banks in our sample study from the 1992q3 to 2015q4. The sample consists of banks that filed Consolidated Report of Condition and Income (Call report) with the Federal Deposit Insurance Corporation (FDIC) and were listed in NYSE or NASDAQ. Panel A: Summary Statistics for all banks from 1992q3 to 2015q4, inclusive. Variable Obs Mean Std.Dev Min Max Return on Equity 37857 9.2758 41.8059-315.7702 362.5850 Tier 1 Ratio 37936 11.7757 4.7317-19.6500 238.8900 Cash Ratio 37794 5.9853 5.1636-0.1259 96.4734 Debt Ratio 37818 8.6626 8.5292-1.1971 77.1430 Beta 19775 0.5711 0.5092-2.3041 3.4291 Total Volatility 19775 0.0273 0.0194 0.0045 0.2498 Fed Funds Rate 37842 2.6069 2.3093 0.0700 6.5200 Prime Rate 37842 5.6503 2.2540 3.2500 9.5000 48 Month Consumer Rate 37842 7.1032 1.6194 4.0000 9.7800 30 Year Mortgage Rate 37842 6.0813 1.4816 3.5000 9.1100 Panel B: Mean of ratios for all banks during the sub-periods and percentage changes from the previous sub-period Pre- Gramm- Leah- Bliley Gramm-Leach-Bliley (GLB) % change from Pre GLB period Great Recession Post Great Recession Dodd-Frank % change from GLB period % Change from the crisis period % Change from the post crisis period Variables Mean Mean Mean Mean Mean Return on Equity 11.9398 11.5544-3% -5.0026-143% 10.7781 315% 8.1904-24% Tier 1 Ratio 11.2382 11.4939 2% 11.1242-3% 12.3907 11% 13.3316 8% Cash Ratio 6.1579 5.6872-8% 4.5828-19% 6.9571 52% 6.2057-11% Debt Ratio 7.9876 10.1566 27% 11.3796 12% 8.4698-26% 6.1525-27% Beta 0.6072 0.5427-11% 0.6056 12% 0.5103-16% 0.6045 18% Total Volatility 0.0234 0.0184-22% 0.0411 124% 0.0412 0% 0.0177-57% Fed Funds Rate 5.1242 2.5522-50% 1.2105-53% 0.1359-89% 0.1356 0% Prime Rate 8.1087 5.5436-32% 4.3319-22% 3.2500-25% 3.2782 1% 48-Month Consumer Loan Rate 8.7203 7.2734-17% 6.9246-5% 6.0359-13% 4.2810-29% 30 Year Mortgage Rate 7.6661 6.1804-19% 5.6250-9% 4.6203-18% 3.9552-14% Notes: The sub-periods are as follows: The Pre-Gramm-Leach-Bliley (Pre-GLB) period: 1992q3-2000q1, the Gramm-Leach-Bliley (GLB) period: 2000q2-2007q3, the Great Recession period: 2007q4-2009q2, the post-great Recession period: 2009q3-2011q4, and the Dodd-Frank period:2012q4-2015q4. 20
Table 3. Regression results. The table shows regression results for all banks as well as largest banks and small to medium bank. Largest banks are banks with their total assets ranking in the 10the decile (top 10%) according to their total assets. Small to medium banks are banks with total assets ranked in 1-9the deciles by size. The data is quarterly data of US banking firms filing Consolidated Report of Condition and Income (Call report) with the Federal Deposit Insurance Corporation (FDIC) and listed in NYSE or NASDAQ. The data range is from 1992q3 to 2015q4. Panel A. Profitability performance for all banks for the period : 1992q3-2015q4 All Banks Largest Banks Small to Medium Banks Return on Equity Tier-1 Capital Ratio -0.488* 0.016-0.052 0.331-0.548* 0.014 Cash Ratio 0.369* 0.024 0.031* 0.030 0.631** 0.006 Debt Ratio 0.070 0.500 0.033* 0.045 0.110 0.351 Market Beta -0.294 0.852-0.434 0.211 0.665 0.721 Total Volatility of Returns -28.822 0.519-96.043*** 0.000-36.959 0.463 Prime-Fed Funds Spread -8.615 0.355-5.729*** 0.000-8.913 0.394 48M Consumer-Prime Spread 0.002 0.999 0.096 0.787 0.004 0.999 30Y Mortgage-Fed Funds Spread 0.117 0.891-0.310* 0.024 0.186 0.845 Constant 32.472 0.233 23.817*** 0.000 32.095 0.295 N 19691 2247 17444 Prob>F 0.1429 0.0000 0.0858 Adjusted R-squared 0.0002 0.1133 0.0003 Panel B. Profitability performance for all banks for the Pre-Gramm-Leach-Bliley period: 1992q3-2000q1 All Banks Largest Banks Small to Medium Banks Return on Equity Tier-1 Capital Ratio -0.022* 0.029 0.102 0.253-0.013 0.197 Cash Ratio 0.009 0.284 0.004 0.803-0.003 0.799 Debt Ratio -0.010 0.076 0.042 0.108-0.014* 0.016 Market Beta 0.398*** 0.000-0.453 0.302 0.259* 0.015 Total Volatility of Returns -32.842*** 0.000-94.311** 0.007-28.110*** 0.000 Prime-Fed Funds Spread -10.451*** 0.000 5.957 0.126-12.242*** 0.000 48M Consumer-Prime Spread 0.166 0.256 0.611 0.192 0.146 0.345 30Y Mortgage-Fed Funds Spread 0.276*** 0.000-0.259 0.246 0.328*** 0.000 Constant 34.923*** 0.000-11.499 0.323 40.035*** 0.000 N 3503 397 3106 Prob>F 0.0000 0.0380 0.0000 Adjusted R-squared 0.0587 0.0211 0.0667 21
Table 3. Continued Panel C. Profitability performance for all banks for the Gramm-Leach-Bliley period: 2000q2-2007q3 All Banks Largest Banks Small to Medium Banks Return on Equity Tier-1 Capital Ratio -0.011 0.243-0.197** 0.010 0.006 0.494 Cash Ratio -0.001 0.941 0.033* 0.032-0.002 0.874 Debt Ratio -0.012** 0.006-0.007 0.684-0.018*** 0.000 Market Beta 1.005*** 0.000-4.549*** 0.000 0.988*** 0.000 Total Volatility of Returns -64.538*** 0.000 56.071** 0.006-61.500*** 0.000 Prime-Fed Funds Spread -2.597 0.351-10.530 0.248-2.544 0.375 48M Consumer-Prime Spread -0.245* 0.029-0.211 0.557-0.212 0.068 30Y Mortgage-Fed Funds Spread 0.075** 0.006-0.227* 0.014 0.080** 0.005 Constant 11.476 0.167 41.764 0.125 11.030 0.196 N 4824 484 4340 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.0648 0.1546 0.0633 Panel D. Profitability performance for all banks for the Great Recession period: 2007q4-2009q2 All Banks Largest Banks Small to Medium Banks Return on Equity Tier-1 Capital Ratio 0.666*** 0.000 0.215 0.310 0.758*** 0.000 Cash Ratio -0.271* 0.017 0.037 0.459-0.581*** 0.000 Debt Ratio 0.045 0.365 0.072 0.055 0.013 0.810 Market Beta 0.815 0.289 1.996 0.115-0.012 0.989 Total Volatility of Returns -128.45*** 0.000-141.25*** 0.000-116.22*** 0.000 Prime-Fed Funds Spread -2.096 0.605 7.317* 0.029-2.754 0.535 48M Consumer-Prime Spread 3.583** 0.010 4.844*** 0.000 3.665* 0.017 30Y Mortgage-Fed Funds Spread -0.652 0.453-0.391 0.599-0.772 0.416 Constant 6.703 0.524-19.986* 0.025 9.568 0.407 N 3151 298 2853 Prob>F 0.0000 0.0000 0.0000 Adjusted R-squared 0.0263 0.2049 0.0283 22
Table 3. Continued Panel E. Profitability performance for all banks for the post-great Recession period: 2009q3-2011q4 All Banks Largest Banks Small to Medium Banks Return on Equity Tier-1 Capital Ratio -1.815* 0.037 0.894*** 0.000-1.894* 0.042 Cash Ratio 1.524* 0.054-0.058 0.441 2.033* 0.035 Debt Ratio 0.460 0.410 0.049 0.533 0.633 0.314 Market Beta 1.151 0.873 0.324 0.790 3.756 0.655 Total Volatility of Returns -92.490 0.599-126.31*** 0.000-122.174 0.527 Prime-Fed Funds Spread 2.483 0.978 2.758 0.822 1.964 0.984 48M Consumer-Prime Spread -8.115 0.491-3.377* 0.034-8.969 0.494 30Y Mortgage-Fed Funds Spread 18.797 0.264 4.319 0.086 21.297 0.254 Constant -78.082 0.794-34.779 0.396-90.629 0.785 N 3957 394 3563 Prob>F 0.2679 0.0000 0.2262 Adjusted R-squared 0.0005 0.0675 0.0007 Panel F. Profitability performance for all banks for the Dodd-Frank period: 2012q4-2015q4 All Banks Largest Banks Small to Medium Banks Return on Equity Tier-1 Capital Ratio -0.171* 0.031 0.028 0.524-0.206* 0.023 Cash Ratio 0.029 0.567 0.027* 0.021 0.073 0.326 Debt Ratio 0.096* 0.025 0.034* 0.020 0.125* 0.016 Market Beta 0.434 0.459-2.361*** 0.000 1.275 0.086 Total Volatility of Returns 36.637 0.175-35.658* 0.034 41.817 0.180 Prime-Fed Funds Spread 24.287 0.323-13.216 0.119 31.037 0.288 48M Consumer-Prime Spread 0.469 0.801 0.200 0.757 0.488 0.825 30Y Mortgage-Fed Funds Spread 0.408 0.797 0.325 0.558 0.303 0.872 Constant -75.258 0.296 44.322 0.075-96.412 0.260 N 4256 674 3582 Prob>F 0.0155 0.0000 0.0053 Adjusted R-squared 0.0026 0.1106 0.0039 Legend: * 5% significance, ** 1% significance, and *** 0.1% significance. 23