Within our recent working paper, we study the consequence of alternation in banking competition on firms’ personal bankruptcy rates within the U . s . States.
We all know from empirical evidence that banking competition typically decreases rates of interest, causes it to be simpler for firms to gain access to bank credit (Boyd and De Nicolo 2005), and results in economic growth (Jayaratne and Strahan, 1996). Kerr and Nanda (2009) further reveal that following instances of banking deregulation, exit and entry of firms increase, reinforcing Schumpeterian competition and growing firms’ innovativeness (Chava et al. 2013).
However, there’s also drawbacks associated with banking competition. Indeed, banking competition could reduce banks’ charter values, which would decrease incentives to watch and screen borrowers (Keeley 1990 Hellmann et al. 2000). In addition, banking competition could trigger a degeneration of lending relationships (Petersen and Rajan 1994 Petersen and Rajan 1995). Within our work, we reveal that personal bankruptcy rates of high-leverage firms rise after a rise in banking competition.
To document this result, we make use of the passage from the Interstate Banking and Branching Efficiency Act (IBBEA) being an exogenous shock to banking competition.
In the past, the united states banking sector continues to be very segmented. Banks accustomed to face limitations that avoided them from expanding their activities with other states. IBBEA deregulated the procedure to determine out-of-condition bank branches. However, even though the IBBEA removes federal limitations on interstate bank expansion, additionally, it enables states to find out how this really is implemented.
The United States Congress passed the IBBEA regulation in 1994, that was implemented by condition legislators within the following years. Throughout the implementation period, condition legislators could adopt provisions to limit competition from out-of-condition banks. Some states deregulated between 1995 and 1997, some states ongoing altering the IBBEA provisions until 2005. This led to a staggered implementation from the IBBEA, with various states imposing different limitations. Following a implementation from the IBBEA, the amount of branches established by out-of-condition banks dramatically elevated, thus growing competition within the banking industry (Manley and Grain 2008).
Exploiting the IBBEA implementation, we evaluate personal bankruptcy rates within the years that adopted. We discover that deregulation doesn’t impact all firms in the same manner. As the personal bankruptcy rates on most firms aren’t impacted by greater banking competition, high-leverage firms suffer much greater personal bankruptcy rates. We classify high-leverage firms as individuals that financial leverage is incorporated in the greatest quartile. Our findings are robust to various thresholds.
Figure 1: Personal bankruptcy Rates and IBBEA Implementation
A line chart showing Figure 1: Personal bankruptcy Rates and IBBEA Implementation
Figure 1 is definitely the average personal bankruptcy rates for low-leverage (blue line) and-leverage (eco-friendly line) firms in every quarter. Additionally, it shows the typical worth of the deregulation index (red line) within our sample. Condition legislators implemented the IBBEA in various quarters, with various barriers to entry that altered with time. Therefore, the typical deregulation index elevated with time.
We discover the personal bankruptcy rates of low-leverage firms didn’t increase following the implementation from the IBBEA, and just spiked throughout the us dot-com bubble. However, the personal bankruptcy rates of high-leverage firms possessed a rapid increase following IBBEA implementation. The rise in high-leverage firms’ personal bankruptcy rates follows IBBEA deregulation having a lag of the couple of quarters. The personal bankruptcy rates of high-leverage firms went from typically under 1% before IBBEA deregulation to some peak of just about 2.5% using the bursting from the us dot-com bubble.
Figure 2: Personal bankruptcy Rates pre and post IBBEA Implementation
A line chart showing Figure 2: Personal bankruptcy Rates pre and post IBBEA Implementation
The personal bankruptcy rates plotted in figure 2 reinforce evidence presented in figure 1. Indeed, figure 2 presents average personal bankruptcy rates for low-leverage (blue line) and-leverage (eco-friendly line) firms calculated within the quarters pre and post IBBEA deregulation. The typical personal bankruptcy rate for low-leverage firms didn’t change pre and post the rise in banking competition. However, the typical personal bankruptcy rate for top-leverage firms greater than bending following the IBBEA deregulation required place.
Within the paper, we further investigate results of debt maturity and bank lending on personal bankruptcy rates. We discover that personal bankruptcy rates of high-leverage firms were particularly exacerbated among firms rich in amounts of short-term debt. We discover that, following a IBBEA, syndicated loans for highly leveraged firms decreased. We document that syndicated loans which were taken with the objective of acquisitions and mergers decreased for such firms following the IBBEA. Our results claim that this may be damaging for firms’ survival over time, as large companies frequently depend on obtaining small , innovative firms.
Granted that banking competition generally increases economic growth (Jayaratne and Strahan 1996), we highlight some possible drawbacks of increases in banking competition. Concretely, we discover the credit chance of high-leverage firms increases following increases in banking competition. Credit risk is even greater for firms more uncovered to rollover risk (i.e., firms rich in amounts of short-term debt). This finding might be described by losing relationship lending for top-leverage firms in times of elevated banking competition. Our results claim that to avert this problem with elevated competition, policy makers should focus on measures to mitigate the chance of high-leverage firms during instances of deregulation.
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