Lending investments and the financial crisis palgrave macmillan studies in banking and financial institutions

Titles include : Elena Beccalli and Federica Poli editors BANK RISK, GOVERNANCE AND REGULATION Domenico Siclari editor ITALIAN BANKING AND FINANCIAL LAW Supervisory Authoriti

Series Editor: Professor Philip Molyneux

The Palgrave Macmillan Studies in Banking and Financial Institutions are national in orientation and include studies of banking within particular coun-tries or regions, and studies of particular themes such as Corporate Banking, Risk Management, Mergers and Acquisition The books’ focus is on research and prac-tice, and they include up-to-date and innovative studies on contemporary topics

inter-in bankinter-ing that will have global impact and inter-influence

Titles include :

Elena Beccalli and Federica Poli ( editors )

BANK RISK, GOVERNANCE AND REGULATION

Domenico Siclari ( editor )

ITALIAN BANKING AND FINANCIAL LAW

Supervisory Authorities and Supervision

Intermediaries and Markets

Crisis Management Procedures, Sanctions, Alternative Dispute Resolution Systems and Tax Rules

Dr Fayaz Ahmad Lone

ISLAMIC FINANCE

Its Objectives and Achievements

Valerio Lemma

THE SHADOW BANKING SYSTEM

Creating Transparency in the Financial Markets

Imad A Moosa

GOOD REGULATION, BAD REGULATION

Elisa Menicucci

FAIR VALUE ACCOUNTING

Key Issues Arising from the Financial Crisis

Ted Lindblom, Stefan Sjogren and Magnus Willeson ( editors )

GOVERNANCE, REGULATION AND BANK STABILITY

FINANCIAL SYSTEMS, MARKETS AND INSTITUTIONAL CHANGES

Gianluca Mattarocci

ANOMALIES IN THE EUROPEAN REITS MARKET

Evidence from Calendar Effects

Joseph Falzon ( editor )

BANK PERFORMANCE, RISK AND SECURITIZATION

BANK STABILITY, SOVEREIGN DEBT AND DERIVATIVES

Josanco Floreani and Maurizio Polato

THE ECONOMICS OF THE GLOBAL STOCK EXCHANGE INDUSTRY

Rym Ayadi and Sami Mouley

MONETARY POLICIES, BANKING SYSTEMS, REGULATION AND GROWTH IN THE SOUTHERN MEDITERRANEAN

Gabriel Tortella, Ruiz García and Luis José

SPANISH MONEY AND BANKING

Adrift in a Sea of Red Ink

Mario Anolli, Elena Beccalli and Tommaso Giordani ( editors )

RETAIL CREDIT RISK MANAGEMENT

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Lending, Investments and the Financial Crisis

Edited by

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Professor, Università Cattolica del Sacro Cuore,

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Lending, investments and the financial crisis / [edited by] Elena Beccalli, Federica Poli

pages cm.—(Palgrave Macmillan studies in banking and financial institutions)

Contents

Paola Bongini, Arturo Patarnello, Matteo Pelagatti,

and Monica Rossolini

2 The ‘Wisdom of the Crowd’ as an Antidote to the

Daniele Previati, Giuseppe Galloppo and Andrea Salustri

2.2 Crowdfunding defined: from policy orientations to

2.3 Different kinds of crowdfunding and some data about

2.6 Crowdfunding Attractiveness Index in the Euro Area 39

Elisa Giaretta and Giusy Chesini

vi Contents

4 The Role of Loan Dynamics and Structure for

Ewa Miklaszewska and Katarzyna Mikołajczyk

4.2 The role of credit and its structure for economic growth 79 4.3 Role and factors influencing credit for SMEs 82 4.4 Loan dynamics and structure in CEE in the pre- and

5 China’s Shadow Banking System and Its Lurking Credit

René W.H van der Linden

5.2 China’s debt concerns and subsequent policy responses 107 5.3 The nature of China’s shadow banking and a

5.4 The rationale behind the rapid expansion of China’s

5.5 The size and scope of China’s shadow banking system 117 5.6 Reasons for and against a potential crisis in the making 121 5.7 Preventive and remedial policy measures to tackle shadow

6 An Index of Bank Liquidity Creation: An Application to the Banking Systems of the Eurozone and the Liquidity Policy

Pierluigi Morelli, Giovanni B Pittaluga and Elena Seghezza

6.3 The trend of the liquidity needs of the banking systems

6.4 The way ECB faced banks’ liquidity needs in the recent

7 The Performance of Listed European Innovative Firms 157

Luisa Anderloni and Alessandra Tanda

8 Investment Strategies of Institutional Investors: An

International Comparison of Sovereign Pension and

Alberto Dreassi, Stefano Miani and Andrea Paltrinieri

8.2 Literature review and hypothesis development 185

8.5 Conclusions and policy recommendations 201

List of Figures

1.1 Floating rate bonds: the relationship between the cost

1.2 Fixed rate bonds: the relationship between the cost at

1.3 Floating rate bonds: the relationship between the cost

1.4 Fixed rate bonds: the relationship between the cost at

2.4 CFA Index 2013: household & internet skill 42

4.1 Annual growth rates of GDP and loans to non-financial

4.3 Annual average loan growth (CAGR), 2004–08 87 4.4 Loan structure in EU countries (loans as percentage of GDP) 89 4.5 Annual average corporate loan growth (CAGR) in CEE

4.6 Annual average household loan growth (CAGR) in CEE

4.7 Corporate loans within total loans in CEE

5.1 The relation between China’s domestic credit to private

sector (percentage of GDP) and its current account

6.2 Banking liquidity creation in the core countries and in

6.5 ECB interest rate on main refinancing operations 149 6.6 Assets and liabilities of the ECB towards the banks 150

6.8 Liquidity creation by the banks and ECB financing

8.1 Illustrative representation of SPRF, SSRF and other

List of Tables

1.1 Descriptive statistics floating rate issues 6

1.4 OLS regression results for floating rate instruments 11 1.5 OLS regression results for fixed rate instruments 13

3.2 Distribution of firms by number of firms involved per

3.3 Distribution of firms by number of regions involved

3.4 Distribution of firms by the scope of the contracts 66

4.1 Relationship banking and SMEs access to bank loans in CEE:

4.3 Loan composition in EU (loans as percentage of GDP) 88

4.5 Regression results calculated separately for each consecutive

4.6 Results for panel data model for all CEE countries 97 4.7 Results for panel data model: CEE sub-regions 98 4.8 Corporate loans growth rate – estimations results 99 4.9 Household loans growth rate – estimations results 100 5.1 Comparison between the Chinese and Western shadow

7.4 Distribution of IPO firms between main and alternative

7.9 Average risk-adjusted performance indexes 174

7.A.1 Monthly returns regression results using alternative risk

8.1 Sample of SPRF and SSRF (AUM December, 2012) 189

8.2 Median and mean values of dependent variables 193

8.3 Main descriptive statistics of dependent and independent

8.4 Pooled-OLS regression on strategic asset allocation

8.5 Pooled-OLS regression on strategic asset allocation

8.6 Pooled-OLS regression on strategic asset allocation

8.A.1 Largest SPRFs and SSRFs by size (AUM December, 2012) 203

8.A.2 Regression results of robustness test on emerging markets:

Preface and Acknowledgements

Lending, Investments and the Financial Crisis provides contemporary

studies on how the financial crisis affected the banks’ ability to lend money as well as the emergence of alternative methods of firms’ financing (including crowdfunding, financing via firms’ networks and venture capital) The volume also addresses issues related to investment strategies of institutional investors in the light of the financial crisis The focus is mainly on the European financial system (including Central and Eastern Europe), although attention is also devoted to the Chinese context These chapters were originally presented as papers at the annual conference of the European Association of University Teachers

of Banking and Finance (Wolpertinger 2014), which was held during 3–6 September 2014 at Università Cattolica del Sacro Cuore in Milan, Italy

In Chapter 1, Paola Bongini, Arturo Patarnello, Matteo Pelagatti and Monica Rossolini analyse the development of bank long-term funding

in Europe, the US and Japan over the period 2006–12 They document the impact of the subprime crisis and the subsequent sovereign crisis

on the volume, frequency of issuance, nature of instrument and cost

of bank bonds Systemic crises deeply impacted on the cost and ability of bank long-term funding, with different effects depending on the issue’s main features and the issuing bank’s main business model characteristics The macro conditions of the country in which banks operate have begun to become relevant since 2011, at the onset of the

avail-EU sovereign debt crisis, though differences among nationalities were appreciated by the market even before Indeed, markets did not fully appreciate the evaluation of credit risk made by rating agencies and did not price the bonds accordingly to their rating class

In Chapter 2, Daniele Previati, Giuseppe Galloppo and Andrea Salustri investigate the linkages between the standard lines of credit (financial intermediaries, public sector, private investors) and the recent devel-opment of the crowdfunding phenomenon They believe that crowd-funding activities, even if yet not significant in terms of volume, might play a major role in the future, complementing the traditional activi-ties of financial intermediation In support of their beliefs, they notice the establishment of several crowdfunding platforms operating at the global level, particularly in the USA and in the EU, and the relevance assigned to crowdfunding procedures in President Obama’s JOBS Act of

2012 and in a consultation on crowdfunding launched at the end of

2013 by the European Commission At the national level, they nize several peculiarities of crowdfunding activities, mostly related

recog-to donation and reward-based schemes, but also the disposals of the so-called Growth Decree 2.0 on the equity-based crowdfunding and the on-line consultation subsequently implemented by the Italian Securities and Markets Autorithy CONSOB The chapter aims to single out the (potentially) main determinants of the crowdfunding demand of funds

By using the available data at the European level, the authors develop

a Crowdfunding Attractiveness Index (CFA), with the aim to rank the crowfunding potential of different European countries

Chapter 3, by Elisa Giaretta and Giusy Chesini, provides evidence

on how firms’ networks are becoming increasingly important for searching technological innovation, growing in foreign markets, opti-mizing know-how, sharing R&D and achieving organizational synergies, allowing firms to join without losing their autonomy In this chapter the authors focus on the Italian context where the network contract has been recently introduced in the domestic legislation (article 3 of Italian Legislative Decree no 5/2009) After a description of the main aspects of the network contract, Chapter 3 aims to check whether or not firms that belong to networks present better financing conditions and better prof-itability For this purpose, they create a database of 4,391 Italian firms that have signed a network contract in the period 2009–12, comparing them with a control sample of non-networked firms using a statistical Probit model Then they investigate the characteristics of network contracts that involve the best performance for networked firms using

an OLS regression model They document that network contracts have

a positive effect on the financial characteristics and profitability of the firms In particular, firms belonging to small networks present better characteristics

In Chapter 4, Ewa Miklaszewska and Katarzyna Mikołajczyk show that, as a major consequence of the 2007–09 global financial crisis, banks operating in Central and Eastern Europe (CEE), both global corpo-rations and domestically-owned banks, have become increasingly risk-averse, which may negatively influence their credit policies, particularly towards corporations and SMEs In the long run, this may also adversely affect investment policies and economic growth in CEE countries Consequently, the main research question analyzed in this chapter is whether the CEE banking sector has been efficient in providing loans

to the enterprise sector, comprising both large and small companies,

in the pre- and post-crisis period In the empirical section, the chapter

xiv Preface and Acknowledgements

analyzes factors influencing corporate loans in CEE, using a database covering the period of 2004–13, aiming at researching whether loan dynamics and structure have a long-term impact on economic growth

in CEE countries

In Chapter 5, René W.H van der Linden investigates the reappearance

of substantial debt after 2008 and at the same time a rapid proliferation

of shadow banking in China associated with increasing financial risks, whereby the authorities fear the arrival of a new financial crisis This chapter analyzes the rationale behind some worrying recent develop-ments in China’s unstable financial system due to more financial liber-alization which has accompanied the growth of the shadow banking predominantly represented by wealth management and trust products The rationale and several pros and cons of China’s shadow banking are described including its main features in comparison with its Western peers This chapter explains the possible reasons for the increase in credit dependency of the Chinese economy and investigates the types of risks the shadow banks pose to the financial system It also gives several policy options to utilize the services of shadow banks in order to prevent

a possible credit crunch in the future

Chapter 6, by Pierluigi Morelli, Giovanni B Pittaluga and Elena Seghezza, aims at constructing a measure of liquidity creation that takes account, besides, as usual, the objective characteristics of assets and liabilities, also the type of bank holders Using this new indicator, they show the evolution of liquidity creation by Eurozone banking systems during the recent crises and how the ECB faced the liquidity risk

In Chapter 7, Luisa Anderloni and Alessandra Tanda examine the performance of European venture capital backed firms operating in the life science and technology industries at the IPO and in the long run Their empirical evidence shows that venture capital backed companies have a lower underpricing and suggests the important role of venture capitalists in softening asymmetries of information at IPO The differ-ences in performance of venture capital backed firms tend to disappear

in the long run, as confirmed by the analysis performed considering various specification of return and risk, as well as employing a three-factor market model approach

Chapter 8, by Alberto Dreassi, Stefano Miani and Andrea Paltrinieri, aims to assess the investment strategies and portfolios of two types

of institutional investors The crisis induced severe adverse effects on profitability, growth and stability of the financial sector At the same time, Sovereign Wealth Funds (SWFs) have increased in numbers and

in the global role of their investment activities, despite within a highly

heterogeneous sector Based on a sample of 12 Sovereign Pension Reserve Funds (SPRFs) and Social Security Reserve Funds (SSRFs), they analyze the effects of size, operational model, country development, fund’s experience and quality of disclosures on the strategic asset alloca-tion for the period 2007–12 Moreover, they investigate the impact of the sovereign debt crisis and the relevance of the ‘home-bias’ issue for both groups Their results suggest a more aggressive asset allocation for SPRFs, where funding relies on fiscal transfers and involves less external scrutiny, and a lower level of home investments, despite these entities may express other domestic strategic goals than retirement Finally, they

do not document major recent shifts in asset allocation induced by the crisis, whereas a reduced amount of home-country investments emerges after the triggering of the sovereign debt crisis

As editors we would like to thank all the authors for their tions We are also grateful to all the referees who acted as reviewers for the chapters published in this volume We thank all the conference participants for their active and constructive discussions during the presentations

Special thanks to Palgrave Macmillan and to Philip Molyneux (Series Editor) for the opportunity to edit the volume, and to the staff at Palgrave Macmillan, especially Aimee Dibbens and Grace Jackson, for the helpful comments and guidance

Finally, as conference organizers, we would like to thank Anthony Saunders, Professor at Stern School of Business, for giving a plenary speech at the conference on ‘Don’t forget the fees’, and the speakers at the Jack Revell Session on ‘Towards the European Banking Union’ (Paolo Angelini, Bank of Italy; Federico Ghizzoni, CEO at Unicredit; and Philip Molyneux, Bangor Business School)

Notes on Contributors

Luisa Anderloni is Professor of Corporate Finance in the Department

of Economics, Management and Quantitative Methods, Università degli Studi di Milano, Italy Her main research interests are venture capital and finance for innovation, overindebtedness and financial vulnerability

Elena Beccalli is Full Professor of Banking at Università Cattolica del

Sacro Cuore, Italy, where she is the Dean of the School of Banking, Finance and Insurance She is Visiting Professor of Accounting at the London School of Economics She is the author of books and articles

in the area of economics of financial institutions Her research interests include stochastic efficiency measurement, technology and perform-ance, mergers and acquisitions, and analyst forecasts

Paola Bongini is Full Professor of Banking at the School of Economics

and Statistics of University of Milan-Bicocca, Italy, where she teaches the modules Asset and Liability Management and Financial Institutions Management Her research interests include bank market structure, financial regulation, financial fragility, financial literacy and banking organization

Giusy Chesini is Associate Professor of Banking and Finance at the

University of Verona, Italy, where she specializes in the structure and regulation of international financial markets Her main research topics include the stock exchange industry, the evolution of financial systems, banking and risk management She often participates in Italian and international conferences, and she has written numerous papers and books on the above topics

Alberto Dreassi holds a PhD in Business Sciences from the University of

Udine, Italy, where he is Assistant Professor of Banking and Finance He

is a Core Faculty Member at the MIB-School of Management of Trieste and has taught at the undergraduate and postgraduate level, as well as to employees of banks and insurance companies His research interests include accounting, regulation and supervision of financial intermediaries

Giuseppe Galloppo is Assistant Professor of Financial Markets and

Institutions at Tuscia University, Viterbo, and a research fellow at the

School of Economics, Tor Vergata University of Rome He teaches banking and finance, with a particular focus on financial markets and institutions and risk methods He is a specialist in applying statistical techniques and methods for analyzing financial instruments and port-folio models and for assessing risk profiles of securities and financial assets portfolios

Elisa Giaretta is a research fellow at the University of Verona, Italy, from

where she received a PhD in Business Administration and Management She works in the ‘Polo Scientifico e Didattico di Studi sull’Impresa’, an academic centre focused on the analysis of Italian business Her research topics include asset management companies, private equity, firm networks and bank risks She has participated in Italian and interna-tional conferences on these subjects

Stefano Miani is Full Professor of Banking and Insurance in the

Department of Economics and Statistics, University of Udine His recent research topics include pension funds and pension systems, the regu-lation and monitoring of insurance companies and the regulation of financial markets and intermediaries

Ewa Miklaszewska is Professor of Banking and Finance at Cracow University of Economics and Associate Professor of Economics at the Jagiellonian University in Cracow She has held several visiting positions

in foreign universities including Polish financial regulatory institutions Her research interests focus on bank regulation and bank strategies

Katarzyna Mikołajczyk is Assistant Professor of Banking and Finance

at Cracow University of Economics Her main research interests relate

to transition economies and include the outcomes of privatization programmes, mergers and acquisitions, and the impact of structural changes in the banking industry on efficiency and stability

Pierluigi Morelli works in the Research Department of the Italian Bank

Association (ABI) where he is responsible for the econometric model

of the Italian economy and of the Italian banking system He ated in Statistics and Economics at the University of Rome ‘La Sapienza’

gradu-in 1988 From 1988 to 2009 he worked at the Centro Europa Ricerche (CER) As Research Director of the CER Monetary and Banking sector,

he was in charge of the econometric models of the Italian economy,

of the banking sector, and of the pension expenditure He has written numerous articles on monetary economics, banking, social security and the environment

xviii Notes on Contributors

Andrea Paltrinieri is a research scholar in Financial Markets and Instruments at the University of Verona His research topics include the evolution of financial systems, stock exchange merger in the emerging markets, asset management and institutional investors, with a particular focus on sovereign wealth funds

Arturo Patarnello is Full Professor of Banking and Dean of the School

of Economics and Statistics of the University of Milan-Bicocca, where he lectures on bank management His research interests and publications include bank business models, banking regulation and the credit rating industry

Matteo Pelagatti is Associate Professor of Economic and Business

Statistics in the Department of Economics, Management and Statistics

of the University of Milan-Bicocca His research interests include retical and applied statistics and econometrics with a strong focus on time series analysis, robust and nonparametric statistical procedures, quantitative finance, energy markets, business cycle analysis, and health econometrics

Giovanni B Pittaluga is Full Professor of Economics at Genoa University,

Italy Previously he was Associate Professor of Monetary Economics at Università Cattolica del Sacro Cuore, Milan (1991–94) and Economist

in the Research Department of the Bank of Italy (1983–88) He has been responsible for the budget of Regione Liguria (2000–02 and 2005–10) He

is the author of books and articles in the area of monetary economics His research interests include central banking, banking, inflation, inter-national political economy and economic history

Federica Poli is Associate Professor of Banking at the Catholic University

of Milan She holds a PhD in Business Administration from the University

of Venice Her main research areas pertain to bank internationalization, bank organizational models, financial distribution channels and finan-cial innovations She is the author of several publications, including book chapters and manuals on banking and financial intermediation, and research coordinator for the MA in International Trade Management

at the Catholic University of Milan

Daniele Previati is Full Professor of Financial Markets and Institutions

in the Department of Management of the University of Rome III, and professor at the SDA Business School, Bocconi University, Milan He has been teaching banking and finance for more than 30 years, with particular focus on bank management, strategy and organization in the

financial services industry and e-finance His main research interests relate to various perspectives on bank management: human resources management, intellectual capital, organizational change, stakeholder management, reputation and reputational risk, operational risk, credit management and finance for SMEs He has published widely in academic journals and books He has also acted as a consultant for banks and the Italian Central Bank on organization design and human resources management

Monica Rossolini is Assistant Professor of Banking and Finance at the

School of Economics and Statistics in the University of Milan-Bicocca She is also a researcher at the Bocconi Monitor on Public Private Partnership (MP3) Her research interests and publications include SME financing, venture capital and portfolio management

Andrea Salustri holds a PhD in Economics Since carrying out

post-doctoral research on market monitoring tools and structural reforms in Europe, he has focused on the connections among the financial crisis, territorial imbalances and local development in Italy Currently, he is working on crowdsourcing and crowdfunding models, with a specific focus on participation, agency and well-being; the role of makers, microfinance, non-profit institutions and SMEs in reviving economic development and growth; and the connections among human develop-ment, well-being and sustainability issues in a multivariate statistical framework

Elena Seghezza is an associate professor at Genoa University, Italy She

previously worked as an economist in the Department of Economic Affairs of the Italian Government and at the Organisation for Economic Cooperation and Development (OECD) She holds a PhD in International Economics from the Graduate Institute of International Studies, Geneva She has written articles on political economy, interest groups, inflation and international trade

Alessandra Tanda received a PhD in Financial Markets and Intermediaries

in 2013 She is a post-doc researcher in Corporate Finance in the Department of Economics, Management and Quantitative Methods, Università degli Studi di Milano Her research fields mainly relate to venture capital, finance for innovation and financial structure

René W.H van der Linden studied Economics at the University of

Amsterdam and is Lecturer in Economics, Banking & Finance at the InHolland University of Applied Sciences in Diemen and Haarlem, the

xx Notes on Contributors

Netherlands He was previously with the Erasmus University Rotterdam and the Amsterdam Academy for Banking and Finance, a collaborative venture between InHolland and the Free University of Amsterdam He has published several papers on the Chinese economy and banking

system and is co-author of the textbook European Business Environment:

Doing Business in the EU (2010)

1.1 Introduction

Banks finance themselves with a variety of sources, with different maturities and credit risk characteristics Heavy reliance on short-term wholesale funding in the years preceding the financial crisis, a distinc-tive characteristic of the Originate to Distribute (OTD) business model

in banking, turned out to be a source of subsequent problems

The subprime crisis, the collapse of the OTD business model and the ensuing regulatory reforms (Basel III), have highlighted the growing importance for banks to rely more on stable, long-term funding sources However, the financial crisis has led to a repricing of risks, with important effects on the demand side in the markets of long-term debt financing instruments The supply side is more eager to issue long-term debt than the willingness (or interest) of the demand side to absorb it Moreover, at least for Euro Area intermediaries, issuance and pricing behaviour has also been affected by the tensions in the markets of government debt

The aim of this study is to investigate the following questions: (1) how deeply systemic crises (subprime, sovereign crisis) impacted on the cost of bank long-term funding?; (2) were such effects tied to the issue’s characteristics – maturity, rating, volume – or to the issuing bank main specific characteristics – for instance, business model – or were they mainly dependent on the macro conditions of the country in which these banks operate?

In order to answer these questions, we collected information on banks’ long-term debt issuance for the years 2006–12 Our sample includes all bond issues by banks headquartered in Europe, the United States and Japan We document the impact of the subprime crisis and

1

How Difficult Is It to Raise Money

in Turbulent Times?

Paola Bongini , Arturo Patarnello, Matteo Pelagatti

and Monica Rossolini

2 Bongini, Patarnello, Pelegatti and Rossolini

the subsequent sovereign crisis on the volume, frequency of issuance, nature of instrument and cost of bank bonds

The analysis is based on a database created using DCM Analytics by Dealogic Our dataset includes detailed information on about 26,350 debt issuances by banks headquartered in France, Germany, Italy, Norway, Spain, Sweden, Switzerland, the United Kingdom, the United States and Japan, during 2006–12 The dataset represents 80 per cent of all issues in the above-mentioned countries

After a review of the relevant literature (Section 1.2), Section 1.3 describes the sample while Section 1.4 investigates the effects of the financial crises on the cost of long-term funds Section 1.5 concludes

1.2 Review of literature

Recent developments have led to important changes in bank funding models and patterns, namely the financial market turmoil that emerged

in the second half of 2007, the severe global financial crisis subsequent

to the collapse of Lehman Brothers in September 2008 and finally the unfolding of the financial crisis in the Euro Area into a sovereign debt crisis Two main trends are nowadays visible around the world, especially

in Europe/euro area: a higher cost of funding (both short- and long-term);

a different structure of liabilities, characterized by a sensible reduction of senior unsecured debt issuance and wholesale funding and an increasing portion of secured funding Overreliance on certain types of wholesale funding was a contributing factor to the global financial crisis: nowadays banks have a lower dependence on wholesale markets and are increas-ingly dependent on customer deposits This is a clear-cut and global change in funding patterns with respect to the pre-crisis period, though some geographical differences are notable Indeed, Euro Area banks are less able to attract new customer deposits, since their economies were hit to a greater extent by financial, real and sovereign debt crises; their recourse to central banking funding increased considerably in order to replace their higher pre-crisis dependency on wholesale funding

Such changes have inspired an increasing array of academic and tutional studies, mainly empirical, highlighting the relevance of liability side issues, beyond bank capital concerns Thereby, not only capital adequacy is under scrutiny, but also the whole structure of bank liabil-ities is analysed and assessed In fact, despite adequate capital ratios, many banks were faced with funding difficulties; moreover, strains in funding markets led to massive interventions by national and suprana-tional authorities as liquidity providers

In sum, research on bank funding structures concentrates on four main themes:

the relationship between bank funding patterns and financial

tures (IMF, 2013; Le Leslé, 2012)

the impact of the crisis on bank funding costs (CGFS 2011; Cardillo

3

and Zaghini, 2012; Bongini and Patarnello, 2012);

the analysis of funding cost advantaged deriving to (some) banks

4

benefiting from implicit, yet valuable, government guarantees (Schich and Lindh, 2012; Schich and Aydin, 2014; Cariboni et al., 2013; Zaghini, 2014 )

Studies are mainly focused on European banking systems, as funding risk has been one of the main problems of Euro Area banks since the starting of the sovereign debt crisis

Are bank funding structures relevant to financial stability? The answer

is positive, according to a study by the IMF (2013), which examined the relationship between bank funding characteristics and bank distress for

a broad range of emerging and advanced economies from 1990 through

2012 The results support the view that overall banking-sector stability requires that banking structures be stable, be diversified and involve less leverage Limiting mismatch between loans and deposits, i.e reducing the reliance on wholesale funding, is also important Higher reliance on short-term debt, in particular in the form of wholesale debt, is associated with an increase in bank distress Lower level of leverage and a higher diversification of funding sources contribute to bank stability

Since the crisis began, most banks have altered their funding tures to make themselves less vulnerable: decreasing reliance on inter-bank and wholesale funding and a shift towards more stable funding is deemed to contribute to overall stability However, policy concerns arise

struc-on account of the increasing reliance struc-on secured lending, which in turn increases the level of asset encumbrance A predominance of secured or collateralized funding may pose limits to bank lending activity and have

an impact on the composition of assets on banks’ balance sheets going forward (ECB, 2012)

Recent regulatory reforms prompted by the crisis and aimed at directly changing bank funding structures and loss-sharing rules across funding instruments 1 tend to reinforce a preference for liquid assets and a

4 Bongini, Patarnello, Pelegatti and Rossolini

reinforcement of asset encumbrance that would persistently affect banks’ asset holdings and their funding strategies (IMF, 2013; ECB, 2012) These reforms are likely to also impact the future cost of bank funding, already hit hard by the financial crisis and the spill-over of the sovereign debt crisis In particular, some regulatory-driven changes to funding structures (i.e more equity) combined with the reallocation of losses upon bank failure among debt-holders (i.e bail-in of creditors in resolution or depositor preference in liquidation) can produce changes

of bank funding costs which cannot be easily anticipated On the one hand, a larger loss-absorbing buffer makes debt safer and potentially cheaper On the other hand, bail-in powers and the possible introduc-tion of depositor preference laws, combined with high levels of asset encumbrance, magnify the expected losses that unsecured debt-holders will suffer in the event of a bank failure and will likely drive upwards the cost at issuance of this class of debt instruments

As a matter of fact, banks’ funding costs have faced a steady and substantial rise since 2009 Not only secured and unsecured debt spread have increased, due to perceived higher bank’s probability of default and ensuing expected losses, but also the price of retail deposits have been driven upwards by increased competition in the household segment of retail deposit markets which have made this source of funding more expensive than before Besides, the linkages between sovereigns and home banking systems affect significantly banks’ cost of funding Cardillo and Zaghini (2012) and Zaghini (2014), analysing the cost of bank bond at issuance, over the years 2006–11, for a sample of US, Euro Area and UK banks, show that in crisis periods the effects of a dete-rioration in (perceived) sovereign creditworthiness spill-over to home banks In a similar vein, the CGFS paper (2011) analysed the impact of sovereign risk on the cost of bank funding for a sample of 534 unsecured fixed rate senior bonds from 114 banks in 14 advanced economies, for the years 2006 and 2010 The main insight of the study is that in normal times the characteristics of the sovereign have virtually no effect on the cost of funding, which instead is closely related to issue-specific and bank-specific factors In crisis time, however, a large part of the spread at launch on bank bonds – nearly 30 per cent – reflects the conditions of the sovereign This percentage increases to 50 per cent for countries for which concerns over public finance conditions are most pronounced Such results imply a significant funding cost advantage for those banks residing in countries with sovereigns of high creditworthiness

Indeed, the issue of implicit guarantees for bank debt has received much attention since the onset of the global financial crisis An implicit

guarantee represents the expectation by market participants of future bail-outs upon failure of the beneficiary institution It is ‘implicit’ because the provider of the guarantee does not have to commit to bailing out the firm In the case of banks, (unwilling) providers of such guarantees are governments and public authorities in general, given the potential disruptive effects of bank failures Implicit guarantees imply a funding cost advantage for beneficiary banks: this in turn is conducive

to competitive distortions and can have important consequences for firms’ risk-taking decisions since beneficiary banks could be induced to take on too much risk (which makes the use of the guarantee, and tax-payers money, more likely) Implicit guarantees also imply an undesir-ably close link between the value of bank and sovereign debt, including potential negative feedback effects from the value of sovereign debt to the value of bank debt and vice versa (Schich and Lindh, 2012)

1.3 Sample characteristics

The analysis is based on a database created using DCM Analytics by Dealogic We collect information on about 26,350 debt issuances by banks headquartered in France, Germany, Italy, Norway, Spain, Sweden, Switzerland, the United Kingdom, the United States and Japan during 2006–12 The dataset contains data on the issuance and maturity dates, the nature of the instrument (MBA, ABS, plain vanilla, covered bonds, etc.), the coupon structure, the placement technique, the market of issu-ance, the issue rating, and the issuance yield and/or price We aggregate the issues on the basis of the issuer parent and selected banks who repre-sent 80 per cent of total deal value

Tables 1.1 and 1.2 show descriptive statistics respectively for floating and fixed rate issues

What is immediately evident is that both crises, especially the 2008–09 financial crisis, hardly hit bonds’ main pre-crises characteristics We document a general reduction in volume, maturities, number and rating

of bonds issued in the 2010–12 period is still one-third with respect to the pre-crisis period level On the contrary, the number of fixed rate issues decreases lightly during the subprime crisis and strongly increases

6 Bongini, Patarnello, Pelegatti and Rossolini

Table 1.1 Descriptive statistics floating rate issues

Pre-crisis (2006–07)

Subprime crisis (2008–09)

Sovereign crisis (2010–12)

Table 1.2 Descriptive statistics fixed rate issues

Pre-crisis (2006–07)

Subprime crisis (2008–09)

Sovereign crisis (2010–12)

Mean coupon value

(percentage)

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during the sovereign debt crisis, hitting a value higher than the one observed during the pre-crisis period The geographical partition of our sample shows that only in the US the number of bond issues diminishes steadily since 2006 In general, there seems to be a switch from floating bonds to fixed rate issues

Along with the number of issues, also the average size of issues dropped during the crisis periods by more than two-thirds in the case of floating rate bonds and by 40 per cent for fixed rate instruments Similarly, the maturity of long-term funds decreased during the subprime crisis and increased during the sovereign crisis

We observe a strong resizing of securitization activities (ABS/MBS), and a robust increase of medium-term note issues

The issuance of guaranteed bonds increases dramatically during the subprime crisis; such feature is less evident during the 2010–12 period Last but not least, the cost of bank bonds at issuance increases over time, signalling increased bank risk perceived by debt markets, given that in the same period reference rates (central banks’ rates and inter-bank rates) had an opposite direction 2 The spread of floating rate bonds witnesses the greatest increase during the subprime crisis, while the cost

at issuance of fixed rate bonds increases onwards since the beginning of the subprime crisis

1.4 The cost of bonds at issuance

Complementing the descriptive analysis above, an econometric exercise can provide additional insight into crises-related changes in bank debt issuance and issuance practices

The cost at issuance of bank bonds is connected, in the first place,

to the characteristics of the issue itself, namely: issuance maturity and size, rating and accompanying guarantees, either private – from the parent bank, for instance – or public – typically from the sovereign The cost of bonds could also reflect the characteristics of the parent bank: size, rating, capital adequacy, interbank market exposure, systemic rele-vance or type of business model chosen for its intermediation activity

In particular we distinguish among OTD and OTH (originate to hold) bank business models via a principal component analysis Finally, the cost could be influenced by the strength and soundness of the sovereign (CGFS, 2012)

In order to evaluate the contribution of these variables during the years under investigation, we run an Ordinary Least Squares (OLS) regression for each sample year

Given that markets receive financial statement information with a time lag, the parent bank’s financial data refer to the year previous to the issue

As said before, bank business models are evaluated via a principal component analysis which considers the typical ratios that are analysed

in the growing literature that, since the onset of the subprime crisis, has studied the main characteristics of the OTD and OTH models in banking (Ayadi et al., 2011; Altunbas et al., 2011; Aracne et al., 2013) In partic-ular, we considered the following characteristics: risk (loan loss reserves over gross loans); profitability (ROA and ROE); liquidity (liquid assets over deposits; liquid assets over total borrowings); efficiency (Cost to income ratio); funding gap (loans over deposits, loans over total borrow-ings); relevance of traditional intermediation activity (loans over total assets, net inter margin over total operating income) We also consid-ered bank funding patterns via the interbank ratio, which proved to be

a third important component by itself, and therefore it was considered

as an explanatory variable in our regression

Table 1.3 reports the results of the principal components analysis run for each year under examination We indicate in bold the variables more representative in each principal component and the relative sign The first component is clearly related to the ‘new’ model of bank intermediation known as ‘originate-to-distribute’ business model, char-acterized by a lower incidence of loans over total assets and a higher incidence of liquid assets This could be ascribed to an intense securiti-zation activity that provided the needed liquidity and reduced the need

Table 1.3 Principal component analysis

Comp.1 (Business Model)

Comp.2 (Profitability)

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to raise new deposits and/or new borrowings The revenue structure of such a model is also characterized by a lower relevance of net interest margin over total operating income The second component concerns bank profitability: it describes banks with higher ROA and ROE, higher efficiency and lower credit risk The two latter ratios contribute to increase overall profitability

Tables 1.4 and 1.5 report regression results for each year under study, separately, considering floating and fixed rate instruments Figures 1.1–1.4 explore the relationship between some variables of interest and the explanatory variable over the time span under inves-tigation It is clearly evident that since the beginning of the subprime crisis the premium paid on longer maturities increased steadily with a pronounced effect on those issues in 2009, where also a reduction in maturities is also evident for floating issues, for which the series stops at

20 years, instead of 30 years In more recent years (2012) the steepness

of the yield curve is returning to values similar to the pre-crisis period (2006)

As expected, the spread over AAA bonds increases as the issue rating decreases; this is particularly evident for floating rate issues in those classes just below investment grade (from BB+ and B+) during the worst period of the subprime crisis (2008) Similarly in 2011, at the height of the sovereign debt crisis, bonds with ratings in the area of BBB+ and BBB− were the most hit by an increase in the risk premium required

by the market For instance, a floating rate issue rated BBB in 2006 was paying 62 bps over AAA bond; in 2008 such a spread widened to 236 bps and to 359 in 2011 Such a likely relationship is less evident in fixed rate issues In fact, it seems as if markets did not fully appreciate the evalua-tion of credit risk made by rating agencies and did not price the bonds accordingly to their rating class

Similarly, when it comes to the rating of the parent bank, markets

do not always seem to consider it as relevant in influencing the cost of

bonds Issue rating paribus , it does not always hold true that the lower

the rating of the parent, the higher the cost at issuance

Country ratings do not influence the cost of floating rate bank bonds until 2011, when they start to exert a negative influence for those finan-cial institutions headquartered in countries with sovereigns rated below AAA In case of a sovereign rated AA+, it would cost the issuing bank a higher charge of 149 bps We also found significant country effects in the fixed rate bonds regressions starting from 2007 For instance, from

2008 till 2011 all European banks with the same rating of German banks faced higher long-term funding costs

T

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The dummy variable ‘guarantee’ analyses the effect of a specific contractualized support to the issue: in 2009 and 2011 such a support

is significantly different from zero and can be measured in an average reduction in the issuance premium of around 78 and 27 bps respectively for floating rate issues For fixed rate issues, it starts to be relevant in

2010 (especially if it is in the form of a public guarantee)

We now focus on two important characteristics of the parent bank: its size and systemic relevance Too-big-to-fail banks are supposed to enjoy a lower cost of debt (implicit subsidy), given their special status Such a result

is confirmed by our data only during the period 2007–09 In 2012, on the contrary, larger banks, measured by total assets, paid higher premiums with respect to their smaller peers Starting from 2011, in fact, the posi-tive effect of the implicit guarantee is limited to SIFIs, i.e those financial institutions that in 2011 the Financial Stability Board (FSB) recognized

as systemically important after applying the criteria set out by the Basel Committee on Banking Supervision (BCBS) to detect such institutions Capital adequacy (both considering a measure of regulatory adequacy and the inverse of the leverage ratio) exerts its positive effects on the cost of borrowing only after 2011

The interbank position does not seem to be informative for the pricing

of bonds, apart from 2011 with two contrasting effects depending on whether the issue is floating or fixed rate

Profitability is negatively associated with the premium paid on bonds:

a higher profitability reduces the cost at issuance

Finally, our measure of business model captures the effect of the different orientation of the bank towards the OTD business model For fixed rate issues, it shows a negative sign for all the periods under inves-tigation apart from the years when such a model was under scrutiny and criticized In fact in 2008 and 2009 banks with an OTD business model paid higher premiums on their long-term funding

We document the impact of the subprime crisis and the subsequent sovereign crisis on the volume, frequency of issuance, nature of instru-ment and cost of bank bonds

Systemic crises (subprime, sovereign crisis) deeply impacted on the cost

of bank long-term funding, which rose since the onset of the subprime crisis, signalling an increased perception of bank risk by debt markets, in

a period when reference rates (central banks’ rates and interbank rates) went in an opposite direction

In such a scenario, the regulatory framework (i.e the new Basel liquidity rules) seems to put additional burdens on banks’ funding poli-cies, requiring them to hold higher amounts of long-term resources to fund the illiquid part of their assets The higher this share, the higher the need to tap financial markets

In turn, as we document, financial markets prove some resistance to invest in longer maturities and increasingly ask for plain vanilla issues or for some form of risk mitigation of the credit risk Moreover, the macr-oeconomic environment in which banks operate becomes relevant since

2011, at the start of the EU sovereign debt crisis, though differences among nationalities were appreciated by the market even before

In this context, commercial banks seem to be more penalized than investment banks, thus suggesting future different behaviours in approaching bank bonds markets according to the business model adopted

Investment banks relying on an OTD business model are likely to be forced to raise funds through issues supported by some form of risk miti-gation that seems to be a preferred feature for bondholders – collateral-ized issues or covered bond issues have proved to be effective in limiting the cost of bond issuance

Traditional commercial banks will probably be induced to accept a structural increase of the cost of long-term funding These institu-tions may follow two strategies in the attempt of limiting the cost of bonds: differentiating the sources of long-term funds towards the retail segments and/or mitigating the perceived risk also by means of shorter maturities

Two further elements are expected to influence the fund-raising egies of banks, regardless of their business model

As an effect of recent systemic crises, markets are less inclined to accept the assessment of credit risk provided by rating agencies and set prices that passively reflect the rating classification of the bond issuance Ratings are no longer expected to be a proxy for the cost of bank long-term debt

Second, investors are increasingly worried about the quality of banks’ assets and tend to look not only to the quality of the loan portfolio but also to that of the trading book in order to assess the borrower’s credit