Monday, May 13, 2013

13/5/2013: Banks Reputation Matters... for Borrowers too

Why banks reputations matter outside the interbank funding markets and regulatory offices? A question that is, perhaps, somewhat distant for Irish bank zombies, but ultimately the answer is not. It turns out, bank's reputation matters to the corporate borrower. And it matters materially.

Here's an interesting paper on this from Ongena, Steven R. G. and Roscovan, Viorel (see link below). As usual, italics are my own.

The authors argue that "banks play a special role as providers of informative signals about the quality and value of their borrowers. [Which is sort of trivial, when considered on 'accept' vs 'reject' or 0:1 basis. A '0' or 'reject' loan application signal provides information to the firm and to investors when the latter can observe the outcome of an application that the firm might be not as credit worthy as previously believed.]

Such signals, however, may have a quality of their own as the banks' selection and monitoring abilities may differ. [In other words, here's the core hypothesis: take two banks. Bank A has a lower capacity to price risk inherent in the firm than bank B. Over time, bank A repetitional capital should be lower than bank B. Now, firm 1 applies for a loan with A and B and gets rejected by B and accepted by A. Another firm, call it firm 2, applies for same loan and get accepted by B. Clearly, if the quality differential between A and B are known to the market, information about firms 1 and 2 experiences in applying for loans should matter in valuing firms 1 and 2.]

Using an event study methodology, we study the importance of the geographical origin and organization of the banks for the investors' assessments of firms' credit quality and economic worth following loan announcements. Our sample comprises 986 announcements of bank loans to US firms over the period of 1980–2003.

We find that investors react positively to such announcements if the loans are made by foreign or local banks, but not if the loans are made by banks that are located outside the firm's headquarters state. Investor reaction is, in fact, the largest when the bank is foreign.

Our evidence suggest that investors value relationships with more competitive and skilled banks rather than banks that have easier access to private information about the firms. [Confirming the core hypothesis above]"

Which is yet more bad news for Irish banks and the corporates stuck with them... and another reason why the banks reforms should deal with reputational fallout of this crisis as much as with macroprudential risks and regulatory capital cushions.

Ongena, Steven R. G. and Roscovan, Viorel, Bank Loan Announcements and Borrower Stock Returns: Does Bank Origin Matter? (June 2013). International Review of Finance, Vol. 13, Issue 2, pp. 137-159, 2013.

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