O. Emre Ergungor

Market- vs. Bank-Based Financial Systems: Do Rights and Regulations Really Matter?

Why are common-law countries market-dominated and civil-law countries bank-dominated? This paper provides an explanation tied to legal traditions. Civil-law courts have been less effective in resolving conflicts than common-law courts because civil-law judges traditionally refrain from interpreting the codes and creating new rules. Therefore, they are not very effective in extending their reach to matters that are not defined in the laws of the country. In a civil-law environment, where potential conflicts between borrowers and individual lenders inhibit the development of markets because the courts are unable to penalize defrauding borrowers, I show that banks can induce borrowers to honor their obligations by threatening to withhold services that only banks can provide. In other words, banks emerge as the primary contract enforcers in economies where courts are imperfect. Therefore, one would expect the civil-law countries to be bank-dominated. The empirical evidence presented in this paper supports this argument. Legal scholars argue that courts, acting as contract enforcers, need the guidance of laws to settle disputes. However, if there are alternative institutions in an economy, such as banks as described in this paper, that can enforce contracts without court intervention, I conjecture that there is relatively little need for investor rights compared to countries where the courts are the primary contract enforcers. In support of this argument, I show that creditor rights play no role in bank-development in civil-law countries but they promote banking growth in common-law countries where courts are more efficient. This paper also reveals that some of the earlier analyses that used a pooled sample of common-law and civil-law countries to test the effect of investor rights on bank development are misspecified. Therefore, in this analysis, common-law and civil-law countries are analyzed separately. I also show that prevailing economic conditions and legal traditions jointly determine the financial structure of a country. Therefore, although a countrys legal tradition is permanent, the organization of its financial system may fluctuate over time between a bank-dominated structure and a market-dominated structure. These results agree with the findings of Rajan and Zingales (2000) who showed that France and Germany were more market-friendly than U.S. and U.K. at the turn of the 20th century.

Systemic Banking Crises

Systemic banking crises can have devastating effects on the economies of developing or industrialized countries. This Policy Discussion Paper reviews the factors that weaken banking systems and make them more susceptible to crises.

Financial system structure and economic development: structure matters

This paper investigates how the structure of a financial system-whether it is bank- or market-oriented-affects economic growth. In contrast to earlier research, which indicated that the financial systems structure is irrelevant for growth, the author finds that countries grow faster when they have a flexible judicial system and more market-oriented financial systems.

On the Resolution of Financial Crises: The Swedish Experience

Sweden was one of the Scandinavian countries experiencing a severe financial crisis In the late 1980s and early 1990s. I review the policy choices and external factors that pushed the countrys financial system over the edge and then examine the steps the government took to make its resolution of the crisis one of the most successful in the past 30 years.

Community banks as small business lenders: the tough road ahead

This paper investigates the performance of community banks as small business (relationship) lenders. Theory suggests that competition reduces the benefits of bank–borrower relationships, making small business loans more risky and less profitable. In support of this theory, the evidence indicates that community banks’ performance deteriorates with increasing small business lending. Policies that encourage community banks to engage in more aggressive small business lending may lessen the soundness of these institutions.

Beyond the Transaction: Depository Institutions and Reduced Mortgage Default for Low-Income Homebuyers

We evaluate the effects of the lending institution and soft information on mortgage loan performance for low-income homebuyers. We find that even after controlling for bank selection, those who receive a loan from a local bank are significantly less likely to become delinquent or default than other bank or nonbank borrowers, suggesting an information effect. These effects are most pronounced for higher-risk borrowers, who likely benefit more from informational advantages of local banks. These findings support previous research on small business lending and provide additional explanation for observed differences in mortgage loan performance between bank and nonbank lenders.

Foreclosures in Ohio: Does Lender Type Matter?

Whether mortgages are originated mostly by depository institutions regulated by the Federal agencies or by less-regulated lenders does not seem to affect the foreclosure filing rate in Ohio’s counties. What seems to matter is whether the lenders have a physical presence in the market, in which case, foreclosure rates are lower.

Banking Relationships and Sell-Side Research

This paper examines disclosures by sell-side analysts when their institution has a lending relationship with the firms being covered. Lending-affiliated analysts’ earnings forecasts are found to be more accurate relative to forecasts by other analysts but this differential accuracy manifests itself only after the advent of the loan. Despite this increased earnings forecast accuracy, lending-affiliated analysts exhibit undue optimism in their brokerage recommendations and forecasts of long term growth. The optimism exists both before and after the lending commences. The evidence suggests that any insights into the covered firm via the lending relationship are employed by bank analysts in a selective manner. They appear unwilling to compromise on disclosures where ex post accuracy is clearly revealed, possibly to preserve their own personal reputation. However, they are overly optimistic on other disclosures where resolution is less readily verifiable, possibly to promote their lending client’s financial standing.

Premium Municipal Bonds and Issuer Fiscal Distress

Economic theory suggests that bond issuers of lower credit quality or higher opacity should be more likely to issue bonds with premium coupons (higher coupon rates relative to yields at issuance). Using a comprehensive data set of municipal bonds issued between 1992 and 2012 by more than 21,000 issuers, we show that this has not been the case until the early 2000s. We examine what changed in this market to bring it into greater alignment with economic principles. We argue that the Government Accounting Standards Board’s Statement 34 that required the use of accrual accounting rules in government financial reports deserves the credit.

Foreclosures: Relationship Lending in the Consumer Market and its Aftermath

Relationship lending theory suggests that lenders in close proximity to their borrowers might be the most efficient providers of screening and monitoring services, because the cost of collecting information declines with distance. The author presents evidence that ties bank branch presence to borrower performance in the low-income housing market, which provides support for this theory.