Philip E. Strahan

Entrepreneurship and Bank Credit Availability

The literature is divided on the expected effects of increased competition and consolidation in the financial sector on the supply of credit to relationship borrowers. This paper tests whether policy changes fostering competition and consolidation in U.S. banking helped or harmed entrepreneurs. We find that the rate of new incorporations increases following deregulation of branching restrictions, and that deregulation reduces the negative effect of concentration on new incorporations. We also find the formation of new incorporations increases as the share of small banks decreases, suggesting that diversification benefits of size outweigh the possible comparative advantage small banks may have in forging relationships.

Risk Management, Capital Structure and Lending at Banks

We test how active management of bank credit risk exposure through the loan sales market affects capital structure, lending, profits, and risk. We find that banks that rebalance their CI they also make more risky loans (loans to businesses) as a percentage of total assets than other banks. Holding size, leverage and lending activities constant, banks active in the loan sales market have lower risk and higher profits than other banks. We conclude that increasingly sophisticated risk management practices in banking are likely to improve the availability of bank credit but not to reduce bank risk.

Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy

Hedge funds using Lehman as prime broker faced a decline in funding liquidity after the September 15, 2008 bankruptcy. We find that stocks held by these Lehman-connected funds experienced greater declines in market liquidity following the bankruptcy than other stocks; the effect was larger for ex ante illiquid stocks and persisted into the beginning of 2009. We find no similar effects surrounding the Bear Stearns failure, suggesting that disruptions surrounding bankruptcy explain the liquidity effects. We conclude that shocks to traders funding liquidity reduce the market liquidity of the assets that they trade.

Do Regulations Based on Credit Ratings Affect a Firm's Cost of Capital?

In February 2003, the SEC officially certified a fourth credit rating agency, Dominion Bond Rating Service (DBRS), for use in bond investment regulations. After DBRS certification, bond yields change in the direction implied by the firms DBRS rating relative to its ratings from other certified rating agencies. A one notch better DBRS rating corresponds to a 39 basis point reduction in a firms debt cost of capital. The impact on yields is driven by cases where the DBRS rating is better than other ratings and is larger among bonds rated near the investment-grade cutoff. These findings indicate that ratings-based regulations on bond investment affect a firms cost of debt capital.

Borrower Risk and the Price and Nonprice Terms of Bank Loans

Banks are in the business of lending to risky and hard-to-value businesses. This paper show that both the price and non-price terms of bank loans reflect observable components of borrower risk. As expected, riskier borrowers -- smaller borrowers, borrowers with less cash, and borrowers that are harder for outside investors to value -- pay more for their loans. In addition, the non-price terms of loans are systematically related to pricing; small loans, loans that are secured, and loans with relatively short maturity carry higher interest rates than other loans, even after controlling for publicly available measures of risk. This suggests that banks use both the price and non-price terms of loans as complements in dealing with borrower risk. To validate this interpretation, I also show that observably riskier firms face tighter non-price terms in their loan contracts. Loans to small firms, firms with low ratings, and firms with little cash available to service debt, for example, are more likely to be small, to be secured by collateral, and to have a short contractual maturity. Larger and more profitable firms are able to borrow on better terms across all three of these non-price dimensions.

E-Finance: An Introduction

E-finance is defined as “The provision of financial services and markets using electronic communication and computation”. In this paper we outline research issues related to e-finance that we believe set the stage for further work in this field. Three areas are focused on. These are the use of electronic payments systems, the operations of financial services firms and the operation of financial markets. A number of research issues are raised. For example, is the widespread use of paper-based checks efficient? Will the financial services industry be fundamentally changed by the advent of the Internet? Why have there been such large differences in changes to market microstructure across different financial markets?

Liquidity Risk and Syndicate Structure

We offer a new explanation of loan syndicate structure based on banks comparative advantage in managing systematic liquidity risk. When a syndicated loan to a rated borrower has systematic liquidity risk, the fraction of passive participant lenders that are banks is about 8% higher than for loans without liquidity risk. In contrast, liquidity risk does not explain the share of banks as lead lenders. Using a new measure of ex-ante liquidity risk exposure, we find further evidence that syndicate participants specialize in liquidity-risk management while lead banks manage lending relationships. Links from transactions deposits to liquidity exposure are about 50% larger at participant banks than at lead arrangers.

Comment on "Regulations, Market Structure, Institutions, and the Cost of Financial Intermediation" by Asli Demirguc-Kunt, Luc Laeven, and Ross Levine

Regulations, Market Structure, Institutions, and the Cost of Financial Intermediation, by Demirguc-Kunt, Laeven, and Levine (2004, this issue of JMCB) offers another piece to a larger puzzle constructed over the past ten years linking finance to economic performance. Starting with King and Levine (1993), over the past ten years an impressive array of facts has been assembled supporting the proposition that the size and efficiency of financial markets and institutions can have a causal impact on long-run growth. We now know, for example, that predetermined measures of financial market depth predict future growth; that industrial sectors relying heavily on external sources for cash to support investment benefit more from good finance than industries that rely on internally generated funds (Rajan and Zingales 1998); and that financial liberalizations seem to be followed by faster growth (Jayaratne and Strahan, 1996, Bekaert, Harvey, and Lundblad, 2003). The key challenge for this research has been to overcome the possibility that causality flows from the performance of the economy to the financial system, rather than the other way around. If financial resources seek the highest return, then we would expect a strong correlation between finance, return on capital, and economic growth. Where the economy leads, finance follows. The causality objection has been met by using timing, by emphasizing differential effects of finance across sectors, or by seeking plausibly exogenous policy or regulatory innovations. Any individual