Sumon C. Mazumdar

Regulations, lender identity and bank loan pricing

Abstract Earlier empirical studies indicate that contract costs associated with loan monitoring influence bank loan pricing and that all lenders may not be equally efficient monitors. We examine whether differential monitoring costs lead foreign banks to price loans to U.S. firms differently from their U.S. counterparts. In particular, we hypothesize that due to relatively lax regulations governing the operations of foreign banks in the U.S. prior to the passage of the FDIC Improvement Act (FDICIA) of 1991, such banks were required to invest less resources in loan monitoring and were thus less efficient, or more costly, monitors. If the regulations introduced through FDICIA were effective then these foreign banks would be forced to improve their monitoring functions which would, in turn, reduce the rates charged on foreign loans. We test these hypotheses regarding the influence of regulations and lender identity by examining the differential lending behavior of American and Japanese banks to U.S. companies, since Japanese banks comprise the major foreign banking presence in the U.S.

Impact of regulatory interactions on bank capital structure

This article examines a banks optimal capital structure and risk-taking decisions in a regulated environment. We focus on the interactive nature of the Feds collateralized discount window lending and the FDICs deposit insurance. Such regulatory interactions are shown to have nonlinear and nonuniform impacts on the banks leverage and risk-taking decisions. Thus, bank moral hazard problems may persist, even when banks are charged risk-adjusted deposit insurance premia and are also subject to market discipline through subordinate debt. Our analysis yields several new policy implications about the design and pricing of bank regulations.

An instantaneous control model of bank reserves and Federal funds management

Abstract Empirical evidence indicates that large banks are generally net buyers of Federal funds, while small banks tend to be net sellers. Asymmetric information, bank monopoly power, or risk-aversion arguments have been offered for this phenomenon. However, these models do not address the close link between bank reserves and Federal funds purchases as alternative means of liquidity management. Our stochastic control model focuses on this link and has three main implications: (1) it analyzes interaction between the above-mentioned influences; (2) it identifies three additional reasons for banks Federal funds activity; and (3) it examines the transmission of monetary policy in a dynamic framework.

A dynamic model of firewalls and non-traditional banking

Abstract Over the last decade, there has been considerable public debate in the U.S. on the need to maintain legal barriers (firewalls) between commercial and non-traditional banking. However, no theoretical model has yet been developed that examines the joint influence of various factors suggested, such as competition, production economies and regulatory subsidies that affect the banks incentive to undertake non-traditional activities. This paper applies a stochastic control model to examine the joint effects of these factors on a banks optimal investment decisions in non-traditional banking and develops some empirically testable hypotheses.

Loan covenants and corporate debt policy under bank regulations

Abstract Firms rely heavily on short-term, flexible bank credit to finance certain projects. Banks offer such “bridge” loans after imposing safety covenants on their clients. These covenants have important spill-over effects on the values of the firms other corporate debt liabilities and its equity value. In particular, we demonstrate that the firms senior bondholders derive a implicit value of protection by delegating the responsibility of monitoring the firm to the bank. We examine the firms optimal debt policy under alternative bank credit regimes. Since the banks choice of covenants may depend on the nature of the bank regulatory environment, our paper highlights the indirect link between bank regulations and corporate debt policy.

Analysing functional forms of stock returns

An a priori test developed by Elderton (1938) is used to examine the distributions of stock returns. The test is known as the kappa criterion (κ-criterion). There have been many functional forms of statistical distributions used to approximate stock return graduations over the past few years. The most prevalent class of distributions analysed have been from the Pearsonian family. The methodology presented is pre-test. The κ-criterion should be used as a way to initially limit the class of stock return distributions under consideration. The κ-criterion should not, and was not intended to be used as a definitive test of functional form choice.

Fairly Priced Deposit Insurance, Incentive Compatible Regulations, and Bank Asset Choices

This article provides incentive compatible regulations that support fairly priced deposit insurance in a competitive banking industry. If informational asymmetry exists between the regulator and banks regarding loan quality, but the regulator can observe actual loan rates charged, then imposing a capital requirement schedule that leads market loan rates to decrease in loan quality is shown to be incentive compatible. Competition in the loan market induces banks to be indifferent to all loans that satisfy a minimum acceptable quality and reject all riskier loans. The regulator could reduce the banking industrys riskiness by imposing stricter capital requirements that increase this minimum quality.