Wednesday, 23 September 2009
Is there any evidence that bank bailouts will improve the real economy? This column uses micro-level evidence from the Japanese banking crisis to assess bank recapitalisation efforts. It says that bailouts do increase lending, but banks continue to lend to low-quality borrowers, and borrowers may hold the cash on their balance sheets rather than investing or hiring.
Mariassunta Giannetti Andrei Simonov
The desirability of bank bailouts is widely debated in academic and policy circles. Proponents argue that bank failures would destroy valuable information that banks have accumulated about their clients and lead to the collapse of the credit market and the disruption of economic activity. Others believe that creditworthy firms could easily substitute other sources of external finance for the failed banks and view bank bailouts as an unnecessary subsidy allowing unviable banks and their clients to stay afloat. Bebchuck (2008), Blanchard (2008), and Diamond and Rajan (2009) illustrate vividly the debate surrounding the implementation of plans for addressing the credit crisis in the US.
Whether bank bailouts benefit the real economy enough to justify their costs to the taxpayers is ultimately an empirical question. However, tackling this issue empirically is challenging because, plausibly, the resources that governments are willing to invest in bailouts and the means of intervention are related to the seriousness and the nature of the banking problems. It is thus arduous to come up with an evaluation of the counterfactual if only macroeconomic data are available. Existing work mostly analyses countries where different policies were applied through case studies without aiming to establish causal effects (Calomiris, Klingebiel, and Laeven, 2005).
Micro-evidence from Japan
In recent research, we exploit the Japanese banking crisis to evaluate the effects of bank bailouts on the clients of the banks (Giannetti and Simonov 2009). Not only do we quantify the effect of government interventions on firms' stock market valuations, access to credit, and employment and investment policies, but we also investigate the characteristics of the firms that benefit most. These distributional issues are crucial to evaluate the effects of bank bailouts on capital allocation.
The Japanese experience can provide helpful insights into the current economic situation for several reasons. First, there are some interesting analogies between the Japanese banking crisis and the current financial crisis (Hoshi and Kashyap, 2008). Not only did both crises originate in the burst of a real estate bubble, but the Japanese government pursued many different interventions in the response to the banking crisis that have parallels with the those currently being enacted by European governments and the US administration. In particular, some banks were recapitalised by the government, while others were induced to merge or to raise capital from private investors. Second, the availability of micro data allows an in-depth analysis of the causal effects of bank recapitalisations, made by the government or by private investors, and bank mergers engineered to avoid bank failures.
Our results show that government recapitalisations increase the value of bank clients, especially if they are highly dependent on bank financing. The effects are not only statistically significant but also large from an economic point of view: Upon the announcement of the recapitalisation, the value of firms that are clients of the recapitalised banks increases by 1% to 9%. After recapitalisations, banks extend larger loans to their existing borrowers, but the effects on the real economy are limited. Only firms that we classify as highly dependent on bank loans invest more than comparable firms that did not benefit from the recapitalisations of their banks. We find no effects on employment; many firms appear to use larger loans to increase the amount of cash on their balance sheets, probably for precautionary reasons.
The empirical evidence also suggests that recapitalisations allow banks to extend larger loans to low- and high-quality firms alike. Low-quality firms (such as real estate firms whose over-investment had contributed to the financial crisis) experience higher abnormal returns than other firms upon the announcement of their bank's recapitalisation, especially when recapitalisations are small and leave the bank insolvent. In addition, after some of the recapitalisations, real estate firms that are clients of the recapitalised banks decrease their assets and employment less than other firms with presumably stronger investment opportunities. This suggests that preventing bank failures to aid viable firms may come at the expense of further capital misallocation.
We also show that bank recapitalisations have similar effects on banks' lending policies whether they are performed by the government or private investors. Bank mergers on average, do not benefit bank clients, as they do not affect banks' overall propensity to lend but cause a reallocation of loans from the clients of the stronger bank to the clients of the weaker bank involved in the merger.
Finally, we explore to what extent our results may depend on the specific structure of bank-firm relationships in Japan. For instance, some banks entertain particularly close relationships with their clients either because they are the main bank or they hold equity in their clients. We find no evidence that the benefits of bank bailouts for bank clients or the effects on the allocation of capital between high- and low-quality firms depend on these factors. Therefore, we believe that our results can inform the current debate on the desirability of bank bailouts and their design.
Our results suggest that bank bailouts can be beneficial but have to be accurately designed to avoid capital misallocation. First, small recapitalisations that fail to re-establish bank solvency lead banks to renew loans to insolvent borrowers in order to avoid a write down in book capital. Second, if bank lending policies have originally impaired bank solvency, problems are unlikely to be corrected by a capital injection alone. It may thus be desirable to direct bank lending away from less productive industries.
References
Bebchuk, Lucien A. (2008), "A plan for Addressing the Financial Crisis�, The Economists' Voice, September 5.
Blanchard, Olivier (2008), "The Crisis: Basic Mechanisms and Appropriate Policies�, mimeo Massachusetts Institute of Technology.
Calomiris, Charles, Daniela Klingebiel and Luc Laeven (2005), "Financial Crisis Policies and Resolution Mechanisms: A Taxonomy from Cross-Country Experience�, in Patrick Honohan and Luc Laeven (Eds.), Systemic Financial Distress: Containment and Resolution, Chapter 2, Cambridge: Cambridge University.
Diamond, Douglas W. and Raghuram Rajan (2000), "A Theory of Bank Capital�, Journal of Finance 55, 2431-2465.
Giannetti, Mariassunta and Andrei Simonov (2009). "On the real effects of bank bailouts: Micro-Evidence from Japan,� EFA 2009 Bergen Meetings, June.
Hoshi, Takeo and Anil K. Kashyap, 2008, "Will the U.S. Bank Recapitalization Succeed? Lessons from Japan�, NBER Working Paper 14401.
