Interesting papers – April 2023

Long overdue, here are some papers recently accepted and forthcoming in JBF that I found interesting!

Klodiana Istrefi and co-authors study the informational content of speeches of Fed officials, focusing on financial stability, from 1997 to 2018. The authors construct indicators that measure the intensity and tone of this topic for both Governors and FRB presidents. When added to a standard forward-looking Taylor rule, a higher share of each speech dedicated to financial stability topics and the use of more negative words in this area is associated with monetary policy being more accommodating than implied by the state of the economy. The results are mainly driven by the sample prior to the global financial crisis and the information in speeches of FRB presidents (rather than the Federal Reserve Chair or governors). This paper is part of an emerging literature focusing on text analysis to get better insights into central banking and the role of financial stability concerns in monetary policy decisions.

Under the title “The more the merrier?” a team of ECB and Bank of England economists assess the value of multiple requirements in bank regulation using a novel empirical rule-based methodology. Exploiting two datasets with banks’ balance sheet data the year before the onset of crises, they apply simple threshold-based rules to assess how different capital and liquidity ratios individually and in combination might have identified banks that failed in the global financial and European sovereign debt crises. Their results support the case for a small  portfolio of different regulatory metrics: a portfolio of a leverage ratio, a risk-weighted capital ratio and a liquidity ratio such as the NSFR correctly identifies a high proportion of failing banks with fewer false alarms than any of these metrics individually. The relative usefulness of individual metrics also varies across different crises and regulatory regimes, highlighting how a portfolio approach may be more robust. Finally, they show that market-based capitalisation measures and loan-to-deposit ratios can provide complementary value in monitoring banks. Overall, this suggests that we indeed need a toolbox of regulatory metrics, not just one.

How do banks react in their capital structure decisions to competitive pressure? Allen Berger, Ozde Oztekin and Raluca Roman use the deregulation episode in the US to explore this question and find an increase in target capital for banks subject to higher competitive pressures.  One can think of two different reasons for that: the competitive defense mechanism captures the effects of geographic deregulation in increasing external competitive pressures on banks, whereas the competitive offense mechanism concerns the effects of geographic deregulation in enlarging banks’ capacity to compete in other markets. The authors find evidence consistent with effects of deregulation on bank capital through both mechanisms.

Several authors of the Bank of Spain use credit and corporate registry data to develop a taxonomy of zombie lending. Sustaining unviable firms through evergreening of loans has negative implications for resource allocation, productivity growth and aggregate growth.   The authors propose to define a distressed firm as one that is at least five years old and has both an interest coverage ratio –EBITDA over interest expense- lower than one and negative equity during at least three consecutive years. A firm is classified as zombie in year t if it is financially distressed and has received new credit from any bank in that year. Using these definitions, they identify a peak in distressed (zombie) firms in 2013 with 5.7% (2.1%) of all firms older than five years. Worryingly, the share of credit to zombie firms reached 16.4% during the same year. In regression analysis, the authors find that zombie firms exhibit less deteriorated ex-ante financial conditions than non-zombie distressed firms, are larger, have more liquid and more tangible assets (which can be pledged as collateral).  Finally, they confirm that zombie firms are less likely to exit the market than non-zombie distressed firms. An important contribution to an important topic given continuous fears of corporate fragility post-Covid and due to the energy crisis.