Bangor University DOCTOR OF PHILOSOPHY Three essays on banking policy & government intervention in the US banking sector Ali, Mohamed Award date: 2019 Awarding institution: Bangor University Link to publication General rights Copyright and moral rights for the publications made accessible in the public portal are retained by the authors and/or other copyright owners and it is a condition of accessing publications that users recognise and abide by the legal requirements associated with these rights. • Users may download and print one copy of any publication from the public portal for the purpose of private study or research. • You may not further distribute the material or use it for any profit-making activity or commercial gain • You may freely distribute the URL identifying the publication in the public portal ? Take down policy If you believe that this document breaches copyright please contact us providing details, and we will remove access to the work immediately and investigate your claim. Download date: 07. Oct. 2021 Three essays on banking policy & government intervention in the US banking sector PhD Thesis 2019 Mohamed Ali Supervised by: Santiago Carbo-Valverde Saverio Stentel Stentella Lopes Yener Altunbas i Abstract This thesis presents evidence on how government intervention and regulation affect financial stability, and analyses how these public actions may affect the banking industry. The first empirical chapter discusses three major regulatory Acts: The Gramm-Leach-Bliley Act of 1999 (GLB), The Sarbanes-Oxley Act of 2002 (SOX) and The Dodd-Frank Act 2010 (DF) and focuses on the impact of off-balance sheet (OBS) activities on bank credit risk performance. Results show that in the presence of deregulation, banks with more OBS usage tend to have better credit risk performance. We employ different credit risk proxies include non-performing assets/total asset, non-performing loans/total loans, provision for loan losses/total assets and loan loss reserves/total assets. These yield more significant results than loan loss reserves. Market discipline is highlighted as an optimising transparency, and disclosure of the risks associated with an entity. It works in concert with regulatory systems to increase the safety and soundness of the market. The following chapter focuses on the Trouble Assets Relief Program (TARP) and tests whether Banking Holding Companies (BHCs) make use of internal capital market to repay TARP capital injection. This is based on the Source of Strength Doctrine. A revised version of this doctrine that was part of the American Reinvestment and Recovery Act (ARRA) of 2009. The Act defines this as the ability of a company that directly or indirectly owns or controls an insured depository institution to provide financial assistance to such insured depository institution in the event of financial distress of the insured depository institution. Agencies are empowered to require that such BHCs submit reports regarding its financial health. Results show that it is less likely for banks who are part of a BHC to repay the Treasury. Moreover, the initiation of the ARRA Act of 2009 had no effect on Treasury repayments. This suggests that BHC had a competitive disadvantage in repaying capital injections. The next chapter discusses the FDIC’s Temporary Debt Guarantee Program (TDGP) which was intended to increase liquidity within the industry. This chapter distinguishes between participant and non-participant institutions in the TDGP and examines the evolution of loan supply before the launch of the TDGP and after the injection of funding for unsecured senior debt. Results show that, as intended by the FDIC, TDGP decreases loan supply but increases liquidity available to participating depository institutions. Moreover, large banks did not have a stronger liquidity position compared to smaller banks; even though large banks participated more in bailouts and interventions. Depository institutions that took part in TDGP vi and TARP had lower liquidity positions and less loan supply than depository institutions that did not take part in TDGP nor TARP. This thesis contributes to the literature on financial stability and regulation of the banking industry in the United States of America (US), it explores three main regulatory Acts: Gramm-Leach-Bliley Act of 1999, Sarbanes-Oxley Act 2002, Dodd-Frank Act 2010. The data used in the thesis comes from the SNL database. The first empirical chapter results showed that de-regulation and the concurrent high OBS usage had a negative significant effect on credit risk. Considering that OBS activities help boosts bank’s fee income, the results show that with deregulation, banks despite their size and capital constraints partake in high OBS usage and tend to have better credit risk management than banks with less emphasis on OBS activity. Moreover, bank size and Capitalization were not associated with a change in credit risk as previous studies have assumed. We find a correlation between high OBS usage and strong banking performance, lending orientation and efficiency. Commercial banks can rely on investing in OBS activity to better allocate and manage credit risk. This, however, cannot be done under harsh regulatory standards; a deregulated industry will encourage banks to invest in OBS activities. The second empirical chapter focuses on the Troubled Asset Relief Program which aimed to improve the stability of the financial system and increase the availability of credit. This chapter aligns with the moral hazard theory, which could be described in two variations. Under the increased moral hazard theory, risk taking increases when there is a perceived increase in the probability of future bailouts. On the other hand, under the decreased moral hazard theory, the surge in capital from the TARP injections may reduce moral hazard, resulting in shifts into safer portfolios, affecting the overall loan and guarantee supplies. We found little difference between banks that entered TARP after executive pay restrictions that were added to the investments in February 2009. What we do find is that those latter participants were significantly smaller and had significantly less capital and more problem assets. The results showed that being part of a bank group did not result in a higher probability to repay TARP. In fact, bank groups were less likely to repay TARP, depository institutions did not show significance in post ARRA initiation, while accounting metrics such as performance and bank size had no significance on the financial institutions inclination to pay back TARP. Non-performing assets to total assets were a significant contributing factor at 5%, and we infer that regulated financial institutions with less non-performing assets to total assets are more likely to repay TARP. Results also reveal that when new government legislation was introduced in 2009, financial institutions were not motivated to pay back the Treasury. We vii contribute to the growing literature on TARP, as well as the literature on bank groups around financial crises and regulatory reforms. In the third empirical chapter, I analyse the main goals of the FDIC’s TDGP initiative. The FDIC gave depository institutions funds for senior unsecured debt. The FDIC wanted to accomplish a spike in liquidity within the industry by lowering the cost of funds and strengthening liquidity. Some allegations were made that TARP participants used funding from the TDGP to repay Treasury, while testing to see if large depository institutions had an advantage of liquidity compared to smaller competitors. The chapters results showed that TDGP participants had lower loan growth rates than non– participants. We find the same results in the second test in which we measured to see if TDGP participants had better loan supply measurements after the FDIC’s initiation in 2008. Both these test show that for every 1% increase in loan growth rate approximately there was approximately a 9% decrease for TDGP participants. Testing the model to incorporate all the hypotheses, we saw that TDGP participants had around 1 % less loan supply than non – participants, while TARP participants were also less likely to issue loans by around 2.5%. TARP and TDGP depository institutions had less liquidity and less loan supply, which could suggest that the funds received from one government intervention could have gone to repay the other as allegations suggested. viii Dedication I dedicate this work to the people who have made this possible. I start with my parents who have always supported me in all my endeavours and have made this journey possible I truly could not have reached where I am today without their support, I love you truly. My siblings (May, Ahmed, Ali) thank you for being you and accepting me, you are the best. My lovely children (Ali, Talia, Dalia) you are the torch that guides me in dark times, you always keep me smiling and pushing forward. My In-Laws (Parents In-Law, Hisham, Nada, Mohammed, Rana) thank you all for your support, thank you for being there and giving me you most precious gem. To the precious gem, to my better half, to my love (Zaina) my lovely wife, you have been my pillar, thank you so much for standing by me and sacrificing so much to see our family grow: you are the greatest. ix Acknowledgments I would first like to thank my supervisors, Professor Santiago and Dr. Saverio for all your patience, hard work and guidance you have provided me on this journey, you have taught me a lot, not only with my work but as great examples of academics and pursuers of knowledge, your kindness and thoughtfulness will always be remembered. I would also like to thank Professor John Williams and Professor Aziz Jaffar who have always given me great opportunities. I would like to thank the academic staff at Bangor University for providing excellent advice when needed and Professor Yener for starting the journey since my Masters degree. Finally, I would like to thank all the people I have meet in Bangor who have made my journey possible, especially to my friends in the PhD room.