Securitization, asset-backed commercial paper, information opacity, systemic risk and banks’ incentives to become large

This thesis consists of five chapters. In the first chapter I provide the introduction to the three essays examined in this thesis. In the second chapter I examine the impact of securitization on U.S. bank holding companies’ (hereafter BHCs) credit risk, credit risk taking, profitability, and capital level between 2001 and 2013. I also study the effect of the credit enhancements and liquidity provision on BHCs’ performance between 2001 and 2013. Since securitization is an endogenous decision, I use the treatment-effects model to control for the selection bias and observe a positive relationship between securitization and credit risk. I also find that securitization decreases BHCs’ profitability, but that securitization increases BHCs’ capital levels. Although it is possible that relatively risk-averse BHCs may consciously increase their capital buffer by retaining earnings, for example, I do not exclude the possibility that BHCs engaged in regulatory capital arbitrage to increase their capital level. Nevertheless, I find that use of securitization for capital regulatory purposes is mitigated by the risk-retention mechanism, i.e. credit enhancements and liquidity provision—banks had to keep the required capital for their extended guarantees. However, as was uncovered during the financial crisis, these credit and liquidity risk-reducing tools were not sufficient to prevent the recent turmoil in the securitization markets. The third chapter analyzes information opacity and systemic risk for the U.S. BHCs in the context of the asset-backed commercial paper (hereafter ABCP) between 2001:Q2 and 2012:Q4. Banks which set up costly ABCP conduits might have benefited from the regulatory capital relief and from providing financing alternatives to their clients. However, they faced costs in terms of the increase in information opacity through the provision of ABCP guarantees to BHCs’ own and third-party sponsored ABCP conduits. Furthermore, I observe that higher information asymmetry about BHCs’ value is associated with higher volatility of returns and also with higher systemic risk. In the fourth chapter I examine the proposal to limit bank size, which is known as tackling the banks’ incentive to become “too big to fail”, and also how this regulation to curb bank size may affect banks’ operating costs. I examine the relationship between the size of BHCs and BHCs’ operating costs from 2001:Q2 to 2014:Q1 to evaluate the costs that the newly suggested regulations on bank size might bring. I find that rules to limit the size of banks could significantly reduce economies of scale. In particular, if large and cost-efficient banks become split into smaller parts, data processing, legal fees, audit and consulting expenses, in addition to expenses on premises and automated teller machines (hereafter ATMs) are likely to increase. I also pay particular interest to legal fees and litigation settlement; I find evidence that larger banks, but not necessarily systemically more risky banks, face litigation charges more frequently. I do not find evidence that larger banks face a lower probability of being fined. This suggests that another phenomenon known as “too big to jail” may not be true, if the assumption is that the misconduct detection is perfect. I do, however, observe that penalties had little effect on BHCs’ profitability, and that some of the largest banks continuously face litigation charges. In turn, this could possibly imply that benefits from wrongdoing outweighed the costs. The fifth chapter summarizes major findings and concludes.