Research

We explore the relationship between credit risk and Environmental, Social, and Governance (ESG) dimensions using Supervised Machine Learning (SML) techniques on a cross-section of European listed companies. Our proxy for credit risk is the z-score originally proposed by Altman (1968). As potential explanatory variables, we consider an extensive number of raw ESG factors sourced from the rating provider MSCI. In the first stage, we demonstrate, using different SML methods such as LASSO and Random Forest, that a selection of ESG factors, in addition to the usual accounting ratios, helps explaining a firm’s probability of default. In the second stage, we measure the impact of the selected variables on the risk of default. Our approach provides a novel perspective to understand which ESG factors may be associated with the credit score of individual companies.

We evaluate the impact of the bail-in, the new resolution policy adopted in 2016 within the Bank Recovery and Resolution Directive, on the cost of funding for EU banks. We first estimate the change in spreads of credit default swaps on subordinated and senior bonds issued by EU banks through an event study around the period when the policy became effective. We find that risk premia of junior bail-in-able bonds raised more compared to senior bonds. The results, however, point to a great heterogeneity in the impact of the policy, both for individual banks and across countries, while a simple theoretical model suggests possible sources of this heterogeneity. We therefore regressed the abnormal values derived from the event study on bank characteristics and macroeconomic factors. We uncovered several factors explaining the larger cost of funds for some of the EU banks after the implementation of bail-in: banks with more problematic loans, less capitalized, and headquartered in countries with a higher risk premium on sovereign debt have experienced a larger rise in their funding costs when issuing subordinated bonds. Overall, our paper provides evidence that the adoption of bail-in has prompted a more accurate evaluation of bank risk by junior creditors, leading to an increase in the cost of funds for banks.

This paper assesses whether compensation practices for bank Chief Executive Officers (CEOs) changed after the Financial Stability Board (FSB) issued post-crisis guidelines on sound compensation. CEO compensation has become more sensitive to risk, with CEOs in the post-reform period at riskier banks receiving less variable compensation than those at less-risky peers. This was particularly true of investment banks. The changes in compensation practices are in line with the FSB’s Principles and Standards of Sound Compensation, although we do not detect significant differences between banks in jurisdictions that directly implemented the FSB guidelines compared to the other banks.

This paper analyzes the choice to interlock as a strategic decision. The choice to invite an executive from a rival company to sit on the board is analyzed within a duopoly where firms with hidden marginal costs of production compete in the product market. Interlocking directorates may emerge as an equilibrium outcome whenever firms gain by disclosing information on their private costs. The degree of efficiency of the companies together with the type of competition, either quantity or price, affects the occurrence and the form of the interlocking. The equilibrium outcome can take different forms: unilateral, bilateral interlocking or no interlocking. We also derive the welfare implications of the different equilibria and show that interlocking directorates are detrimental for the consumers even without assuming collusive behavior in the market. In addition we extend the analysis to three firms to explore the dynamic of networks formation.

In a model where firms rely on bank financing to build capacity, put up specialized productive assets as collateral, and then compete à la Cournot, we introduce a probability of default. We investigate how the number of competitors affects the equilibrium amount of bank credit and derive conditions under which an inverted U-shaped relationship occurs. On the one hand, more competitors enhance the resale value of collateralized productive assets. On the other hand, more competitors shrink firms’ profits and the resulting income that can be pledged to banks. We then extend the analysis to firms outside the Cournot industry that are willing to buy productive assets in liquidation and show that the equilibrium bank credit becomes monotonically decreasing in the number of competitors.

In this paper, we unveil a disregarded benefit of product market competition for firms. We introduce the probability of bankruptcy in a simple model where firms compete à la Cournot and apply for collateralized bank loans to undertake productive investments. We show that the number of competitors and the existence of outsiders willing to acquire the productive assets of distressed incumbents affect the equilibrium share of investment financed by bank credit. Using a sample of Italian manufacturing firms, mostly small- and medium-sized enterprises (SMEs), we found evidence showing that the degree of product market competition is positively correlated with the share of investment financed by bank credit only when outsiders are absent.

This paper studies the relation between CEOs' monetary incentives, financial regulation and risk in banks. We develop a model where banks lend to opaque entrepreneurial projects to be monitored by bank managers. Bank managers are remunerated according to a pay-for-performance scheme and their effort is not observable to depositors and bank shareholders. Within a prudential regulatory framework that imposes a minimum capital ratio and a deposit insurance scheme, we study the effect of increasing the variable component of managerial compensation on bank risk in equilibrium. We test the model's predictions on a sample of large banks around the world, gauging how the monetary incentives for CEOs in 2006 affected their banks' stock price and volatility during the 2007-2008 financial crisis. Our international sample allows us to study the interaction between monetary incentives and financial regulation. We find that greater sensitivity of CEOs' equity portfolios to stock prices and volatility is associated with poorer performance and greater risk at the banks where shareholder control is weaker and in countries with explicit deposit insurance.

In a model where banks play an active role in monitoring borrowers, we analyze the impact of securitization on bankers’ incentives across different macroeconomic scenarios. We show that securitization can be part of the optimal financing scheme for banks, provided banks retain an equity tranche in the sold loans to maintain proper incentives. In economic downturns however securitization should be restricted. The implementation of the optimal solvency scheme is achieved by setting appropriate capital charges through a form of capital insurance, protecting the value of bank capital in downturns, while providing additional liquidity in upturns.

This paper analyzes the optimality of multiple-bank lending, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending leads to higher per-project monitoring whenever the benefit of greater diversification dominates the costs of free-riding and duplication of effort. The model predicts a greater use of multiple-bank lending when banks have lower equity, firms are less profitable and monitoring costs are high. These results are consistent with some empirical observations concerning the use of multiple-bank lending in small and medium business lending.

In this study branching costs and competitiveness of European banks are measured by fitting a monopolistic competition model to a representative sample drawn from nine EEC banking industries in the period from 1990 to 1996. In the theoretical model, banks decide strategically the size of their branching network anticipating the degree of competition faced on interest rates. From the structural equations of the model an econometric test is derived in order to measure branching costs and degree of competition in banking services. The empirical analysis captures their changing over time together with the impact of various European directives aiming at deregulating the banking industry. Furthermore the study shows persistence of segmentation across EEC banking industries.

This paper provides a theory of diversification and financial structure of banks. It shows that by diversifying the bank portfolio and financing it with debt, the bank can commit to a higher level of monitoring. By linking the benefits of diversification to the costs, the paper derives an optimal size of the bank, which is bounded. The costs of diversification lie in the higher overload costs with which the banker is faced by monitoring more projects. The benefits of diversification lie in increasing the bank's owner's incentives to monitor the lenders.