“Investment finance and the recovery”
Banco de Portugal & European Investment Bank
Lisbon, September 5th, 2014
João Santos
Federal Reserve Bank of New York
&
Nova School of Business and Economics
These are my views and not necessarily the views of the Federal Reserve Bank of New York or the Federal Reserve System
1
The Financing capacity of Non-Financial Corporations
and the recovery. What can Europe learn from the US?
Two lessons:
1.
Expand the lending capacity of the banking sector
2.
Expand the role of debt markets in the financial system
2
OVER THE YEARS, US BANKING SYSTEM HAS
EXPANDED ITS LENDING CAPACITY BY:
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A) Branching out of insured deposits
Funding, Top10
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20
10
20
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Funding, All
Deposits
Subdebt
Deposits
Subdebt
CP
FF and Repo
CP
FF and Repo
Other Borrowed Money
Other Borrowed Money
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A) Branching out of insured deposits (cont.)
Deposits, Top10
Insured Deposits
Insured Deposits
Uninsured Deposits
Uninsured Deposits
20
10
20
05
20
00
19
95
19
90
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95
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Deposits, All
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B) By attracting nonbanks into the lending business1
1
Bord, Vitaly and Joao Santos “The rise of the originate-to-distribute model and the role of banks in financial intermediation,”
Federal Reserve Bank of New York Economic Policy Review 21-34, 2012.
6
B) By Attracting nonbanks into lending (cont.)1
1
Bord, Vitaly and Joao Santos “The rise of the originate-to-distribute model and the role of banks in financial intermediation,”
Federal Reserve Bank of New York Economic Policy Review 21-34, 2012.
7
C) By promoting the securitization of corporate loans
(Annual volume of CLO issuance Billions US$)
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D) By fuelling the secondary loan market
The secondary loan market is a market in which a bank,
including lead banks and syndicate participants, sell an
existing loan (or part of a loan) after the origination date.
The US secondary loan market has experienced a spectacular
growth.



From a mere $8 billion in 1991, the trading volume of loans reached
$176 billion by 2005.
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BUT, US BANKING SYSTEM WAS NOT ABLE TO
MAINTAIN THE SAME LEVELS OF ACTIVITY
DURING THE LATEST FINANCIAL CRISIS
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For example, the syndicate loan market came to a halt
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THE EFFECT WAS LIKELY LESS PRONOUNCED (IN
DEPTH AND LENGTH) BECAUSE OF THE CAPITAL
INCREASES IN THE BANKING INDUSTRY
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AND, BORROWERS THAT WERE NOT DEPENDENT
ON BANKS FOR FUNDING WERE LESS AFFECTED
BY BANKS’ FINANCIAL DIFFICULTIES
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Compared to bank-dependent borrowers, borrowers
with access to debt markets experienced:



A smaller increase in the cost of bank lending1
A smaller reduction in the availability of bank credit2
A smaller increase in the cost of liquidity banks provide
through credit lines3
2
Santos, Joao “Bank loan pricing following the subprime crisis,‘ Review of Financial Studies, 2011.
3 Bord, Vitaly and Joao Santos ``Banks' liquidity and the cost of liquidity to corporations'' Journal of Money, Credit and Banking,, 2014..
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ADDITIONALLY, DURING THE CRISIS US FIRMS
WERE ABLE TO CONTINUE RAISING FUNDING IN
THE DEBT MARKETS, INCLUDING
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A) The commercial paper market
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B) The bond market
(Annual bond issuance by nonfinancials Billions US$)
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THE BENEFITS OF ACCESS TO DEBT MARKETS
GO BEYOND THOSE FIRMS EXPERIENCE DURING
CRISES PERIODS
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Benefits from access to the debt markets


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It gives firms the ability to raise funding from banks at lower
interest rates4,5
It gives firms more access to funding6
Winton, Andrew and Joao Santos ``Bank Loans, Bonds, and Information Monopolies across the Business Cycle,'' Journal of Finance, 2008.
Hale, Galina and Joao Santos ``Do Banks price Their Informational Monopoly?'' Journal of Financial Economics, 2009.
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6 Faulkender Michael and Mitchell Petersen “Does the Source of capital affect Capital Structure?” Review of Financial Studies, 2006
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Summing up: What can Europe learn from the US
when it comes to the financing of the corporate sector?
1. Expand the lending capacity of the banking sector

Increase the capital in the banking sector and expand the “originate-to-distribute”
function of banks
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Summing up: What can Europe learn from the US when
it comes to the financing of the corporate sector?
2. Expand the importance of debt markets

7
Euro eliminated exchange rate risk and regulatory restrictions on the currency exposures
of institutional investors in the euro area, bringing down underwriting costs, but markets
still play a limited role7, 8
Tsatsaronis, Kostas and Joao Santos “The Cost of Barriers to Trade: Evidence from the European Market for Bond Underwriting,” Cadernos
do Mercado de Valores Mobili´arios 24, 34-63, 2006 (Special issue of CMVM 15th anniversary).
8 Peristiani, Stavros and Joao Santos ``Has the US bond market lost its edge to the Eurobond market?'' International Review of Finance, 2010.21