Proceedings of 7th Annual American Business Research Conference
23 - 24 July 2015, Sheraton LaGuardia East Hotel, New York, USA, ISBN: 978-1-922069-79-5
Does Bank Liquidity Creation Translate into a Wealth
Effect for Borrowers?
Vinod S. Changarath
This paper revisits the loan announcement effect with a sample of loans from
2004–2009 and relates it to the core banking function of liquidity provision.
Recent criticism of past studies due to selection biases inherent in samples of
announced loans is shown to be unfounded and a small but significant positive
effect is found despite the adoption of a stratified sampling procedure that adjusts
for size and P/B. From an event perspective, it is the announcement of a loan
and not its activation that matters to the market. The sample offers strong
evidence that the banks which create the most liquidity are also the best
monitors. Firms are rewarded by the market for borrowing from such banks,
especially when the economy is doing well. Firms also tend to benefit from the
presence of more aggressive liquidity creating banks on the lower rungs of the
lending syndicate in a recession. Liquidity creating syndicates, in turn, earn
higher spreads, as do syndicates that lend to weaker borrowers. However, the
distribution of these spread gains is top-heavy within the syndicate. While the
market rewards borrowers, it punishes lenders for loans made in a growing
economy and/or to weak borrowers. The burden of this market ‘tax’ falls most
heavily on the lower ranked lenders in the syndicate but they are spared this tax
on loans made in recessions and/or to strong borrowers, hinting at a potential
competitive advantage that can be used to drive growth in difficult economic
conditions when the leading lenders curtail their advances.
Fields of Research: Finance, Banking
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Dr. Vinod S. Changarath, Assistant Professor of Finance, Division of Business, Main 517B,
Marymount Manhattan College, 221 E 71st St., New York, NY 10021,
Email: vchangarath@mmm.edu