Three essays in empirical banking

This dissertation consists of three essays in empirical banking. In the first essay, I trace a fully-specified bank lending channel by using a trade shock, the law of the US granting China Permanent Normal Trade Relation Status (PNTR shock) in 2001. PNTR shock enables me to delineate a clear pathway of the shock’s transmission. Specifically, PNTR shock causes banks to terminate the lending relationship and tighten loan contracts with firms in the trade sector. Next, PNTR shock negatively impacts the bank’s performance via lending relationships. In response to the PNTR shock, banks hedge risk by holding more security assets. Finally, Banks pass this shock to non-trade sector firms in their loan portfolio. Using a micro-econometrics estimate, I infer that the PNTR shock leads to a 38.44 percent loan loss in the macroeconomy. Therefore, my empirical results highlight a bank’s special role as an inter-industry shock transmitter and have policy implications for the bank industry in the United States. In the second essay, co-authored with my advisor, Professor Darius Palia, and my committee member, Professor Christopher James, examine changes in the relationship between bank risk and the structure of bank CEO compensation following the enactment of the Dodd-Frank Act of 2010. Using a diff-in-diff methodology, we find significant differences between high and low pay-risk sensitivity banks. Specifically, we find differences in performance-vesting restricted stock awards, LTIPs, anti-hedging provisions and emphasis on non-financial measures of performance to increase after Dodd-Frank. Additionally, differences in time-vesting options grants and annual bonuses decreased. Instrumenting for these differences in compensation structure, we find that bank equity risk went down in the post-Dodd-Frank period, and this reduction is driven by high pay-risk banks. No significant effect is found for differences in bank equity performance. We find that asset returns were lower after Dodd-Frank, which suggests that debtholders bore the costs of lower risk taking. This is not surprising given that inside debt does not significantly change after Dodd-Frank. In the third essay, co-authored with my advisor, Professor Darius Palia and my committee member, Professor Kose John, we examine four loan contract terms, loan spreads, existence of collateral, and the number and strictness of covenants. Using a bank-level fixed effects model to control for time-invariant bank characteristics, we find that increases in vega are correlated with lower loan spreads, lower probability of the loan being secured, and a lower number and strictness of covenants. This suggests that CEOs reduce the riskiness of their loan portfolios when they have a higher pay-risk sensitivity. We also find that bank stock return volatility is strongly positively correlated with the risk of the loan contract terms, which suggests that the stock market understands the riskiness of the bank loan portfolio. Finally, we find that borrowers that are close to banks are charged higher loan spreads due to higher market power, and this effect is larger when the borrower is located further from the bank. Ph.D.Includes bibliographical reference