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The Real Effects of Universal Banking: Does Access to the Public Debt Market Matter?

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Abstract

I analyze the impact of the formation of universal banks on corporate investment by looking at the gradual dismantling of the Glass-Steagall Act’s separation between commercial and investment banking. Using a sample of US firms and their relationship banks, I show that firms curtail debt issuance and investment after positive shocks to the underwriting capacity of their main bank. This result is driven by unrated firms and is strongest immediately after a shock. These findings suggest that universal banks may pay more attention to large firms providing more underwriting opportunities while exacerbating financial constraints of opaque firms, in line with a shift to a banking model based on transactional lending.

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Notes

  1. See also, for instance, Financial Times (2012).

  2. The provisions of the Glass-Steagall Act restricting banks’ ability to hold equity stakes in borrowing firms remained in place (e.g., Banerji et al. 2002). The study of this facet of universal banking activity is thus outside of the scope of this paper.

  3. Focusing on Japan, Takahashi (2014) investigates how universal banking affects outside investors by looking at earnings forecasts by commercial bank-affiliated analysts.

  4. For an overview of this literature, see Chodorow and Reich (2013, 2019).

  5. See, for instance, “National Treatment Study: Report to Congress on Foreign Government Treatment of U. S. Commercial Banking and Securities Organizations” by the United States Treasury Department, pp. 29-30.

  6. See, e.g., Kwan (1997), Narayanan et al. (2004), and Federal Register, Volume 61, Number 251, pp. 68750-68751.

  7. The bank holding companies that obtained this authorization were Citicorp, J.P. Morgan & Co., and Bankers Trust.

  8. See Federal Register, Volume 61, Number 251, pp. 68750-68756.

  9. See Federal Register, Volume 62, Number 166, pp. 45295-45307.

  10. See https://www.federalreserve.gov/boarddocs/press/bhc/1998/19980923/19980923.pdf.

  11. Carow et al. (2011) provide a detailed description of the events leading to the enactment of the Financial Services Modernization Act.

  12. Moreover, as argued by Kanatas and Qi (2003), universal banks, thanks to cost advantages due to information monopolies, might “lock in” borrowers jointly offering lending and underwriting services, thus increasing their bargaining power with client firms (tying practices). However, Calomiris and Pornrojnangkool (2009) find limited evidence of such practices.

  13. Similarly, Yasuda (2005) documents that public debt issues underwritten by relationship lenders enjoy lower fees. Schenone (2004) shows that IPOs underwritten by relationship lenders are less prone to underpricing.

  14. Though some firms have multiple bank relationships, I find that on average the main bank acts as the lead bank on 92% of total outstanding loans.

  15. When the dependent variable is investment, the internal cash flow is scaled by lagged fixed assets. For other dependent variables, it is scaled by lagged total assets in line with Chen and Chen (2012).

  16. Firm-bank fixed effects are defined based on the eventual parent entity the bank belongs to as of the end of the sample period, to better account for potential anticipation of mergers.

  17. Throughout the empirical analysis, I estimate regressions models using the Stata package REGHDFE by Correia (2018).

  18. Note that the coefficients for Junkf,b and Unratedf,b cannot be estimated, because they are absorbed by bank-firm fixed effects.

  19. I identify the lead arranger following Ivashina (2009).

  20. In case multiple banks have the same outstanding balance in a given period, as a tie-breaking rule, the firm-period is assigned to US commercial banks.

  21. If a firm’s total outstanding loan balance goes to zero, I keep it in the sample for three years afterwards (if available in Compustat) to fully capture the effect of underwriting capacity shocks on corporate policies. This adjustment also allows me not to discard firm-years in between two different lending relationships.

  22. In Table OA.1 of the Online Appendix, by examining bond issues of US firms, I do not find clear evidence that the rise of universal banking made it easier for small and opaque borrowers to access the public debt market.

  23. Furthermore, Table OA.2 of the Online Appendix studies the consequences of mergers increasing relationship banks’ underwriting capacity for other corporate outcomes, showing an increase of cash holdings driven by unrated firms (consistent with a precautionary motive). Table OA.2 of the Online Appendix shows that the baseline results are robust to several sample restrictions.

  24. It is worth noting that CIQ starts reporting the breakdown of total debt by type only from 2001, so that the years in which most of the universal banks emerged are not covered.

  25. Loan-level specifications feature year, Fama-French 30 industry, and loan type fixed effects. The control variables include the loan’s maturity, syndicate size, the firm’s assets, and its asset tangibility, all measured at the time of origination of the loan.

  26. Deal-level specifications feature year and Fama-French 30 industry fixed effects. The control variables include the deal’s amount and maximum maturity, syndicate size, the firm’s assets, and its asset tangibility, all measured at the time of origination of the deal.

  27. Chen and Vashishtha (2017) make a similar point by showing that banks after mergers – potentially disrupting lending relationships – rely more on hard information and thus induce borrowers to disclose more information to the market. At the same time, banks involved in M&As increase monitoring based on hard information through an increase of financial covenants in loan deals.

  28. Neuhann and Saidi (2018), in a difference-in-differences setting, compare firms taking loans from universal banks at any point in time to other firms before and after 1996, the year in which the regulation was proposed by the Board. Thus, in their analysis of firm-level productivity and investment they estimate long-run effects of the deregulation, whereas here I only look at short-term effects defining the treatment group based on loans originated before the final implementation of the regulation in 1997.

  29. Geyfman and Yeager (2009) use these data to study the relation between banks’ expansion into the underwriting market and their exposure to systematic risk.

  30. I exclude foreign bank groups with a grandfathered securities subsidiary, as they were not subject to Section 20 of the Glass-Steagall Act.

  31. Unreported tests show that the results obtained using a treatment definition based on Bhargava and Fraser (1998) are line with those obtained using the preferred treatment definition.

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Acknowledgments

This paper is based on my dissertation at the École Polytechnique Fédérale de Lausanne. I am grateful to my advisors Rüdiger Fahlenbrach and Erwan Morellec for their guidance and constant support. I would also like to thank the Editors (Haluk Ünal and Steven Ongena), an anonymous referee, Shan Ge, Christoph Herpfer, Giang N. Hoang, Michael Koetter, Farzad Saidi, René M. Stulz, and Philip Valta for helpful comments and stimulating conversations. Part of this research was completed while I was visiting the Fisher School of Business, The Ohio State University.

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Colonnello, S. The Real Effects of Universal Banking: Does Access to the Public Debt Market Matter?. J Financ Serv Res 61, 77–110 (2022). https://doi.org/10.1007/s10693-020-00340-x

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