The Effect of Banking Crisis on Bank-dependent Borrowers By Sudheer Chava and Amiyatosh Purnanandam Discussed by Chiwon Yom* * The views expressed here are solely of my own and do not necessarily reflect the views of Federal Deposit Insurance Corporation.

Research Questions Does bank’s financial health affect borrowers’ performance? Is the effect larger on bank-dependent borrowers without alternative sources of financing?

Methodology Use the Russian default and the outflow of capital from Brazil during the fall of 1998 as exogenous shocks to the U.S. banking sector. Use event study methodology to estimate abnormal market-model adjusted returns for firms with and without public debt (or CP rating) during the 16-day (August 17, 1998 – September 3, 1998) period. Run cross-sectional regressions of firm abnormal returns on a set of variables related to the financial and bank dependence characteristics of the firm.

Findings Bank-dependent firms experienced significantly lower announcement period abnormal returns compared to firms with public debt or CP rating. Negative returns are concentrated in bank-dependent firms with higher growth opportunities (proxied by higher market-to-book ratio and higher R&D expenses). Smaller losses for bank-dependent firms with greater financial flexibility (proxied by high unpledged collateral).

The crisis events allow the authors to control the direction of causality running between banking sector and borrower performance. Peek and Rosengren (2000) Ashcraft (2005) Ramirez and Shively (2005)

Does the event window represent a period when banking problems were widespread in the U.S.? This paper takes the view that banking problems were widespread, so that bank dependence was costly for a firm regardless of whether its bank was exposed to Russia or Brazil.

According to Gatev, Schuermann, and Strahan (2005), 2.2% of domestic banking organizations with assets over $1 billion were exposed to Russia.

Abnormal returns of the U.S. bank portfolios around crisis events (From Kho, Lee, and Stulz, 2000) Russia Exposed banksNon-exposed banks (day of devaluation)0.11[0.94]-1.40[0.06] (day before suspension of convertibility)-4.19[0.00]-0.70[0.36] (day of suspension of convertibility)-2.11[0.13]0.35[0.64] [0.02]1.65[0.04] Brazil Exposed banksNon-exposed banks [0.18]3.55[0.00] (Outflow of capital)-4.57[0.00]-0.63[0.36] “After taking into account market movements, exposed banks are affected by events while nonexposed banks are generally not.”

Evidence of a banking crisis from accounting data The median bank increased its loan loss provision from 0.072% in June to 0.111% in September 1998.

Suggestions Investigate whether the identity of the bank (or the size of the bank’s exposure to Russia or Brazil) can explain the borrower’s abnormal returns. Do borrowers of banks that are exposed to Russia or Brazil suffer more than borrowers of banks without the exposure? Provide some information on extent to which U.S. banks were exposed to Russia and Brazil. Analyze the impact of these crisis events on U.S. bank stock returns.