Greater transparency and richer and more robust flows of information about the banking system have been central to the official response to the financial crisis.
Clear, accessible and reliable data, it has been said, will help avert any repetition of the turmoil that followed the 2007 credit crunch and led to banks being bailed out by taxpayers.
In short, fuller disclosure should make the banking system work better for society and the economy as a whole. That it may also help it to work better for the banks themselves is a notion heard rather less frequently. Indeed, in some quarters it is hotly contested, not least on the other side of the Atlantic.
Yet in three critical areas, our research indicates that increased transparency and disclosure have been effective - not only for the benefit of banks but also for the borrowers and, potentially, the economic system.
Put simply, these three areas comprise
We found that banks that switch to quarterly financial reporting see a marked drop in the number of non-performing loans and enjoy lower funding costs. The extension of public credit registries, pooling information on borrowers and loans, has led to timelier provision for losses by the banks. And finally, the imposition on banks in the euro-zone of the so-called loan-level reporting initiative has allowed banks to raise capital more cheaply and to increase their lending, notably to small businesses.
These findings are, we suggest, of considerable importance to policymakers and financial practitioners alike. The imposition of strict new rules ought not be seen simply as a semi-punitive measure to “rein in the banks” but can have creative and fruitful consequences for the banks themselves and conceivably many other stakeholders.
Look first at the effect of increasing the frequency of banks’ financial reporting. Quarterly reporting has been common in the US for nearly half a century, but has been adopted in Europe only more recently and in a less thoroughgoing manner. Further, European regulators This feature, however, makes Europe a highly suitable region for our research, which confined itself to banks that have switched either to or from quarterly reporting at least once during our sample period.
Better disclosure ought to enhance market discipline
What might one expect to find from research such as this? One might guess that on the positive side of the argument, more frequent financial reporting might curb rational agency issues or irrational exuberance on the part of banks’ managements, making them less likely to take on inefficient investments.
Furthermore, better disclosure ought to enhance market discipline, as external investors get a clearer picture of the risk exposures of the bank in question, transmitting this information through share prices and funding costs.
But there is a potentially negative aspect, in that bank managements may be tempted to take short-term decisions to “window dress” quarterly performance, disregarding the longer-term consequences. This is in fact consistent with European regulators recent removal of interim reporting requirements. These unwelcome outcomes could include defaults on loans that were made following a lowering of lending standards.
Given these competing pressures, we need one or more measures that can tell us how the switch to quarterly reporting affected banks in practice, rather than in theory: what actually happened, rather than what we might think should have happened?
First, we looked at the behaviour of non-performing loans in relation to more frequent financial reporting. We examined 417 public banks from 32 different European countries over the period 2000-2014. We found that banks that switched to quarterly reporting saw an 11 per cent decline in loans that went sour, and similar improvements in other measures of loan quality, such as the size of loan-loss reserves and the ratio of “unreserved” – in other words unanticipated – non-performing loans to equity.
To investigate whether this may be a phenomenon restricted to Europe, we looked also at banks in Japan and Singapore, and found, again, that banks switching to quarterly financial reporting enjoyed improvements in the quality of their loan portfolios.
Finally, the effects of more frequent financial reporting on our European bank sample could be found not only in their loan book but the cost of funding and the market view of their credit risk. Both deposit rates and spreads on credit-default swaps were reduced after the switch to quarterly reports.
And what about the sharing of credit information? We focused on public credit registries (PCRs) and their impact on banks’ decisions in terms of creating reserves for likely non-performing loans. Creating reserves, or loan loss provisioning, has become increasingly important across the world as regulators have responded to banks’ failure before the crisis to spot expected defaults - a failure that, of course, exacerbated the crisis.
PCRs collect and share borrower and lender data among all lenders, a process intended to broaden and deepen the information available to the banking system – such as on loss events and the health of borrowers - and allow managers to make better credit decisions. We expected this to be the outcome of the spread of PCRs, but how to measure it?
Compulsory sharing of credit information improved timeliness in bad-loan provisioning
Our method was to take data from the World Bank on the establishment of PCRs in different jurisdictions – 24 developing countries between 1994 and 2013 – and measured the timeliness of loan-loss reserves by banks in each country. This was done by comparing current loan-loss reserves with the actual total of non-performing loans in the following year.
Then we compared the timeliness of banks’ reporting of loan-loss reserves in PCR jurisdictions with those in similar countries without such registers. We found that the compulsory sharing of credit information improved timeliness in bad-loan provisioning by between 41 per cent and 59 per cent.
Of course, it is in a sense unsurprising that a better overview of the loan landscape leads banks to make more accurate provisions against anticipated losses. Furthermore, there is evidence that some jurisdictions may have introduced mandatory PCRs precisely because they improve such provisioning.
Our findings are, as we said, from emerging economies only, and more work would be needed to apply them more broadly. Also, there may be a downside to the wider sharing of information if it encourages banks to ration the supply of credit in ways that do not lead to an increase in social welfare.
The third area of our study focused on the impact of the European Central Bank’s 2013 loan-level reporting initiative. Again in response to the financial crisis, the ECB ordered those eurozone banks that use securities backed by loan assets as collateral for the banks’ own borrowing to make standardised quarterly reports on the performance and structure of those assets. As the name suggests, these reports were to be at the level of millions of individual loans.
An immediate effect was to bring about a dramatic increase the information available to investors about the banks’ securitised loan portfolios – in effect, from no information at all to details on every single loan. In the slightly longer term, we found that those banks required to make loan-level disclosures raised more capital more cheaply than had been the case before the disclosure regime; and they increased their lending.
Why would this be?
Previous research has suggested that credible reporting regimes reduce the cost of capital and improve corporate financing decisions because they narrow the information gap between the banks and those who supply its capital. This, in turn, means investors are happier to lend at reduced cost, given the lower perceived risk of doing so.
In other words, the reporting regime would seem to have increased the supply of credit to the real economy. Banks in the disclosure regime saw their debt financing costs fall relative to similar banks outside the regime. They also increased their inter-bank borrowings and issued more equity.
What is more, they seem to have been passing these benefits on to borrowers, rather than simply paying off debts or increasing dividends. These banks showed a four to five per cent increase in loan growth.
There can, of course, be no growth in the supply of loans without a corresponding rise in the demand for credit. Should the latter show a marked increase, then loan growth may tell us nothing about the willingness of banks to lend.
Given the importance attached by regulators to increasing the credit supply to small and medium-sized enterprises (SMEs), we examined ECB surveys on the access of SMEs to finance. Because they are designed specifically to gauge how easy it is for SMEs to get bank loans, they allow loan supply to be distinguished from demand.
We established that in countries where banks provide loan-level disclosures, SMEs found credit access easier relative both to borrowers in other countries and to their own experience before the introduction of the disclosure regime.
To sum up, across three quite different areas, officially mandated increases in disclosure and transparency on the part of the banks have proved beneficial not only to the wider economy but to the banks themselves.
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