Essays on financial intermediation

Abstract

We present three essays on financial intermediation in this dissertation. The first essay examines the credit risk choices of the public sector banks (PSBs) in India with novel data that identifies borrowers with their banks by ownership type. We determine the ownership type of the lender bank associated with every firm using a lender type prediction model. The analysis of the lending decisions suggests that the PSBs are more likely to lend to observably riskier firms relative to the private sector banks. The higher risk of the borrowers of the PSBs is more pronounced for small and medium-sized banks. The channels that contribute to the poor credit risk choices of the PSBs include lending to riskier firms in the service sector and firms that are impacted by the change of political regime. The essay contributes empirically to the understanding of lender moral hazard in state-owned banks. The second essay examines the impact of risk-sensitive Basel regulations on debt financing of firms around the world and investigates how firms cope with the impact through adjustments to their financing sources and capital investments. We find that the implementation of Basel II regulations is associated with reduced credit availability and higher cost of debt, particularly for lower-rated firms. Such firms mitigate the shortage in bank credit through increased reliance on accounts payables, lower payouts to shareholders, and reduction in their capital investments in the post-Basel II period. The findings of this essay substantially contribute to the understanding of the real effects of risk-sensitive bank capital regulations. In the final essay, we examine the role of pledge of shares as collateral for bank borrowings. We model the collateral choices of entrepreneurs and argue that it is optimal for the entrepreneur to issue debt securities with tangible collateral compared to collateral choices that include promoter pledge of shares. Further, we show empirically that firms would exercise the pledge of shares as the last option in the pecking order of collateral choices. Finally, we show that a regulatory change that substantially improved the creditor rights negatively impacts the propensity to pledge promoter ownership stake as collateral.