Enhancing Loan Quality Through Transparency: Evidence from the European Central Bank Loan Level Reporting Initiative

Abstract

We explore whether transparency in banks’ securitization activities enhances loan quality. We take advantage of a novel disclosure initiative introduced by the European Central Bank, which requires, as of January 2013, banks that use their asset‐backed securities as collateral for repo financing to report securitized loan characteristics and performance in a standardized format. We find that securitized loans originated under the transparency regime are of better quality with a lower default probability, a lower delinquent amount, fewer days in delinquency, and lower losses upon default. Additionally, banks with more intensive loan level information collection and those operating under stronger market discipline experience greater improvement in their loan quality under the new reporting standards. Overall, we demonstrate that greater transparency has real effects by incentivizing banks to improve their credit practices.

Corporate Tax Enforcement Externalities and the Banking Sector

“…First, our findings contribute to the literature examining bank lending to SMEs (e.g., Berger and Udell [1995, 2002, 2006], Berger, Klapper, and Udell [2001]), and in particular research examining how regulatory actions impact SME lending (Ertan, Loumioti, and Wittenberg‐Moerman [2017], Balakrishnan and Ertan [2019]). For example, Ertan, Loumioti, and Wittenberg‐Moerman [2017] find that bank regulations requiring greater transparency on SME loans underlying asset‐backed securities lead to improvement in the bank's information set on borrowers, and consequently an increase in loan quality. We contribute by documenting that a nonbanking regulator, the tax authority, affects both the amount and average quality of bank lending via its oversight of SMEs, and that the impact on quality of the information used in the lending decision is at least partially responsible.…”

Asset-Level Transparency and the (E)Valuation of Asset-Backed Securities

“…Our study also contributes to the debate about whether transparency enhances the stability of banks and the financial system (Beatty and Liao, 2014;Bushman, 2014;Acharya and Ryan, 2016). Most studies provide evidence of benefits of transparency, such as lower cost of capital (Kleymenova, 2016), fewer failures (Granja, 2016), enhanced risk-taking discipline (Bushman and Williams, 2012), lower exposure to illiquidity and tail risks (Bushman and Williams, 2015), and increased loan supply (Balakrishnan and Ertan, 2017). Some papers provide evidence of costs of transparency, however, including managerial myopia (Goldstein and Sapra, 2013), limited risk-sharing (Goldstein and Leitner, 2018), and reduced liquidity provision (Dang et al, 2017).…”

“…Schmidt and Zhang (2018) find that monthly public filings of poollevel information about the underlying assets required after January 1, 2006 under the original Regulation AB increase the volume and liquidity of trading in secondary ABS markets. Ertan et al (2017) find that the European Central Bank's loan-level disclosure requirements for banks that pledge ABS as collateral to borrow under its repurchase financing operations increase the quality of loans to small and medium-sized enterprises. Our study complements these studies by examining how Reg AB II's asset-level disclosure requirements affect the ability of investors to value and credit rating agencies to evaluate ABS.…”

“…The bulk of this literature examines corporate bond and equity markets (e.g., Bushman et al, 2004;Yu, 2005;Francis et al, 2009;Lang et al, 2012;Firth et al, 2015). Schmidt and Zhang (2018) and Ertan et al (2017) are among the few studies that examine the more opaque structured finance markets. Schmidt and Zhang (2018) find that monthly public filings of poollevel information about the underlying assets required after January 1, 2006 under the original Regulation AB increase the volume and liquidity of trading in secondary ABS markets.…”

Risk Information Disclosure and Bank Soundness: Does Regulation Matter? Evidence from China*

“…The Regulation was issued on July 7, 2012 by the China Banking Regulatory Commission and adopted since January 1, 2013 by Chinese commercial banks. According to the Regulation, all the banks are required to disclose information about exposure and evaluation of credit risk, market risk, operational risk, and other risks, as well as risk management.Motivated by the recent literature on information disclosure and bank risk assessment (Chen et al 2015; Hanley and Hoberg 2016; Ertan et al 2017), we propose a novel measure to capture the completeness of information disclosure associated with bank risks in China. Then, we link this risk information disclosure index (RDI) to bank soundness.…”