Essays on banking: opacity, stability, and monetary policy

This thesis comprises three essays on banking, tied together by the themes of bank opacity (equivalently, transparency), bank stability, and conventional monetary policy.

The first chapter shows that a bank uses loan loss provision disclosures to smooth reported earnings in a non-linear fashion, so that the direction and size of earnings smoothing depends on where current earnings sit in the banks' distribution of earnings. This smoothing is estimated to have a positive effect on the market value of the bank, even when controlling for the variance in reported earnings which the smoothing is targeting. A supporting theoretical model shows that bank managers have an incentive to smooth reported earnings in this way when investors display risk aversion and demand a risk premium for volatile returns.

The second chapter studies how a conventional monetary loosening effects bank stability. I obtain a monetary policy shock from a Factor Augmented Vector Autoregression (FAVAR) for the US and project this shock onto stability measures for banks with different levels of deposits. The bank responses to the monetary policy shock provide evidence that when interest rates are far from zero, a cut in the policy rate is associated with an improvement in the stability of banks. However, when the policy rate is already close to zero, the stability of high deposit banks is shown to deteriorate, with the effect strongest for high deposit banks with low levels of capital.

The third chapter explores the role of bank transparency in the bank lending channel of monetary policy. An important proposition in the bank lending channel is that bank responses to policy changes depend on outsider perceptions of their balance sheet strength, which in turn are influenced by the level of bank transparency and information asymmetry between banks and depositors. Transparency about bank asset quality is introduced to the framework of Disyatat (2011) to demonstrate its role in the bank's response to changes in conventional monetary policy. Empirical tests using bank equity prices show that transparency can act to strengthen or attenuate a bank's response to a monetary policy surprise, depending on the quality of the bank's assets and broader macroeconomic and financial conditions.