Available at: https://ssrn.com/abstract=4866943
Summary:
Banking theories highlight the critical role of depositor confidence in maintaining financial stability. In this study, I examine how banks' legal rights during borrower bankruptcies influence depositor confidence and market dynamics. Exploiting staggered changes in U.S. state bankruptcy exemptions for personal bankruptcies from 1994 to 2023 as a quasi-natural experiment, I find that increases in exemptions lead to significant declines in uninsured deposits. I estimate that raising exemptions in the least generous state to match those in the most generous state could decrease uninsured deposits at an average bank by between 2.5 and 6.1 percentage points. The effect is amplified for banks with larger consumer/credit card lending, smaller banks, and banks with lower capital ratios. Conversely, banks specializing in mortgage or agricultural lending, which are less affected by bankruptcy exemptions, experience no significant change in uninsured deposits. In further support of these observations, I find that the enactment of a 2005 federal law that strengthened creditor rights led to an increase in uninsured deposits. Finally, I show that higher exemptions are associated with greater consumer lending concentration, suggesting a shift towards greater specialization amid increased market frictions. These findings underscore the impact of legal frameworks governing creditor rights on depositor confidence and the competitive landscape of lending markets.
Commentary:
Worth attention is that this study looks only at the impact on uninsured deposits at banks, which, according to FDIC reports, account for only approximately 44% of all funds held. As the FDIC insurance limit is $250,000 the vast majority by both number and amount of all depositors are insured, with uninsured depositors certainly being more sophisticated and likely institutional or corporate, thus less prone to causing bank runs and instability.
Additionally, it is unclear if the FDIC, which is through its insurance indirectly the most sophisticated of depositors, or any other bank regulators view higher exemptions as presenting any substantial increased risk of bank failure and require those banks to price credit higher.
Further, while many banks maintain both lending and depository functions, many other financial institutions, including some of the largest, are purely lenders with no other banking activities or with lending segregated into separate corporate entities.
This research also pays scant attention to the mobility of debtors (who, even with the requirement of 11 U.S.C. §522(b)(3)(A) that an individual to be continuously domiciled in a state for at least 730 days to use its exemptions, do routinely move to other states) and the nationwide reach of many, if not most, lenders, who neither show evidence of higher interest rates or other restrictions for borrowers, either at the inception of a loan or by changing terms (positively or negatively) for those that move to another state.
Lastly, to the extent that BAPCPA actually did increase the confidence of uninsured depositors by a whopping 1.3%, all of us are still waiting to see the mythical $400 a year in annual savings promised by MBNA/Bank of America.
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