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Reserve requirements, bank share prices, and the uniqueeness of bank loans
Journal of Banking and Finance 16 (1992) 799-812. North-Holland
Reserve requirements, bank share prices, and the uniqueness of bank loans* Dale K. Osborne The IJniuersity of Texas at Dallas, Richardson,
TX 75083-0688,
USA
Tarek S. Zaher fndiana State University, Terre Haute, IN 47809, USA Received July 1990, linal version received December 1991
This study examines the impact of changes in reserve requirements on large banks’ stock returns. It finds statistically and economically significant abnormal returns on the day following the announ~ment of such changes. This findin is consistent with the notion that reserve requirements are a tax on deposits. It indicates, however, that bank’s shareholders bear at least part of the tax; thus it does not support the hypothesis advanced by some authors that the tax falls exclusively on banks’ borrowers. The evidence further suggests that part of the tax falls on demand depositors. These ladings undercut the case for the uniqueness of bank loans insofar as it is based on the incidence of the deposit tax.
1. In&&u&on Commercial banks that belong to the Federal Reserve System (and, since 1980, all other depository institutions) are required to hotd reserves in specified ratios to their deposits. The reserves may be held as vault cash or as balances in the banks’ reserve accounts at the Fed, neither of which earn interest. Some of these ‘non-earning’ assets are wiflingly held because they save transaction costs in the clearing of checks and in meeting withdrawals, but it seems unlikely that all reserves are willingly held. Since World War II, excess reserves (actual minus required reserves) have been negligible, and this suggests that reserve requirements impose binding constraints on banks’ asset portfolios. Insofar as reserve requirements are binding, they act as a tax on deposits. Black (1970, 1975) appears to have been the first to interpret reserve requirements this way. In principle, the reserve-requirement tax can be avoided. As the tax rate Correspondence to: Professor Dale K. Osborne, School of Management, The University of Texas at Dallas, P.O. Box 830688, Richardson, TX 75083.0688, USA. *We are indebted to Larry Lockwood, Larry Merville, Dan Pieptea. Ernest Swift, John Wiorkowski and an anonymous referee for comments. All errors are ours.
0378-4266/92/505.00 0 l992-Elsevier
Science Publishers B.V. All rights reserved
800
D.K.
Osborne
and 7X
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uniqueness
ofbankloans
(the reserve-requirement ratio) is not uniform across the various types of deposits and does not extend to all bank liabilities, the tax bill depends on the mix of liabilities. Banks have considerable influence on their liability mix, and since the middle 1970s they have developed a number of devices that economize on required reserves. ’ But as long as avoidance is costly, complete avoidance is not likely to be optimal. Given that the tax is not completely avoided, who bears it? Just because it is nominally a tax on deposits does not mean that it falls exclusively or even partially on depositors. Like many other taxes, it might be shifted to other parties. Aside from its intrinsic interest, the incidence of the deposit tax bears on the theory of financial intermediation. Recent developments of this theory emphasize informational asymmetries between banks and other lenders.* As pointed out by Black (1970, 1975), banks obtain information about potential borrowers by providing payment services, and this information is not available as cheaply to other lenders. If the resulting informational advantage is sufficiently great, banks can remain the cheapest source of funds for many borrowers even after shifting the deposit tax to them. On the basis of this consideration, Fama (1985) hypothesized that borrowers bear the tax. This hypothesis became more plausible when Mikkelson and Partch (1986) and James (1987) found that announcements of bank credit agreements are accompanied by positive abnormal returns to the common stock of the borrowers, suggesting that bank loans convey favorable information to the market about borrowers* characteristics. 3 Since favorable information should reduce the borrowers’ cost of capitai from all sources, borrowers might ‘purchase’ it by bearing the deposit tax.4 Both Fama and James reported evidence bearing on the incidence of the tax. Fama (1985) compared the average rates of interest on commercial paper and large certificates of deposit {CDs) during 1967-1983 and found no significant difference. James (1987) found that average CD rates did not differ in two diRerent required-reserve regimes. Since both findings suggest that ‘The main purpose of these devices, such as overnight repurchase agreements, was to circumvent the prohibition of interest payments on demand deposits. Wood and Wood (1985, ch. 3) provide an extensive discussion of these ‘New Ways of Paying Interest on Money’. ‘The importance of informational asymmetries in financial inte~~iation has been emphasized by Leland and Pyle (1977). Campbell and Kracaw (1980), Diamond (198% and many others. It is not disputed that other factors, especially transaction costs, are also important; see Bentson and Smith (1976). ‘By contrast, a host of empirical studies have found that most fmancing announcements induce non-positive abnormal returns. ‘Lummer and McConnell (1989) report that positive abnormal returns accompany only the announcements of favorably renewed bank loans. Announcements of new bank loans evoke no statistically signiiicant abnormal returns, while announc~ents of unfavorably renewed loans are accompanied by negative abnormal returns. On this evidence we migfit expect only a subset of borrowers (at most) to bear the tax.
D.K.
Osborne and TS. Zaher,
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holders of large CDs do not bear the tax, they are consistent with Fama’s hypothesis that the tax falls on borrowers, and they support the notion that bank loans possess unique informational properties. Although the findings cited above are consistent with Fama’s hypothesis, they do not represent direct tests of it. A finding that holders of large CDs escape the tax does not imply that borrowers bear it unless we can be sure that no other parties bear it, and we cannot be sure of this a priori. The incidence of this tax is an empirical question. If the tax does fall wholly on borrowers (or on borrowers and depositors collectively), so that shareholders bear none of the tax, a change in the tax rate will not affect bank share prices. Therefore, if share prices fall when reserve requirements increase, and rise when they decrease, we must conclude that borrowers and depositors collectively do not bear the whole tax.’ Thus an important question is whether changes in reserve requirements affect bank share prices. Two recent studies have addressed this question. Kolari et al. (1988) examined four changes in reserve requirements on demand deposits. Using event-study methods, they found statistically signiticant abnormal returns, opposite in sign to the change in reserve requirements, for two of these events. They concluded that bank share prices respond to permanent changes in reserve requirements but not necessarily to temporary changes made for monetary policy purposes. Because their study focused on changes in reserve requirements on demand deposits, it leaves open the question of responses to changes in the time deposit tax, which is the main focus of Fama’s analysis. The other recent study was by Slovin et al. (1990), who examined changes in reserve requirements on both demand and time deposits. They did not identify the changes they examined, but reported having excluded changes that were accompanied by other Federal Reserve actions. Instead of using event-study methods, the authors employed regression analysis with dummy variables that take the value unity on the day (and in some regressions, the preceding day) that an announcement of a change in reserve requirements appeared in the business press. The dummy variables had statistically significant coefficients with signs opposite to the reserve requirement change, also suggesting that bank share prices tend to respond to changes in the sShare-price effects cannot by themselves prove that there is a tax. If higher reserve requirements reduce risk in banking, a change in the requirements will induce an opposite change in bank share prices so as to preserve a capital market equilibrium. Therefore, price effects could just be movements along the security market line as shareholders accept lower return in exchange for lower risk. However, our tests (reported below) find no evidence of risk changes. Moreover, on this line of reasoning. risk would be altered more by a change in reserve requirements against demand deposits (which have more liquidity risk) than by an equal change in the requirements against time deposits, so share-price etTects would be larger, the more a reserve-requirement change applied to demand deposits. Since we fmd no evidence of this (the tendency is actually in the opposite direction), we treat share-price effects as indication of a tax, not a change in banking risk.
802
D.K.
Osborne
and 7X. Zuher.
The uniqueness
of bank loans
deposit tax. The use of dummy variables to represent changes in reserve requirements, while appropriate for the purposes of their study, disallows measuring the size of the abnormal stock return in relation to the size of the tax change. The present research builds upon these studies in three ways: (1) Like Kolari et al. we employ classical event-study methods, which allow us to examine the relation between the size of a tax change and the size of the associated abnormal return. (2) Like Slovin et al. we examine changes in the tax on time deposits as well as on demand deposits. (3) We impose rigorous controls for developments in banking or monetary policy that may be expected to affect bank shareholders’ returns. Such controls help to rule out contaminating events as causes of observed abnormal returns. We examined all reserve-required changes occurring in the years 1966 through 1989. After rigorously filtering out events contaminated by other changes in banking or monetary policy, we found statistically and economically signlicant effects on bank stock returns. The effects are strong and occur mostly on the day following the announcement of a change, which is usually the first day on which the announcement can affect price. The abnormal returns on that day range from 0.83% to 3.45% in absolute value. Not only are these abnormal returns quite large relative to observed daily returns, but they are directly related to the size of tax change, especially in the case of reserve requirements on time deposits as opposed to demand deposits. These findings are consistent with Black’s notion that reserve requirements are a tax on the banking industry. However, they do not support Fama’s hypothesis that the tax falls exclusively on bank borrowers. The findings indicate that the tax falls at least partly on bank shareholders.6 Thus our findings do not support the case for ‘uniqueness’ of bank loans. Section 2 describes the events, the sample of banks, and our method of analysis. Section 3 reports and discusses the abnormal returns. Section 4 analyzes the relation between abnormal returns and the size and type of reserve-requirement change. Section 5 contains concluding comments. 2. Sample and method a. Sample All announced changes in reserve requirements from January 1, 1966 through December 31, 1989 (hereafter ‘RR-announcements’), initially were gathered from the Federal Reserve Bulletin and the Wall Street Journal Index. Since there were no RR-announcements after October 1979, all %sofar as the tax falls on shareholders, it affects only those who hold shares when the tax is (unexpectedlyf imposed or changed. Those who buy shares after the price has adjusted are not affected.
D.K.
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announcements applied exclusively to Federal Reserve member banks. For this reason our bank sample consisted of 64 member banks for which data are available on both the Standard and Poor’s Annual Compustat tape and the Center for Research in Security Prices (CRSP) Daily Rates of Return Tape. Additional information about the banks in this sample was collected from Moody’s Banks and Finance Manual. All banks in the sample had more than $400 million in net demand deposits throughout the period. For each RR-announcement, the initial sample of banks was trimmed by eliminating all banks that: (a) were targets for mergers or acquisitions during the year of the RR-announcement; or (b) submitted multiple bids for other banks during the year of the RR-announcement, where the sum of bids exceeded one-third of the bidder’s size as measured by total assets; or (c) announced major recapitalizations or bankruptcies during the year of the RR-announcement; or (d) announced dividends, earnings, new issues, or redemptions or repurchases of securities within one week of the RRannouncement. Thus, the surviving sample for each RR-announcement consisted of banks whose stock prices were not affected by any newsworthy banking developments except the RR-announcement itself. The list of RR-announcements was filtered by discarding those: (a) for which fewer than ten banks survived the bank-sample purge; or (b) that increased reserve requirements against some liabilities and decreased the requirements against others; or (c) followed a previous RR-announcement within 80 days. The seven RR-announcements described in table 1 passed these screens.’ b. Method
The one-factor market’ model is employed to obtain estimates of bank’s abnormal stock returns around the announcement date, which is taken as ‘Two of these announcements were mixed with a 1% change of the discount rate in the same direction. However, since discount-rate changes are not expected to effect bank stock prices during our sample period because of the Fed’s operating procedure [see Gilbert (1985). Hafer (1986). Roley (1983) Santoni (1985). Thornton (1986). and Cook and Hahn (1988)] we did not discard these announcements. ‘The one-factor model has been the standard in event studies, including studies in banking such as Dann and James (1982). Swary (1986) and Kolari et al. (1987). Some researchers argue that the one-factor model may not adequately control for potential relevant industry factors such as interest rates and suggest that a two-factor model should be used instead, especially for studies in banking. We have chosen to use the one-factor model mainly because evidence on the impact of interest-rate changes on linancial institution stock returns is inconclusive. For example, Flannery and James (1984) found significant effects of interest rate volatility on bank stock returns over the 19761980 period, but Chance and Lane (1985) found no such effect over the 1972-1976 period. (Five of the seven events we examine in our study occur in the later, more stable, interest-rate period.) G’Hara and Shaw (1990) used one-factor and two-factor models to examine the impact on bank’s stock returns of an important regulatory announcement and found no significant difference in the results. Finally, Slovin et a). (1990) found no effect on interest rates of the reserve-requirement changes they examined.
804
D.K. Osborne and LT. Zaher, The uniqueness of bank loans
Table 1 Announced changes in reserve requirements examined in this study. Announcement date’ Jun. 29. 1973
Announcement contentb 1. Increased reserve requirements on all but the hrst $2 million of net demand deposits by f percentage point. 2. Increased the discount rate by 4 percentage point.
Dec. 7, 1973
Reduced from 11% to 80,d the marginal denomination certificates of deposit.
reserve
requirement
Sep. 4, 1974
Removed the 3% supplemental reserve requirement on large-denomination certificates of deposit with an initial maturity of four months or longer.
Dec. 24, 1975
Reduced from 3.0% to 2.5% the reserve requirement against member-bank time deposits maturing in 180 days to four years.
Dec. 17, 1976
Decreased reserve requirements by 0.5% on net demand deposits up to $10 million and by 0.25% on net demand deposits above that amount.
Nov. 1, 1978
1. Established a 20/, supplementary denominations of %lOO,ooOor more.
reserve requirement
on large-
on time deposits in
2. Increased the discount rate by 1 percentage point. Oct. 6, 1979
1. Established an 8% marginal reserve requirement on increases in managed liabilities. 2. Increased the discount rate by 1%. 3. Changed the method used to conduct monetary policy.
‘Announcement date is the day before the date on which the announcement was reported in the Wall Street Journal. bAnnouncement contents are extracted from the next Federal Reseroe Bulletin following the indicated date.
the business day before the Wall Street Journal reported it. Following Dann and James (1982), equally-weighted portfolio rates of return were used to estimate the market model parameters. 9 With day 0 as the event (announcement) day, the event period consists of the 11 business days starting at day -5 and ending at day +5 relative to the event day. The event period is then divided into three subperiods. Subperiod 1 includes day -5 through day - 1; subperiod 2 includes days 0 and + 1, and subperiod 3 includes days +2 through day +5. The non-event (estimation) period spans the 80 business days from day -85 to day -6.” 9The portfolio approach avoids the potential statistical problems created by event-date clustering. Brown and Warner (1980, 1985) suggest that when there is clustering in event dates, the abnormal returns are positively correlated across securities. This will increase the variance of the abnormal returns and therefore lower the power of the tests. “‘For event 1, we used a post-event estimation period which spans the 80 days starting on day +6 and ending on day +85 relative to the event day. During the 47 business days preceding this event there were three changes in the discount rate. This unsettled period was not a good time to estimate the market model.
D.K. Osborne and TS. Zaher. The uniqueness of bank loans
805
Reserve-requirement changes are usually announced after the close of the markets on day 0, hence any impact on stock prices would occur on or after day 1. To account for the possibility that some announcements could have been made before the close of the market on day 0, we test for the significance of cumulative abnormal returns over subperiod 2 (days 0 and 1). Additionally, to test for market anticipations of an announcement and for delays in responses, we examine the returns during the pre-announcement period (subperiod 1) and the post-announcement period (subperiod 3). The abnormal portfolio return or prediction error over day t is defined as A&,
(1) where = the rate of return on portfolio p over period r, of return on the CRSP equally-weighted market portfolio over period t, d,, /?, = ordinary least squares estimates of portfolio p’s market-model parameters. RN
R mr =rate
To determine whether the abnormal returns are significantly different from zero, two statistical test procedures were employed. First, following Dann and James (1982), one-day abnormal returns were tested using the T-statistic defined by
(2)
T= AR,,IS(AR,,), where 1+ 1/L+(R,,-R)2
1/Z r=l 11 i
i
(R,,-R,,,)’
,
Si is the variance of the market-model residuals for portfolio p, L is the number of days in the estimation period, and W, is the mean market return over the estimation period. Assuming that the market model residuals are independent and identically distributed, the T-statistic is distributed as Student-t with (L -2) degrees of freedom. Second, to test the significance of cumulative abnormal portfolio returns over each of the event subperiods, we use the test statistic suggested by Dodd and Warner (1983). For each bank i, the standardized abnormal returns (SARi,) for each of the (dl-d, + 1) days in the interval under study are summed to obtain a standardized, cumulative, abnormal return SCARi,
806
D.K.
SCAR,=
Osborne
2
and 73. &her,
[SAR,/‘(d2--d,
7he uniqueness
of bank loans
-t l)]?
t=d,
where SAR, = AR,/S,, S, is the estimated residual forecast standard deviation for bank i, and d, and dL are the beginning and the ending day of the interval, respectively. Then, using SCAR,=t/N
~ SCARi i=l
for a sample of N banks, the test statistic Z is computed, where Z= SCAR,JN.
(3)
Assuming that the standardized cumulative abnormal returns are crosssectionally independent, the Z-statistic is distributed unit normal under the null hypothesis that the expected value of the standardized abnormal returns is equal to zero. 3. Results Table 2 contains the parameter estimates for the market model based on the selected estimation period for each of the seven events. The F-statistics are significant in every case. The R2 values range between 5176 and 71%. Estimates of the slope term, p^,range from 0.475 to 1.17.” To ensure that estimated abnormal returns are not biased by a change in the risk structure, separate regressions were run on the market model for a pre-event estimation period (days -85 through -S), a post-event estimation period (days +6 through + 85) and for the pooled estimation period (preevent plus post-event periods), followed by a Chow test of equality of the betas for pre-event and post-event periods. The results of the Chow test indicate no change in the risk structure for any of the sample banks in the seven events. The F-statistics from the Chow tests for events one through seven are 2.07, 2.11, 1.58, 1.86, 0.61, 1.05, and 0.93, respectively, and the 5% critical F(2,176) value is 3.00. Table 3 presents the results of the tests for abnormal returns on days 0 “Since the estimated betas are portfolio betas (not individual stock betas) and portfolio size and composition differ across events, the beta estimates vary across events even if a given bank’s beta is constant during an estimation period.
D.K.
Osborne and ET. Zaher,
The uniqueness
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Table 2 Market model estimates asociated with reserve-requirement Event Announcement no. date
i
807
changes.’
RZ
F
DWb
N
1
Jun. 29, 1973
0.4758 (14.0)’
0.0001 (0.19)
0.71
197.5
1.61
20
2
Dec. 7, 1973
0.579+ (11.5)
(::p
0.63
134.1
1.80
19
3
Sep. 4, 1974
1.1708 (9.85)
-0.0018 (- 1.59)
0.55
97.1
1.60
18
4
Dec. 24, 1975
0.898* (9.74)
-0.0012 (- 1.66)
0.54
94.9
1.63
15
5
Dec. 19, 1976
0.792’ (9.23)
0.0003 (0.42)
0.52
85.3
1.80
14
6
Nov. 1, 1978
0.611’ (10.5)
O.OQOl (0.13)
0.59
110.6
2.12
26
7
Oct. 6, 1979
0.524* (5.89)
0.0004 (0.85)
0.51
1.67
12
B
34.78
‘For events 2 through 7 the regressions use daily data for the 80 days from day -6 through day -85. For event 1 the estimation period runs from day +6 to day +85. “The Durbin-Watson statistics indicate that the residuals for all regressions are free from first order serial correlation. ‘r-Statistics are in parentheses. *SigniIicantly different from zero at O.COOllevel.
and 1 and the cumulative abnormal returns during the three sub-event periods. Over the period (- 5, - I), cumulative abnormal returns reject the null hypothesis only for event 7 (discussed further below). On day 0, abnormal returns reject the null hypothesis only twice (events 6 and 7). Hence, there is little evidence that the market anticipated the events. On day 1 abnormal returns reject the null hypothesis five times. The statistically significant abnormal returns range from 0.83% to 3.45”; per day in absolute value, with an average of 1.93%. For the period (0,l) cumulative abnormal returns reject the null hypothesis three times, though their signs agree with the alternative hypothesis six times (events 2-7). Thus, it does not appear that the rejections on day 1 represent recoveries from unusual conditions in banking on day 0. For the period (2,5), cumulative abnormal returns reject the null hypothesis once and their signs agree with the alternative hypothesis six times (events 2-7). Hence, there is no evidence that subsequent price changes reverse the changes occurring on day 1. Indeed, there is a suggestion that the market’s response to the events is somewhat prolonged, though most of it occurs on day 1. The event with the longest response time is event 7. This
Jun. 29, 1973
Dec. 7, 1973
Sep. 4, 1974
Dec. 24, 1975
Dec. 17, 1976
Nov.
Oct. 6, 1979
I
2
3
4
5
6
7
increase
increase
decrease
decrease
decrease
decrease
increase
Reserve change
abnormal
Table
3
-0.0129 ( - 2.8500)’
-0.0157** (-3.IOOO)
-0.0014 ( - 0.3500)
0.0077 (1.1900)
-0.0101 1.6900)
(-
- 0.0084 ( - 1.5900)
0.0022 (0.6500)
Day 0
Abnormal
1
0.0083’ (2.0900)
- 0.0259 (-4.3900)*’
-0.038x** (-5.1200)
0.0267’ 2.7200)
(-
-0.0216” 3.2000)
(-
(-0.1900)
-0.0012
0.006Y
( I .2200)
- 0.0053
0.0204* (2.2300)
(1.0000)
0.0144
0.0066 (0.9200)
(-0.6ooo)
0.0108 (0.7500)
0.0090 (0.3700)
0.0345** (3.3100) 0.0127* ( I .9700)
- 0.0029 ( - 0.2400)
0.0152*
returns Days (0.1)
0.0056 (0.1600)
abnormal
(- 5, - 1)
0.0011 (0.5400)
Days
Cumulative (2.)
-0.0114
O.OWJ (0.7400)
0.0095 (0.7400)
( 1.OSOO)
0.0218
0.0039 (0.3900)
0.0043 (1.1200)
h)‘S
-0.033W (-3.7100)
I8
19
20
Sample size
I”- and Z-statistics).
( - I .3200)
changes (and corresponding
(2.9ooo)
0.0033 (0.9400)
Day
- 0.0058 I .43OO)
(-
returns
returns associated with reserve-requirement
__ ~_ ~~ *Rejects null hypothesis al 0.05 level. **Rejects null hypothesis aI 0.01 level.
I, 1978
Announcment date
and cumulative
Event no.
Daily
$ z
2
8 00
D.K. Osborne and ZS. Zaher, i%e uniqueness of bank loans
809
event was very complicated, including the announcement of a new monetary policy which would devote more attention to the money stock than to interest rates. It would not be surprising if investors needed some time to analyze its implications for bank profits. Returning to the results for days 0 and 1, we note that the rejection rate for the null hypothesis is 85.7% (6 of 7 events). Given the null hypothesis, with a significance level of SoA,the probability of a rejection for a given event is 5%. Assuming that the tests for the seven events are independent, the binomial law,
gives the probability of six or more rejections as 7.92 x lo-‘. Therefore, the observed rejection rate is not consistent with the null hypothesis.
4. Abnormal returns in relation to event size and type The evidence reviewed thus far strongly indicates that the reserverequirement tax falls at least partly on bank shareholders. If it falls exclusively on shareholders, abnormal returns should vary montonically (in the opposite direction) with the size of a tax change, as larger tax changes would produce larger changes in bank wealth. The exact size of a tax change cannot be determined for our sample banks but, for six of the events, it is estimated for the whole banking system. For example, event 1 increased required reserves for the whole banking system by $800 million according to Federal Reserve estimates at the time of the event, while event 2 decreased required reserves by $370 million. Thus, event 1 was ‘larger’ than event 2 for the banking system. It is reasonable to assume that the ordering of event sizes for the sample banks is the same as for the banking sytem, because the liability structures of large member banks (who hold most of the required reserves) show little cross-sectional variation. Using Federal Reserve estimates of size, table 4 shows the estimated size and abnormal return for the first six of the seven events examined (the Fed did not report an estimated size for event 7). The table also shows the type of liability to which the changed reserve requirements applied. Table 4 does not reveal the monotonic relation between event size and abnormal return that we should see if stockholders bore the whole tax. The table reveals three failures of monotonicity. These three may represent two distinct types. First, although event 6 is the largest by far, its abnormal return is only the second largest. Just what might explain this result is not clear; but the fact that the abnormal return occurred on day 0, while day 1
810
D.K.
Osborne
and TS. Zaher,
7he uniqueness
of bank loans
Table 4 Event characteristics. Event no.
Date
1 2 3 4 5 6
Jun. 29, 1973 Dec. 7, 1973 Sep. 4, 1974 Dec. 24, 1975 Dec. 17, 1976 Nov. I, 1978
Size’
Abnormal returnP
+800 -370 -400 -340 - 550 + 3,cQO
0.0033 o.o1s2* 0.034s* 0.0127’ 0.0083* 0.0157**
Deposit type demand time time time demand (day 0) time
“In S millions. bOn day I except as noted.
lSignificant at the 5% level. **Significant at the 1% level.
showed no statistically significant abnormal return, suggests that news of event 6 leaked out before the ‘event day’. The other type of monotonicity failure concerns events 1 and 5. Event 1 is the second largest of all events, but it is the only one for which abnormal returns are statistically insignificant. Event 5 is the third largest but its abnormal returns are the smallest of all the statistically significant ones. All the remaining events show montonicity. Because events 1 and 5 are the only events that affected demand deposits, they raise the possibility of a differential incidence of the tax. Specifically, shareholders might bear less of the tax when it is levied on demand deposits than when it is imposed on time deposits. 5. Summary and conclusion On six of the seven occasions, an announcement of changed reserve requirements induced statistically and economically significant abnormal returns to holders of large member banks’ common shares. Because these abnormal returns had signs opposite to those of the changes in reserve requirements, they have a simple interpretation: An increase (decrease) in reserve requriements reduces (increases) the expected profits of the affected banks. The change in profits alters expected returns to shareholders, thus inducing changes in share prices to restore a capital market equilibrium. In this way, bank shareholders bear at least part of the deposit tax. It is possible that shareholders bear the \z?hole tax on large time deposits, as all five changes in reserve requirements against such deposits induced significant abnormal returns. Moreover, with one exception probably attributable to news leakage, the abnormal returns varied montonically with the size of these five reserve requirement changes. These results support previously reported evidence that holders of large time deposits do not bear the
D.K. Osborne and 73. Zaher. The uniqueness of bank loans
811
reserve requirements tax. The tax apparently cannot be shifted to those depositors. By contrast, changes in reserve requirements against demand deposits induced smaller abnormal returns. For these two changes, the abnormal returns were 0.33% and 0.83% per day on day 1, the first not being significantly different from zero, even though the potential effects on required reserves were among the largest examined. Apparently, shareholders bear less of the tax on demand deposits, suggesting that some of it is shifted to other parties. It might be argued that the small abnormal returns associated with changes in the demand deposit tax show that the tax is partly shifted to borrowers, just as Fama hypothesized. But the problem with this argument is that it should apply with equal force to the time deposit tax. If borrowers can be made to bear the demand deposit tax, why not saddle them with the time deposit tax as well? After all, they presumably do not care how the bank obtains the funds it lends them. A more plausible hypothesis is that part of the reserve requirements tax falls on demand depositors. Intuitively, demand deposits ought to have a less elastic demand function than large time deposits. Although demand deposits have many substitutes as portfolio assets, only they (besides currency) serve as exchange media. Insofar as holders of demand deposits are insensitive to variations in the own rate of return, they will bear a share of the deposit tax.” This hypothesis is well worth rigorous testing in future research.13 We emphasize that our results to not preclude the possibility that part of the tax might fall on borrowers and that bank loans are unique. But the results undercut the empirical case for uniqueness insofar as it is built on incidence of the tax. If bank loans are unique, empirical evidence must be sought elsewhere. “Flannery and James (1984) report evidence that savings deposits and small time deposits, well as demand deposits, are demanded inelastically with respect to their own rate of return. “A hypothesis cannot be tested by use of the data that suggest it.
as
References Benston, G. and C. Smith, 1976, A transaction cost approach to the theory of financial intermediation, Journal of Finance 31, 215-231. Black, F., 1970, Banking and interest rates in a world without money, Journal of Bank Research 1, 8-20. Black, F., 1975, Bank funds management in an efficient market, Journal of Financial Economics 2, 323-339. Brown, S. and J. Warner, 1980, Measuring security price performance, Journal of Financial Economics 8, 205-258. Brown, S. and J. Warner, 1985, Using daily stock returns: The case of event studies, Journal of Financial Economics 14,3-3 1. Campbell, T. and W. Kracaw, 1980, Information production, market signaling, and the theory of intermediation, Journal of Finance 35, 863-882.
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Osborne
and TX
Zaher,
l&e uniqueness
of bank loans
Chance, D. and W. Lane, 1985, A re-examination of interest rate senstivity in the common stocks of financial institutions, Journal of Financial Research 8, 49-55. Cook, T. and T. Hahn, 1988, The information content of discount rate announcements and their eNect on market interest rates, Journal of Money, Credit, and Banking 20, 167-180. Dann, L.Y. and C. James, 1982, An analysis of the impact of deposit rate ceilings on the market value of thrift institutions, Journal of Finance 37, 1259-1275. Diamond, D., 1984, Financial intermediaries and delegated monitoring, Review of Economic Studies 51. 393-414. Dodd, P. and J. Warner, 1983, On corporate governance. A study of proxy contests, Journal of Financial Economics 1I, 401-438. Fama, E., 1985, What’s diNerent about banks?, Journal of Monetary Economics 15, 29-36. Flannery, M.J. and C.M. James, 1984, Market evidence on the effective maturity of bank assets and liabilities, Journal of Money, Credit, and Banking 16, 4354t5. Gilbert, R.A. 1985, Operating procedures for conducting monetary policy, Federal Reserve Bank of St. Louis, Economic Review, Feb., 13-21. Hafer. R.W., 1986, The response of stock prices to changes in weekly money and the discount rate, Federal Reserve Bank of St. Louis, Economic Review, Mar., 5-14. James, C., 1987, Some evidence on the uniqueness of bank loans, Journal of Financial Economics 19, 217-235. Kolari, J., A. Mahajan and E. Saunders, 1988, The effect of changes in reserve requirements on bank stock prices, Journal of Banking and Finance 12, 184-198. Leland, H. and D. Pyle, 1977, Information asymmetries, financial structure and financial intermediaries, Journal of Finance 32, 371-387. Lummer, S.L. and J.J. McConnell, 1989, Further evidence on the bank lending process and the capital market response to bank loan agreements, Journal of Financial Economics 25. 99-122. Mikkelson, W. and M. Partch, 1986, Valuation effects of security offerings and the issuance process, Journal of Financial Economics 15, 31-60. O’Hara, M. and W. Shaw. 1990, Deposit insurance and wealth effects: The value of being too big to fail, Journal of Finance 45, 1587-1599. Roley, V., 1983, The response of short-term interest rates to weekly money supply announcements, Journal of Money, Credit, and Banking 15, 344-354. Santoni, C.J.. 1985, The monetary control act, reserve taxes and the stock prices of commercial banks, Federal Reserve Bank of St. Louis, Economic Review 67 (Jun./Jul.), 12-20. Slovin, M., E. Sushka and Y. Bendeck, 1990, The market valuation effects of reserve regulation, Journal of Monetary Economics 25, l-17. Swary. I., 1986, Stock market reaction to regulatory action in the Continental Illinois Crises, Journal of Business 59, 451-473. Thornton, D.L., 1986. The discount rate and market interest rates: Theory and evidence, Federal Reserve Bank of St. Louis, Economic Review, Aug./Sep., 5-21. Wood, J.H. and N. Wood, 1985, Financial markets (Harcourt Brace Jovanovich, New York).
Reserve requirements, bank share prices, and the uniqueness of bank loans* Dale K. Osborne The IJniuersity of Texas at Dallas, Richardson,
TX 75083-0688,
USA
Tarek S. Zaher fndiana State University, Terre Haute, IN 47809, USA Received July 1990, linal version received December 1991
This study examines the impact of changes in reserve requirements on large banks’ stock returns. It finds statistically and economically significant abnormal returns on the day following the announ~ment of such changes. This findin is consistent with the notion that reserve requirements are a tax on deposits. It indicates, however, that bank’s shareholders bear at least part of the tax; thus it does not support the hypothesis advanced by some authors that the tax falls exclusively on banks’ borrowers. The evidence further suggests that part of the tax falls on demand depositors. These ladings undercut the case for the uniqueness of bank loans insofar as it is based on the incidence of the deposit tax.
1. In&&u&on Commercial banks that belong to the Federal Reserve System (and, since 1980, all other depository institutions) are required to hotd reserves in specified ratios to their deposits. The reserves may be held as vault cash or as balances in the banks’ reserve accounts at the Fed, neither of which earn interest. Some of these ‘non-earning’ assets are wiflingly held because they save transaction costs in the clearing of checks and in meeting withdrawals, but it seems unlikely that all reserves are willingly held. Since World War II, excess reserves (actual minus required reserves) have been negligible, and this suggests that reserve requirements impose binding constraints on banks’ asset portfolios. Insofar as reserve requirements are binding, they act as a tax on deposits. Black (1970, 1975) appears to have been the first to interpret reserve requirements this way. In principle, the reserve-requirement tax can be avoided. As the tax rate Correspondence to: Professor Dale K. Osborne, School of Management, The University of Texas at Dallas, P.O. Box 830688, Richardson, TX 75083.0688, USA. *We are indebted to Larry Lockwood, Larry Merville, Dan Pieptea. Ernest Swift, John Wiorkowski and an anonymous referee for comments. All errors are ours.
0378-4266/92/505.00 0 l992-Elsevier
Science Publishers B.V. All rights reserved
800
D.K.
Osborne
and 7X
Zoher.
7ke
uniqueness
ofbankloans
(the reserve-requirement ratio) is not uniform across the various types of deposits and does not extend to all bank liabilities, the tax bill depends on the mix of liabilities. Banks have considerable influence on their liability mix, and since the middle 1970s they have developed a number of devices that economize on required reserves. ’ But as long as avoidance is costly, complete avoidance is not likely to be optimal. Given that the tax is not completely avoided, who bears it? Just because it is nominally a tax on deposits does not mean that it falls exclusively or even partially on depositors. Like many other taxes, it might be shifted to other parties. Aside from its intrinsic interest, the incidence of the deposit tax bears on the theory of financial intermediation. Recent developments of this theory emphasize informational asymmetries between banks and other lenders.* As pointed out by Black (1970, 1975), banks obtain information about potential borrowers by providing payment services, and this information is not available as cheaply to other lenders. If the resulting informational advantage is sufficiently great, banks can remain the cheapest source of funds for many borrowers even after shifting the deposit tax to them. On the basis of this consideration, Fama (1985) hypothesized that borrowers bear the tax. This hypothesis became more plausible when Mikkelson and Partch (1986) and James (1987) found that announcements of bank credit agreements are accompanied by positive abnormal returns to the common stock of the borrowers, suggesting that bank loans convey favorable information to the market about borrowers* characteristics. 3 Since favorable information should reduce the borrowers’ cost of capitai from all sources, borrowers might ‘purchase’ it by bearing the deposit tax.4 Both Fama and James reported evidence bearing on the incidence of the tax. Fama (1985) compared the average rates of interest on commercial paper and large certificates of deposit {CDs) during 1967-1983 and found no significant difference. James (1987) found that average CD rates did not differ in two diRerent required-reserve regimes. Since both findings suggest that ‘The main purpose of these devices, such as overnight repurchase agreements, was to circumvent the prohibition of interest payments on demand deposits. Wood and Wood (1985, ch. 3) provide an extensive discussion of these ‘New Ways of Paying Interest on Money’. ‘The importance of informational asymmetries in financial inte~~iation has been emphasized by Leland and Pyle (1977). Campbell and Kracaw (1980), Diamond (198% and many others. It is not disputed that other factors, especially transaction costs, are also important; see Bentson and Smith (1976). ‘By contrast, a host of empirical studies have found that most fmancing announcements induce non-positive abnormal returns. ‘Lummer and McConnell (1989) report that positive abnormal returns accompany only the announcements of favorably renewed bank loans. Announcements of new bank loans evoke no statistically signiiicant abnormal returns, while announc~ents of unfavorably renewed loans are accompanied by negative abnormal returns. On this evidence we migfit expect only a subset of borrowers (at most) to bear the tax.
D.K.
Osborne and TS. Zaher,
The uniqueness
of bank loans
801
holders of large CDs do not bear the tax, they are consistent with Fama’s hypothesis that the tax falls on borrowers, and they support the notion that bank loans possess unique informational properties. Although the findings cited above are consistent with Fama’s hypothesis, they do not represent direct tests of it. A finding that holders of large CDs escape the tax does not imply that borrowers bear it unless we can be sure that no other parties bear it, and we cannot be sure of this a priori. The incidence of this tax is an empirical question. If the tax does fall wholly on borrowers (or on borrowers and depositors collectively), so that shareholders bear none of the tax, a change in the tax rate will not affect bank share prices. Therefore, if share prices fall when reserve requirements increase, and rise when they decrease, we must conclude that borrowers and depositors collectively do not bear the whole tax.’ Thus an important question is whether changes in reserve requirements affect bank share prices. Two recent studies have addressed this question. Kolari et al. (1988) examined four changes in reserve requirements on demand deposits. Using event-study methods, they found statistically signiticant abnormal returns, opposite in sign to the change in reserve requirements, for two of these events. They concluded that bank share prices respond to permanent changes in reserve requirements but not necessarily to temporary changes made for monetary policy purposes. Because their study focused on changes in reserve requirements on demand deposits, it leaves open the question of responses to changes in the time deposit tax, which is the main focus of Fama’s analysis. The other recent study was by Slovin et al. (1990), who examined changes in reserve requirements on both demand and time deposits. They did not identify the changes they examined, but reported having excluded changes that were accompanied by other Federal Reserve actions. Instead of using event-study methods, the authors employed regression analysis with dummy variables that take the value unity on the day (and in some regressions, the preceding day) that an announcement of a change in reserve requirements appeared in the business press. The dummy variables had statistically significant coefficients with signs opposite to the reserve requirement change, also suggesting that bank share prices tend to respond to changes in the sShare-price effects cannot by themselves prove that there is a tax. If higher reserve requirements reduce risk in banking, a change in the requirements will induce an opposite change in bank share prices so as to preserve a capital market equilibrium. Therefore, price effects could just be movements along the security market line as shareholders accept lower return in exchange for lower risk. However, our tests (reported below) find no evidence of risk changes. Moreover, on this line of reasoning. risk would be altered more by a change in reserve requirements against demand deposits (which have more liquidity risk) than by an equal change in the requirements against time deposits, so share-price etTects would be larger, the more a reserve-requirement change applied to demand deposits. Since we fmd no evidence of this (the tendency is actually in the opposite direction), we treat share-price effects as indication of a tax, not a change in banking risk.
802
D.K.
Osborne
and 7X. Zuher.
The uniqueness
of bank loans
deposit tax. The use of dummy variables to represent changes in reserve requirements, while appropriate for the purposes of their study, disallows measuring the size of the abnormal stock return in relation to the size of the tax change. The present research builds upon these studies in three ways: (1) Like Kolari et al. we employ classical event-study methods, which allow us to examine the relation between the size of a tax change and the size of the associated abnormal return. (2) Like Slovin et al. we examine changes in the tax on time deposits as well as on demand deposits. (3) We impose rigorous controls for developments in banking or monetary policy that may be expected to affect bank shareholders’ returns. Such controls help to rule out contaminating events as causes of observed abnormal returns. We examined all reserve-required changes occurring in the years 1966 through 1989. After rigorously filtering out events contaminated by other changes in banking or monetary policy, we found statistically and economically signlicant effects on bank stock returns. The effects are strong and occur mostly on the day following the announcement of a change, which is usually the first day on which the announcement can affect price. The abnormal returns on that day range from 0.83% to 3.45% in absolute value. Not only are these abnormal returns quite large relative to observed daily returns, but they are directly related to the size of tax change, especially in the case of reserve requirements on time deposits as opposed to demand deposits. These findings are consistent with Black’s notion that reserve requirements are a tax on the banking industry. However, they do not support Fama’s hypothesis that the tax falls exclusively on bank borrowers. The findings indicate that the tax falls at least partly on bank shareholders.6 Thus our findings do not support the case for ‘uniqueness’ of bank loans. Section 2 describes the events, the sample of banks, and our method of analysis. Section 3 reports and discusses the abnormal returns. Section 4 analyzes the relation between abnormal returns and the size and type of reserve-requirement change. Section 5 contains concluding comments. 2. Sample and method a. Sample All announced changes in reserve requirements from January 1, 1966 through December 31, 1989 (hereafter ‘RR-announcements’), initially were gathered from the Federal Reserve Bulletin and the Wall Street Journal Index. Since there were no RR-announcements after October 1979, all %sofar as the tax falls on shareholders, it affects only those who hold shares when the tax is (unexpectedlyf imposed or changed. Those who buy shares after the price has adjusted are not affected.
D.K.
Osborne and T.S. Zaher,
The uniqueness
of bank loans
803
announcements applied exclusively to Federal Reserve member banks. For this reason our bank sample consisted of 64 member banks for which data are available on both the Standard and Poor’s Annual Compustat tape and the Center for Research in Security Prices (CRSP) Daily Rates of Return Tape. Additional information about the banks in this sample was collected from Moody’s Banks and Finance Manual. All banks in the sample had more than $400 million in net demand deposits throughout the period. For each RR-announcement, the initial sample of banks was trimmed by eliminating all banks that: (a) were targets for mergers or acquisitions during the year of the RR-announcement; or (b) submitted multiple bids for other banks during the year of the RR-announcement, where the sum of bids exceeded one-third of the bidder’s size as measured by total assets; or (c) announced major recapitalizations or bankruptcies during the year of the RR-announcement; or (d) announced dividends, earnings, new issues, or redemptions or repurchases of securities within one week of the RRannouncement. Thus, the surviving sample for each RR-announcement consisted of banks whose stock prices were not affected by any newsworthy banking developments except the RR-announcement itself. The list of RR-announcements was filtered by discarding those: (a) for which fewer than ten banks survived the bank-sample purge; or (b) that increased reserve requirements against some liabilities and decreased the requirements against others; or (c) followed a previous RR-announcement within 80 days. The seven RR-announcements described in table 1 passed these screens.’ b. Method
The one-factor market’ model is employed to obtain estimates of bank’s abnormal stock returns around the announcement date, which is taken as ‘Two of these announcements were mixed with a 1% change of the discount rate in the same direction. However, since discount-rate changes are not expected to effect bank stock prices during our sample period because of the Fed’s operating procedure [see Gilbert (1985). Hafer (1986). Roley (1983) Santoni (1985). Thornton (1986). and Cook and Hahn (1988)] we did not discard these announcements. ‘The one-factor model has been the standard in event studies, including studies in banking such as Dann and James (1982). Swary (1986) and Kolari et al. (1987). Some researchers argue that the one-factor model may not adequately control for potential relevant industry factors such as interest rates and suggest that a two-factor model should be used instead, especially for studies in banking. We have chosen to use the one-factor model mainly because evidence on the impact of interest-rate changes on linancial institution stock returns is inconclusive. For example, Flannery and James (1984) found significant effects of interest rate volatility on bank stock returns over the 19761980 period, but Chance and Lane (1985) found no such effect over the 1972-1976 period. (Five of the seven events we examine in our study occur in the later, more stable, interest-rate period.) G’Hara and Shaw (1990) used one-factor and two-factor models to examine the impact on bank’s stock returns of an important regulatory announcement and found no significant difference in the results. Finally, Slovin et a). (1990) found no effect on interest rates of the reserve-requirement changes they examined.
804
D.K. Osborne and LT. Zaher, The uniqueness of bank loans
Table 1 Announced changes in reserve requirements examined in this study. Announcement date’ Jun. 29. 1973
Announcement contentb 1. Increased reserve requirements on all but the hrst $2 million of net demand deposits by f percentage point. 2. Increased the discount rate by 4 percentage point.
Dec. 7, 1973
Reduced from 11% to 80,d the marginal denomination certificates of deposit.
reserve
requirement
Sep. 4, 1974
Removed the 3% supplemental reserve requirement on large-denomination certificates of deposit with an initial maturity of four months or longer.
Dec. 24, 1975
Reduced from 3.0% to 2.5% the reserve requirement against member-bank time deposits maturing in 180 days to four years.
Dec. 17, 1976
Decreased reserve requirements by 0.5% on net demand deposits up to $10 million and by 0.25% on net demand deposits above that amount.
Nov. 1, 1978
1. Established a 20/, supplementary denominations of %lOO,ooOor more.
reserve requirement
on large-
on time deposits in
2. Increased the discount rate by 1 percentage point. Oct. 6, 1979
1. Established an 8% marginal reserve requirement on increases in managed liabilities. 2. Increased the discount rate by 1%. 3. Changed the method used to conduct monetary policy.
‘Announcement date is the day before the date on which the announcement was reported in the Wall Street Journal. bAnnouncement contents are extracted from the next Federal Reseroe Bulletin following the indicated date.
the business day before the Wall Street Journal reported it. Following Dann and James (1982), equally-weighted portfolio rates of return were used to estimate the market model parameters. 9 With day 0 as the event (announcement) day, the event period consists of the 11 business days starting at day -5 and ending at day +5 relative to the event day. The event period is then divided into three subperiods. Subperiod 1 includes day -5 through day - 1; subperiod 2 includes days 0 and + 1, and subperiod 3 includes days +2 through day +5. The non-event (estimation) period spans the 80 business days from day -85 to day -6.” 9The portfolio approach avoids the potential statistical problems created by event-date clustering. Brown and Warner (1980, 1985) suggest that when there is clustering in event dates, the abnormal returns are positively correlated across securities. This will increase the variance of the abnormal returns and therefore lower the power of the tests. “‘For event 1, we used a post-event estimation period which spans the 80 days starting on day +6 and ending on day +85 relative to the event day. During the 47 business days preceding this event there were three changes in the discount rate. This unsettled period was not a good time to estimate the market model.
D.K. Osborne and TS. Zaher. The uniqueness of bank loans
805
Reserve-requirement changes are usually announced after the close of the markets on day 0, hence any impact on stock prices would occur on or after day 1. To account for the possibility that some announcements could have been made before the close of the market on day 0, we test for the significance of cumulative abnormal returns over subperiod 2 (days 0 and 1). Additionally, to test for market anticipations of an announcement and for delays in responses, we examine the returns during the pre-announcement period (subperiod 1) and the post-announcement period (subperiod 3). The abnormal portfolio return or prediction error over day t is defined as A&,
(1) where = the rate of return on portfolio p over period r, of return on the CRSP equally-weighted market portfolio over period t, d,, /?, = ordinary least squares estimates of portfolio p’s market-model parameters. RN
R mr =rate
To determine whether the abnormal returns are significantly different from zero, two statistical test procedures were employed. First, following Dann and James (1982), one-day abnormal returns were tested using the T-statistic defined by
(2)
T= AR,,IS(AR,,), where 1+ 1/L+(R,,-R)2
1/Z r=l 11 i
i
(R,,-R,,,)’
,
Si is the variance of the market-model residuals for portfolio p, L is the number of days in the estimation period, and W, is the mean market return over the estimation period. Assuming that the market model residuals are independent and identically distributed, the T-statistic is distributed as Student-t with (L -2) degrees of freedom. Second, to test the significance of cumulative abnormal portfolio returns over each of the event subperiods, we use the test statistic suggested by Dodd and Warner (1983). For each bank i, the standardized abnormal returns (SARi,) for each of the (dl-d, + 1) days in the interval under study are summed to obtain a standardized, cumulative, abnormal return SCARi,
806
D.K.
SCAR,=
Osborne
2
and 73. &her,
[SAR,/‘(d2--d,
7he uniqueness
of bank loans
-t l)]?
t=d,
where SAR, = AR,/S,, S, is the estimated residual forecast standard deviation for bank i, and d, and dL are the beginning and the ending day of the interval, respectively. Then, using SCAR,=t/N
~ SCARi i=l
for a sample of N banks, the test statistic Z is computed, where Z= SCAR,JN.
(3)
Assuming that the standardized cumulative abnormal returns are crosssectionally independent, the Z-statistic is distributed unit normal under the null hypothesis that the expected value of the standardized abnormal returns is equal to zero. 3. Results Table 2 contains the parameter estimates for the market model based on the selected estimation period for each of the seven events. The F-statistics are significant in every case. The R2 values range between 5176 and 71%. Estimates of the slope term, p^,range from 0.475 to 1.17.” To ensure that estimated abnormal returns are not biased by a change in the risk structure, separate regressions were run on the market model for a pre-event estimation period (days -85 through -S), a post-event estimation period (days +6 through + 85) and for the pooled estimation period (preevent plus post-event periods), followed by a Chow test of equality of the betas for pre-event and post-event periods. The results of the Chow test indicate no change in the risk structure for any of the sample banks in the seven events. The F-statistics from the Chow tests for events one through seven are 2.07, 2.11, 1.58, 1.86, 0.61, 1.05, and 0.93, respectively, and the 5% critical F(2,176) value is 3.00. Table 3 presents the results of the tests for abnormal returns on days 0 “Since the estimated betas are portfolio betas (not individual stock betas) and portfolio size and composition differ across events, the beta estimates vary across events even if a given bank’s beta is constant during an estimation period.
D.K.
Osborne and ET. Zaher,
The uniqueness
of bank loans
Table 2 Market model estimates asociated with reserve-requirement Event Announcement no. date
i
807
changes.’
RZ
F
DWb
N
1
Jun. 29, 1973
0.4758 (14.0)’
0.0001 (0.19)
0.71
197.5
1.61
20
2
Dec. 7, 1973
0.579+ (11.5)
(::p
0.63
134.1
1.80
19
3
Sep. 4, 1974
1.1708 (9.85)
-0.0018 (- 1.59)
0.55
97.1
1.60
18
4
Dec. 24, 1975
0.898* (9.74)
-0.0012 (- 1.66)
0.54
94.9
1.63
15
5
Dec. 19, 1976
0.792’ (9.23)
0.0003 (0.42)
0.52
85.3
1.80
14
6
Nov. 1, 1978
0.611’ (10.5)
O.OQOl (0.13)
0.59
110.6
2.12
26
7
Oct. 6, 1979
0.524* (5.89)
0.0004 (0.85)
0.51
1.67
12
B
34.78
‘For events 2 through 7 the regressions use daily data for the 80 days from day -6 through day -85. For event 1 the estimation period runs from day +6 to day +85. “The Durbin-Watson statistics indicate that the residuals for all regressions are free from first order serial correlation. ‘r-Statistics are in parentheses. *SigniIicantly different from zero at O.COOllevel.
and 1 and the cumulative abnormal returns during the three sub-event periods. Over the period (- 5, - I), cumulative abnormal returns reject the null hypothesis only for event 7 (discussed further below). On day 0, abnormal returns reject the null hypothesis only twice (events 6 and 7). Hence, there is little evidence that the market anticipated the events. On day 1 abnormal returns reject the null hypothesis five times. The statistically significant abnormal returns range from 0.83% to 3.45”; per day in absolute value, with an average of 1.93%. For the period (0,l) cumulative abnormal returns reject the null hypothesis three times, though their signs agree with the alternative hypothesis six times (events 2-7). Thus, it does not appear that the rejections on day 1 represent recoveries from unusual conditions in banking on day 0. For the period (2,5), cumulative abnormal returns reject the null hypothesis once and their signs agree with the alternative hypothesis six times (events 2-7). Hence, there is no evidence that subsequent price changes reverse the changes occurring on day 1. Indeed, there is a suggestion that the market’s response to the events is somewhat prolonged, though most of it occurs on day 1. The event with the longest response time is event 7. This
Jun. 29, 1973
Dec. 7, 1973
Sep. 4, 1974
Dec. 24, 1975
Dec. 17, 1976
Nov.
Oct. 6, 1979
I
2
3
4
5
6
7
increase
increase
decrease
decrease
decrease
decrease
increase
Reserve change
abnormal
Table
3
-0.0129 ( - 2.8500)’
-0.0157** (-3.IOOO)
-0.0014 ( - 0.3500)
0.0077 (1.1900)
-0.0101 1.6900)
(-
- 0.0084 ( - 1.5900)
0.0022 (0.6500)
Day 0
Abnormal
1
0.0083’ (2.0900)
- 0.0259 (-4.3900)*’
-0.038x** (-5.1200)
0.0267’ 2.7200)
(-
-0.0216” 3.2000)
(-
(-0.1900)
-0.0012
0.006Y
( I .2200)
- 0.0053
0.0204* (2.2300)
(1.0000)
0.0144
0.0066 (0.9200)
(-0.6ooo)
0.0108 (0.7500)
0.0090 (0.3700)
0.0345** (3.3100) 0.0127* ( I .9700)
- 0.0029 ( - 0.2400)
0.0152*
returns Days (0.1)
0.0056 (0.1600)
abnormal
(- 5, - 1)
0.0011 (0.5400)
Days
Cumulative (2.)
-0.0114
O.OWJ (0.7400)
0.0095 (0.7400)
( 1.OSOO)
0.0218
0.0039 (0.3900)
0.0043 (1.1200)
h)‘S
-0.033W (-3.7100)
I8
19
20
Sample size
I”- and Z-statistics).
( - I .3200)
changes (and corresponding
(2.9ooo)
0.0033 (0.9400)
Day
- 0.0058 I .43OO)
(-
returns
returns associated with reserve-requirement
__ ~_ ~~ *Rejects null hypothesis al 0.05 level. **Rejects null hypothesis aI 0.01 level.
I, 1978
Announcment date
and cumulative
Event no.
Daily
$ z
2
8 00
D.K. Osborne and ZS. Zaher, i%e uniqueness of bank loans
809
event was very complicated, including the announcement of a new monetary policy which would devote more attention to the money stock than to interest rates. It would not be surprising if investors needed some time to analyze its implications for bank profits. Returning to the results for days 0 and 1, we note that the rejection rate for the null hypothesis is 85.7% (6 of 7 events). Given the null hypothesis, with a significance level of SoA,the probability of a rejection for a given event is 5%. Assuming that the tests for the seven events are independent, the binomial law,
gives the probability of six or more rejections as 7.92 x lo-‘. Therefore, the observed rejection rate is not consistent with the null hypothesis.
4. Abnormal returns in relation to event size and type The evidence reviewed thus far strongly indicates that the reserverequirement tax falls at least partly on bank shareholders. If it falls exclusively on shareholders, abnormal returns should vary montonically (in the opposite direction) with the size of a tax change, as larger tax changes would produce larger changes in bank wealth. The exact size of a tax change cannot be determined for our sample banks but, for six of the events, it is estimated for the whole banking system. For example, event 1 increased required reserves for the whole banking system by $800 million according to Federal Reserve estimates at the time of the event, while event 2 decreased required reserves by $370 million. Thus, event 1 was ‘larger’ than event 2 for the banking system. It is reasonable to assume that the ordering of event sizes for the sample banks is the same as for the banking sytem, because the liability structures of large member banks (who hold most of the required reserves) show little cross-sectional variation. Using Federal Reserve estimates of size, table 4 shows the estimated size and abnormal return for the first six of the seven events examined (the Fed did not report an estimated size for event 7). The table also shows the type of liability to which the changed reserve requirements applied. Table 4 does not reveal the monotonic relation between event size and abnormal return that we should see if stockholders bore the whole tax. The table reveals three failures of monotonicity. These three may represent two distinct types. First, although event 6 is the largest by far, its abnormal return is only the second largest. Just what might explain this result is not clear; but the fact that the abnormal return occurred on day 0, while day 1
810
D.K.
Osborne
and TS. Zaher,
7he uniqueness
of bank loans
Table 4 Event characteristics. Event no.
Date
1 2 3 4 5 6
Jun. 29, 1973 Dec. 7, 1973 Sep. 4, 1974 Dec. 24, 1975 Dec. 17, 1976 Nov. I, 1978
Size’
Abnormal returnP
+800 -370 -400 -340 - 550 + 3,cQO
0.0033 o.o1s2* 0.034s* 0.0127’ 0.0083* 0.0157**
Deposit type demand time time time demand (day 0) time
“In S millions. bOn day I except as noted.
lSignificant at the 5% level. **Significant at the 1% level.
showed no statistically significant abnormal return, suggests that news of event 6 leaked out before the ‘event day’. The other type of monotonicity failure concerns events 1 and 5. Event 1 is the second largest of all events, but it is the only one for which abnormal returns are statistically insignificant. Event 5 is the third largest but its abnormal returns are the smallest of all the statistically significant ones. All the remaining events show montonicity. Because events 1 and 5 are the only events that affected demand deposits, they raise the possibility of a differential incidence of the tax. Specifically, shareholders might bear less of the tax when it is levied on demand deposits than when it is imposed on time deposits. 5. Summary and conclusion On six of the seven occasions, an announcement of changed reserve requirements induced statistically and economically significant abnormal returns to holders of large member banks’ common shares. Because these abnormal returns had signs opposite to those of the changes in reserve requirements, they have a simple interpretation: An increase (decrease) in reserve requriements reduces (increases) the expected profits of the affected banks. The change in profits alters expected returns to shareholders, thus inducing changes in share prices to restore a capital market equilibrium. In this way, bank shareholders bear at least part of the deposit tax. It is possible that shareholders bear the \z?hole tax on large time deposits, as all five changes in reserve requirements against such deposits induced significant abnormal returns. Moreover, with one exception probably attributable to news leakage, the abnormal returns varied montonically with the size of these five reserve requirement changes. These results support previously reported evidence that holders of large time deposits do not bear the
D.K. Osborne and 73. Zaher. The uniqueness of bank loans
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reserve requirements tax. The tax apparently cannot be shifted to those depositors. By contrast, changes in reserve requirements against demand deposits induced smaller abnormal returns. For these two changes, the abnormal returns were 0.33% and 0.83% per day on day 1, the first not being significantly different from zero, even though the potential effects on required reserves were among the largest examined. Apparently, shareholders bear less of the tax on demand deposits, suggesting that some of it is shifted to other parties. It might be argued that the small abnormal returns associated with changes in the demand deposit tax show that the tax is partly shifted to borrowers, just as Fama hypothesized. But the problem with this argument is that it should apply with equal force to the time deposit tax. If borrowers can be made to bear the demand deposit tax, why not saddle them with the time deposit tax as well? After all, they presumably do not care how the bank obtains the funds it lends them. A more plausible hypothesis is that part of the reserve requirements tax falls on demand depositors. Intuitively, demand deposits ought to have a less elastic demand function than large time deposits. Although demand deposits have many substitutes as portfolio assets, only they (besides currency) serve as exchange media. Insofar as holders of demand deposits are insensitive to variations in the own rate of return, they will bear a share of the deposit tax.” This hypothesis is well worth rigorous testing in future research.13 We emphasize that our results to not preclude the possibility that part of the tax might fall on borrowers and that bank loans are unique. But the results undercut the empirical case for uniqueness insofar as it is built on incidence of the tax. If bank loans are unique, empirical evidence must be sought elsewhere. “Flannery and James (1984) report evidence that savings deposits and small time deposits, well as demand deposits, are demanded inelastically with respect to their own rate of return. “A hypothesis cannot be tested by use of the data that suggest it.
as
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