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'Off-balance sheet vehicles, voluntary support and bank reputation'

Detail Summary
Date 31 March 2015
Time 12:30 - 14:00

Abstract:

During the 2007-09 financial crisis sponsor banks granted voluntary support to their off-balance sheet vehicles, which was perceived as a way for these banks to preserve their reputation. I develop a model of a bank's decision to finance a project with a mix of debt issued on-balance sheet and off-balance sheet (through a vehicle that owns the project) in which the anticipation of the reputational implications of voluntary support plays the central role. On-balance sheet debt reduces asymmetric information and debt dilution costs for a good bank. Off-balance sheet debt allows to avoid reputation deterioration when the project fails through the voluntary support of the vehicle, which reduces the funding costs in the future. I find that off-balance sheet funding emerges when both the size of investment opportunities in the future and the a priori reputation of the bank are sufficiently high. In these cases, the introduction of a ban on voluntary support would benefit a bad bank at the expense of a good one.