The Journal of Finance

Is the International Convergence of Capital Adequacy Regulation Desirable?

Published: 11/07/2003   |   DOI: 10.1046/j.1540-6261.2003.00621.x

Viral V. Acharya

The merit of international convergence of bank capital requirements in the presence of divergent closure policies of different central banks is examined. The lack of a complementary variation between minimum bank capital requirements and regulatory forbearance leads to a spillover from more forbearing to less forbearing economies and reduces the competitive advantage of banks in less forbearing economies. Linking the central bank's forbearance to its alignment with domestic bank owners, it is shown that in equilibrium, a regression toward the worst closure policy may result: The central banks of initially less forbearing economies also adopt greater forbearance.

Leverage, Moral Hazard, and Liquidity

Published: 01/06/2011   |   DOI: 10.1111/j.1540-6261.2010.01627.x

VIRAL V. ACHARYA, S. VISWANATHAN

Financial firms raise short‐term debt to finance asset purchases; this induces risk shifting when economic conditions worsen and limits their ability to roll over debt. Constrained firms de‐lever by selling assets to lower‐leverage firms. In turn, asset–market liquidity depends on the system‐wide distribution of leverage, which is itself endogenous to future economic prospects. Good economic prospects yield cheaper short‐term debt, inducing entry of higher‐leverage firms. Consequently, adverse asset shocks in good times lead to greater de‐leveraging and sudden drying up of market and funding liquidity.

A Crisis of Banks as Liquidity Providers

Published: 06/02/2014   |   DOI: 10.1111/jofi.12182

VIRAL V. ACHARYA, NADA MORA

Can banks maintain their advantage as liquidity providers when exposed to a financial crisis? While banks honored credit lines drawn by firms during the 2007 to 2009 crisis, this liquidity provision was only possible because of explicit, large support from the government and government‐sponsored agencies. At the onset of the crisis, aggregate deposit inflows into banks weakened and their loan‐to‐deposit shortfalls widened. These patterns were pronounced at banks with greater undrawn commitments. Such banks sought to attract deposits by offering higher rates, but the resulting private funding was insufficient to cover shortfalls and they reduced new credit.

Aggregate Risk and the Choice between Cash and Lines of Credit

Published: 05/13/2013   |   DOI: 10.1111/jofi.12056

VIRAL V. ACHARYA, HEITOR ALMEIDA, MURILLO CAMPELLO

Banks can create liquidity for firms by pooling their idiosyncratic risks. As a result, bank lines of credit to firms with greater aggregate risk should be costlier and such firms opt for cash in spite of the incurred liquidity premium. We find empirical support for this novel theoretical insight. Firms with higher beta have a higher ratio of cash to credit lines and face greater costs on their lines. In times of heightened aggregate volatility, banks exposed to undrawn credit lines become riskier; bank credit lines feature fewer initiations, higher spreads, and shorter maturity; and, firms’ cash reserves rise.

A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk

Published: 08/11/2014   |   DOI: 10.1111/jofi.12206

VIRAL ACHARYA, ITAMAR DRECHSLER, PHILIPP SCHNABL

We model a loop between sovereign and bank credit risk. A distressed financial sector induces government bailouts, whose cost increases sovereign credit risk. Increased sovereign credit risk in turn weakens the financial sector by eroding the value of its government guarantees and bond holdings. Using credit default swap (CDS) rates on European sovereigns and banks, we show that bailouts triggered the rise of sovereign credit risk in 2008. We document that post‐bailout changes in sovereign CDS explain changes in bank CDS even after controlling for aggregate and bank‐level determinants of credit spreads, confirming the sovereign‐bank loop.

Rollover Risk and Market Freezes

Published: 07/19/2011   |   DOI: 10.1111/j.1540-6261.2011.01669.x

VIRAL V. ACHARYA, DOUGLAS GALE, TANJU YORULMAZER

The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short‐term debt that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy‐to‐hold investor. We then show that a small change in the asset's fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008.

The Internal Governance of Firms

Published: 05/23/2011   |   DOI: 10.1111/j.1540-6261.2011.01649.x

VIRAL V. ACHARYA, STEWART C. MYERS, RAGHURAM G. RAJAN

We develop a model of internal governance where the self‐serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, in which dividends are paid by self‐interested CEOs to maintain a balance between internal and external control.

Zombie Credit and (Dis‐)Inflation: Evidence from Europe

Published: 04/11/2024   |   DOI: 10.1111/jofi.13342

VIRAL V. ACHARYA, MATTEO CROSIGNANI, TIM EISERT, CHRISTIAN EUFINGER

We show that “zombie credit”—subsidized credit to nonviable firms—has a disinflationary effect. By keeping these firms afloat, zombie credit creates excess aggregate supply, thereby putting downward pressure on prices. Granular European data on inflation, firms, and banks confirm this mechanism. Markets affected by a rise in zombie credit experience lower firm entry and exit, capacity utilization, markups, and inflation, as well as a misallocation of capital and labor, which results in lower productivity, investment, and value added. If weakly capitalized banks were recapitalized in 2009, inflation in Europe would have been up to 0.21 percentage points higher post‐2012.

The Anatomy of the Transmission of Macroprudential Policies

Published: 08/10/2022   |   DOI: 10.1111/jofi.13170

VIRAL V. ACHARYA, KATHARINA BERGANT, MATTEO CROSIGNANI, TIM EISERT, FERGAL MCCANN

We analyze how regulatory constraints on household leverage—in the form of loan‐to‐income and loan‐to‐value limits—affect residential mortgage credit and house prices as well as other asset classes not directly targeted by the limits. Loan‐level data suggest that mortgage credit is reallocated from low‐ to high‐income borrowers and from urban to rural counties. This reallocation weakens the feedback between credit and house prices and slows house price growth in “hot” housing markets. Banks whose lending to households is more affected by the regulatory constraint drive this reallocation, but also substitute their risk‐taking into holdings of securities and corporate credit.