Journal of Monetary Economics 12 (1983) 417-432. North-Holland AN ANALYSIS OF INTRA-INDUSTRY DIFFERENCES IN THE EFFECT OF REGULATION The Case of Deposit Rate Ceilings Christopher JAMES* Oflce of the Comptroller of the Currency, Washington, DC 20219, USA University o/Oregon, Eugene, OR 97403, USA This study examines the impact of deposit rate ceiling changes on the market value of commercial banks and stock savings and loan associations. Statistically significant increases in market value are found on announcement of the removal of ceilings on large denomination certificates of deposit. In contrast, retail commercial banks and savings and loans experienced declines in value on announcei;%ent of the elimination or relaxation of deposit rate ceilings on small denomination consumer accounts. In addition, for all events analyzed, significant differences were found in the effect of ceiling changes on the market value of wholesale and retail commercial banks. 1. htroduction Recent attempts to explain the pattern of regulation have focused on regulation as a means of transferring wealth between competing interest groups.’ A common assumption in this literature is that there are two competing homogenous interest groups in the regulatory process: consumers and producers. Empirical studies have focused on examining which of these groups prevails in the regulatory process by examining the net benefits received by each. A common approach to measuring the wealth effects has been to examine changes in the value of firms in the regulated industry following the announcement of regulatory actions.2 While the examination of the wealth transfers between producers and consumers has provided important evidence regarding the competing theories of regulation, the wealth effects uf regulation may be more complex than the intergroup transfers analyzed in the literature. As Peltzman (1976) argues, if producers differ in terms of their cost structures or if differences in product demand exist then intra-industry transfers may also be important. In *The author would like to thank the referee, L.Y. Dann, M. Hopewell, W. Mikkelson, M. Flannery, G. Kaufman, P. Wier, .and especially Kathi Martell. The views expressed in this paper are the author’s and do not necessarily represent the views of the Office of the Comptroller of the Currency. ‘The best known papers on this topic are Stigler (1971). Jordan (1972), and Peltzman (1976). ‘See Schwert (1981) for a review 0.T the empirical literature concerning the effect of regulation. 0304-3923/83/$3.00 0 1983, Elsevier Science Publishers B.V. (North-Holland)
Transcript
Journal of Monetary Economics 12 (1983) 417-432. North-Holland
AN ANALYSIS OF INTRA-INDUSTRY DIFFERENCES IN THE EFFECT OF REGULATION
The Case of Deposit Rate Ceilings
Christopher JAMES* Oflce of the Comptroller of the Currency, Washington, DC 20219, USA
University o/Oregon, Eugene, OR 97403, USA
This study examines the impact of deposit rate ceiling changes on the market value of commercial banks and stock savings and loan associations. Statistically significant increases in market value are found on announcement of the removal of ceilings on large denomination certificates of deposit. In contrast, retail commercial banks and savings and loans experienced declines in value on announcei;%ent of the elimination or relaxation of deposit rate ceilings on small denomination consumer accounts. In addition, for all events analyzed, significant differences were found in the effect of ceiling changes on the market value of wholesale and retail commercial banks.
1. htroduction
Recent attempts to explain the pattern of regulation have focused on regulation as a means of transferring wealth between competing interest groups.’ A common assumption in this literature is that there are two competing homogenous interest groups in the regulatory process: consumers and producers. Empirical studies have focused on examining which of these groups prevails in the regulatory process by examining the net benefits received by each. A common approach to measuring the wealth effects has been to examine changes in the value of firms in the regulated industry following the announcement of regulatory actions.2
While the examination of the wealth transfers between producers and consumers has provided important evidence regarding the competing theories of regulation, the wealth effects uf regulation may be more complex than the intergroup transfers analyzed in the literature. As Peltzman (1976) argues, if producers differ in terms of their cost structures or if differences in product demand exist then intra-industry transfers may also be important. In
*The author would like to thank the referee, L.Y. Dann, M. Hopewell, W. Mikkelson, M. Flannery, G. Kaufman, P. Wier, .and especially Kathi Martell. The views expressed in this paper are the author’s and do not necessarily represent the views of the Office of the Comptroller of the Currency.
‘The best known papers on this topic are Stigler (1971). Jordan (1972), and Peltzman (1976). ‘See Schwert (1981) for a review 0.T the empirical literature concerning the effect of regulation.
418 C. James, An analysis of intra-industry lii@erences
particular, certain firms in the regulated industry m,ay earn subsidies while others are taxed by regulation. Empirical studies which examine the average impact of regulation on tirms in an industry may therefore mask important differences among firms.
In this paper, rht: impact of deposit rate regulation on the market value of commercial banks is analyzed by examining the effect of deposit rate ceiling changes on the common stock price performance of actively traded commercial banks. The empirical investigation focuses on two important issues. The first issue concerns whether commercial banks lhave earned rents on deposit accounts because of the existence of deposit rate ceilings. A statistically significant decline in market value at announcement of the relaxation or removal of ceilings would be evidence consistent with the existence of a subsidy attributable to ceilings. The second issue investigated concerns the existence of systematic intra-industry differences in the effect of deposit rate ceilings on the market value of commercial banks.
Three important findings emerge from the investigation. First, for the entire sample of commercial banks, statistically significant increases in value were experienced at the announcement of the removal of ceilings on certificates of deposits of over %lOO,OOO. This finding is consistent with the hypothesis that ceilings on these accounts act as a tax on earnings. In eontrast, for the entire sample of banks, no statistically significant change in value was observed at the announcement of the removal of ceilings on consumer certificate accounts and the introduction of Money Market Certificates. Second, for retail oriented commercial banks, statistically significant declines in value were experienced on the announcement of ceiling changes on consumer accounts. This finding is consistent with the hypothesis that ceilings applied to consumer accounts provide these institutions with a subsidy.3 Finally, for all events analyzed significant differences in the response of wholesale and retail banks to ceiling changes were found. The evidence suggests’ that sign&ant intra-industry wealth transfers have resulted from ceilings. The results provide valuable insights into the pattern of regulations as well as the effect of future deregulation4
The paper is organized as follows: Section 2 contains a brief discussion of the factors determining the effect of deposit ceilings on market value and describes the hypothesis tested in this paper. Section 3 describes the data
‘An alternative interpretation would be that there is no subsidy associated with ceiling but the transition from low interest-high service deposit accounts to high interest-low service payment i is easily. The de+cline in market value therefore reflects the cost of adjustment. Thi+ interpretation is discussed below.
*By examining the impact of changes in rate ceilings on the value of depository institutions the wealth effects associated with the administration of regulation are analyzed. Passage of th:: Depository Institutions Deregulation and Monetary Control Act of 1980, which requires thz elimination of ceilings, has rekindled an interest in the effect of rate controls on earnings cf depository institutions.
C. James, An analysis of intra-industry diftrences 419
used and the regulatory changes analyzed. Section 4 describes the methodology used to measure security price performance. Section 5 contains the results of the analysis. The final section offers conclusions.
2. Background on the effect of deposit rate ceilings
While it is widely recognized that ceilings impose losses on depositors [see Pyle (1974), Kane (1970), and Clotfelder and Lieberman (1978)], the effect of ceilings on the value of depository institutions is still a matter of considerable debate. Ceilings were originally implemented to limit interinstitutional competition for deposits as a means of reducing deposit costs and, therefore, of contributing to the financial integrity of depository institutions; particularly retail commercial banks and thrift institutions.’ In this view, ceilings serve as a government administered price fixing agreement, with the result of reduced deposit costs and increased earnings. Whether ceilings succeed in effecting a wealth transfer from depositors to the owners of the institution depends on the e?asticity of deposit supply and the extent to which ceilings can be circumvented through the use of non-interest payments.6 Success in circumvention in turn depends on the effectiveness of restrictions on non-price competition such as branching restrictions and limitations on the use of premiums.’
As the above discussion indicates that the effect of ceilings will depend, in part, on the characteristics of the deposit instrument subject to ceilings. For example, in the case of small denomination time and passbook accounts. minimum transaction quantities, and information and transactions costs, result in a less elastic supply than for large denomination certificates of
5F~r a history of the rationale and administration of ceilings, see the U.S. Treasury Department’s Interagency Task Force Report (1979).
“When ceilings are binding, deposit growth slows or declines. However, ceilings mav reduce interest expense’on deposits below competitive rates increasing net margins. The growth and expense effects are, therefore, countervailing with the result that the effect of ceilings on earnings becomes an empirical question. However, the less elastic the supply, cereris @bus, the smaller the growth effect and hence the higher the probability of ceilings improving earnings. Given binding ceilings, firms will have an incentive to circumvent the ceilings through non-interest, payments. In the absence of restrictions on the use of non-interest payments (e.g.. premiums. additional branches, etc.) banks will offer a combination of implicit and explicit payments equal to the: competitive rate [the exception occurs when rate regulation also a!Tects the competitibc structure of the industry, see footnote 7 and White (1972)]. Whether existing restrictions on branching and premiums are effective in making circumvention less than complete is an empirical issue addressed in this paper.
‘It is interesting to note that ceilings together with branching restrictions may serve as an effective entry barrier to local banking markets. Ceilings limit the ability of an institution located outside the local market to compete for deposits while branching restrictions limit rhe ability of potential entrants to compete using non-interest payments. Therefore, removal of ceilings ma! reduce the market value of certain institutions by the present discounted value of the entry barriers.
420 C. James An analysis of intra-industry difl’erences
deposits or purchased funds. Ceilings on small denomination accounts may therefore augment earnings. Alternatively, in the case of large certificates of deposits, the imposition of ceilings may result in a decline in earnings. As Friedman (1970) argues, the supply of these deposits is relatively elastic and because circumvention of ceilings is costly, rate controls will serve as a tax, resulting in a decline in value by the present discounted value of the circumvention or avoidance costs.
Closely related to the issue concerning the effect of ceilings on the market value of depository institutions is the question of whether the effect of rate regulation on market value varies among commercial banks. There are two reasons to expect a differential response. First, banks differ in terms of their deposit portfolio composition. For example, as table 1 indicates, large banks hold a substantially smaller proportion of their liabilities in the form of small denominat:ion time and passbook accounts than do smaller retail oriented institutions;. Any rents accruing from ceilings on small denomination deposits will therefore represent a larger proportion of total market value of retail oriented commercial banks than for wholesale banks.
Second, even in the absence of difference in the composition of their liability portfolios, ceilings may result in differences in subsidies (or taxes) among banks. In general, rate regulation can be viewed as a government administered price fixing agreement. Like any cartel, if members differ in terms of their cost structure they will differ in terms of their preferred cartel price. In t.he case of deposit production, it can be shown that high cost producers (i.e., banks with a higher relative marginal cost of producing deposits) will ceteris puribus prefer lower deposit rate ceilings than will low cost producers. ’ To the extent, ,therefore, that banks differ in terms of their cost of prod’ucing de:posit services, ceiling changes will effect them differently.’
3. Descriprtioa of the datra
To investigate the et%ct of changes in deposit rate ceilings on the market value of commercial banks, daily common stock returns are examined around four ceilings changes that occurred during the period 1970-1978. The
‘This: is asnalogous to the case of cartel pricing with cost differences in the product market. See !3cherer (19&D, pp. 199-229).
‘With differences in deposit costs changes in the ceilings may move some institutions towards their preferred cartel price, resulting in an increase in market value, while other institutions are movd:d away from their preferred or profit maximizing prim. Difterences in cost structure refer to di.&rena?s in the marginal cost of producing deposits. It is important to note that difTerences in cost structures or differences in deposit demand conditions are consistent with differences in the direction of market value changes. Differences in market response due solely to differencw in portfolio composition would imply differences in the magnitude of market value changes but not differences in the dir&on of change.
C. James, An 18?talysis of intra-indusctry d@rencts 421
Table 1
Distribution of interest bearing liabihties at commercial banks and savings and loans as a percentage of total interest bearing liabilities (19661980).
1966 1969 i973 1974 1978 1980
Large banksb
Passbook ceiling time Fixed ceiling time Total fixed ceiling
Total subject to fixed ceilings 94.0 93.8 92.2 89.5 80.0 42.2 --- -- - -
MMC’s _ - -_ - 8.4 30.7 ssc’s _ - - -- - 9.3
Total not subject to ceilings 6.0 6.2 7.8 10.5 11.6 17.8
__ - - .- --
‘Source: Federal Reserve. bBanks with $100 million or more in assets. CBanks with less than $100 million in assets. ‘Savings and loan characteristics are discussed in section 6.
422 C. James, An analysis of intru-industry dtgerences
four regulatory changes examined are summarized below:
Announcement date Regulatory chaage
__.-
6/‘23,‘70 Interest rate ceilings suspended on certificates of deposits of $100,000 or more with maturities of 30 through 89 days.
5.!16’73 Ceilings suspended on certificates of $100,000 or more with maturities of 90 days or more.
7: 5.‘73
5;l I:‘78
Ceilings removed on certificates of %l,OOO or more with maturities of 4 years or more. Passbook savings rates increased l/4 of a point to 5 1,‘4 percent.
Money Market Certificate (MMC) with ceiling tied to the average rate on new issues of 6-month Treasury bills introduced. In addition, an g-year certilicate with a fixed 8 percent ceiling introduced.
The announcement dates represent the date the announced change was fist published in American Banker. Issues of Anrerican Banker were examined for 30 days before and after the announcement to determine whether c,gncurrent regulatory changes were announced that may have affected the lit-m’s share price. With the exception of the 1973 ceiling change discussed below, no announcements regarding ceilings were made during the 60-day rperiod surrounding the event.”
Measuring the effect of ceiling’s changes during the 1970-1978 period was facilitated by the fact that regulatory agencies acted, in most cases, without prior public announcement. Therefore, the main problem encountered in many studies of the impact of regulatory change is, in large part, avoided in this study. A 1 P
Daily common stock price, dividend and trading volume information were obtained for commercial bank issues from the Data Resources Incorporated (DRI) Securities Price Me. l2 Bank issues were included in the analysis if they met the following three criteria: (1) shares of the firm were traded daily during the 1lChiay period used to estimate the parameters of the model, (2)
‘%eposit rate ceiling occurring after 1978 were not included in this study because of the high frequency and close spacing of ceiling changes. For example, five changes in the rate structure were announced during the spring of 1979.
“Schwert (1981) identifies the difficulties encountered in analyzing the impact date(s) of regulatory changes. In only one instance during the 1970-1978 period were ceilings changed as a result of legislative action: the reimposition of ceilings on $1,000 four-year certificates in November 1973. Because of the difficulty in identifying a date for this change, the effect of reimposing ceihngs is not investigated.
“‘Data Resources hcorporated obtains price and trading volume from Telstat Incorporated ivhich supplies trading information to the Wall Street Journal and other sources. Price and trading volume are maintained for all NYSE and AMEX stock from 1968 to present. Over the cmnter issues are maintained from 1972 to present. For the 1970 ceiling change, price information for stocks traded over the counter was obtained from issues of American Banker.
C. James, An analysis of intra-industry dlferences 423
for bank holding company issues, the lead bank in the holding company had assets equal to 60 percent or more of the assets of the holding company, and (3) the bank or bank holding company had an equity value of $50 million or more.
Only firms with non-zero trading volume for each day in the estimation period was used Ito reduce biases in the parameter estimates induced by infrequent [see Dimson (1980)]. The sample was limited to bank holding companies with1 an identifiable !ead bank to permit segmentation of banks based on their deposit portfolio characteristics. The characteristics of the lead bank in the holding company were used to classify banks in a manner discussed below. YFinally, limiting the analysis to banks with equity value of $50 million or more was done to insure that banks in the sample had actively traded shares.
4. Mehdoiogy
To analyze the effect of deposit rate ceiling changes on the value of commercial ba.nks, the common stock price performance around changes in deposit rate ceilings is examined. Rates of return to commercial bank stockholders are examined for two principal reasons. First, it is assumed that the observed market values of commercial bank shares incorporate the capitalized value of the expected future rents (or taxes) arising from deposit rate ceilings. Moreover. substantial and compelling evidence exists which suggest that security prices ‘efficiently’ impound changes in expected future cash flows.’ 3 Second, it is likely to be much easier to dete:t the effects (if any) of ceiling changes in the market price of commercial bank shares than in non-market variables such as bank accounting earnings.
To measure security price performance, a single factor market model was used. The market model gives the relationship between the rate of return on the security (or portfolio) and the rate of return on the market portfolio. This provides a method of isolating the effects of general market conditions from firm or industry specific events. The market model is expressed:
4 = ~:j + flj iI,, -t tjr 7 where
4, = rate of retu.rn on security j over period f, a mr = rate of return on an equally-weighted market portfolio over period r.
p.i =cov(Bj,,R,,)/var(ll:,,).
OLj = E&l - ,$ E&J, * "jr = disturbance term of security j over period f, and E(Ej,) = 0.
“See IFama (1976) for an elaboration of the efficient markers, rational expectation hypothesis. Note that since the efftcient markets/rational expectations hypo:hesis posits that security prices reflect al1 available information. the security price movement on announcement day reflects on14 the effect of unanticipated changes in regulation.
424 C. Jams, An analysis of intra-industry difirences
The parameter ~j can be interpreted a a measure of the security systematic or undiversifiable risk.
The market model is used to calculate prediction errors, PE,,, for each lirm, j, and for each day,, t, of interest around the economic event, where
The coefficients dij and ipi are estimated using data for a period outside of the period in which th.e event occurs. The prediction error represents an estimate of the abnormal returns to the shareholders of firm j. It is an abnormal return in the sense that it represents the deviation of the return on the security from its expected return, given the return on the market index during the period.
Although the market mode1 methodology just described is generally applied to individual securities, it can be applied equally well to linear combinations (portfolios) of securities. l3ecause announcements of regulatory change affect all firms in the sample simultaneously, a portfolio approach is used in this study. By analyzing portfolio returns, Rpt, and the associated prediction errors, H&, the cross-sectional dependence of the component security returns can be directly incorporated into the analysis, facilitating joint tests of significance. l4 For this reason around each of the regulatory changes investigated the following mode1 was estimated:
Estimates of & and &, were then used to calculate the predicticn error for portfolio, PE,, , for days around the regulatory change. The market mode1 was run first using a portfolio consisting of all banks in the sample. Prediction errors were then calculated for each day in the analysis. period to measure the average response of banks to changes in ceilings. Next, banks in the sample were divided into groups based on their deposit portfolio composition. Portfolios consisting of common stocks of banks in each group were formed. The market model was then used to estimate prediction errors for each of these portfolios.
5.1. Average bank response
The effect of ceiling changes on bank market value is first investigated
“It is unhkely that the returns or market model prediction errors for firms in the same :;idustry are contemporaneously uncorrelated [see King (1966) for evidence of industry influence]. Therefore, tests for abnormal performance based upon a cross-sectional average of th measures will reject too frequenting the null hypothesis of no abnormal performance, See Schwert a 1981) and James (1981).
C. James, An analysis of intra-industry d@venrc.: 425
using the entire sample of commercial banks. Since intra-industry differences
in response are ignored the results are referred to as average bank response. Estimates of the parameters of the market model were obtained using daily
returns for 110 days around each regulatory cl*iange.1 5 Using these parameter estimates, prediction errors and cumulative prediction errors were calculated for each regulatory change. Table 2 summa,rizes the results for the entire sample of commercial banks for 10 days before: and after the date of announcement. The cumulative prediction errors can be interpreted as an index of the total abnormal price changes around the event.
Table 2
Percentage daily prediction errors (PE) and cumulative prediction errors (CPE) for deposit rate ceiling chaages for 10 days before and after the announcement
As the data in table 2 indicate, positive abnormal returns were earned on the announcement date of the 1970 removal of ceilings on certificates of
“The 1973 CD and Wild Card events occurred within 65 trading days of one another. To avoid any possible contamination of the parameter estimates, portfolio returns within the analysis period for each event were not used in estimating the parameter of the market model. Therefore, the 55 days of returns after the CD event were not sequential. Similarly, the 55 days of returns prior to the Wild Card change were nor sequential, rat3zr the returns for days - 10 lo + IO around the CD ceiling change were excluded.
426 C. Aames, An unolysis of intra-industry differences
deposit (CD’s), while negative returns were observed on the dates of subsequent regulatory changes.”
To determine whether thr:. announcement day prediction errors are sign%cantiy different from zero the following test statistic was used:
where T=announcement day, PJ!& =the prediction error for day T,
+10
1 PE,,- APQ2 ‘, APE =+, +$-) PEP,. 1=-10 I 1=-10
f+T t+T
For one event, the 1970 removal of ceilings on CD’s, the announcement day prediction error is significantly different from zero at the 5 percent level. The t statistic for the announcement day return is 2.26.” Fqr the other events analyzed the prediction errors on announcement day are not statistically significant at the 5 percent level.
Based on the average bank response, the increase in the market value at announcement of the 1970 ceiling change suggests that ceilings on certificates of deposit imposed a binding constraint on banks, and this constraint served as a tax on bank earnings. The lack of a statistically significant response on the announcement of ceiling changes affecting consumer accounts may be considered evidence inconsistent with the hypothesis that ceilings on these accounts provide bank owners a subsidy.
Before concluding, however, that ceilings do not imply a transfer from depositors to shareholders, it is <PC interest to examine whether the effect of ceilings changes on market value varies among commercial banks. As discussed in section 2, the impact of ceilings on the market value of the bank may differ across commercial banks, depending upon their size and/or the composition of their liability portfolio. Since the prediction error for the portfolio of all banks represents a weighted average of the prediction errors for the individual securities, the prediction errors presented in table 2 may mask cross-sectional diff&ences in the response of banks. Moreover, intra- industry transfers may be more important in the consumer deposit market where, as discussed above, the supply of deposits is less than perfectly elastic, Hence, the lack of a sign&ant response to ceiling changes may be the result of a differential effect among the banks in the sample.
T’he nhrmber of banks included in each portfolio are listed on the bottom of table 2. “The lack of any positive and significant reaction to the subsequent removal of ceilings on
CD% in f973 suggests that regulatory action in 1970 effectively deregulated this portion of the deposit market.
C. James, An analysis of intro-industry diflerences 427
5.2. intra-industry differences
To test the hypothesis that the impact of ceiling changes varies depending on the bank’s deposit portfolio composition, the ratio of passbook savings deposits to total deposits was calculated for each of the banks in the sample. The ratio of savings deposits to total deposits was used as an indicator of the bank’s activity in the consumer deposit market. Next, portfolios were formed based on the deposit portfolio composition of each instituion. Banks with less than 10 percent of their total deposits in passbook accounts were classified as wholesale banks. Banks with 20 percent or more of their deposits in passbook accounts in 1978 were classified as retail banks. The banks that were classified in the sample as retail institutions had deposit portfolios similar in composition to small commercial banks.18
For each group of banks, an equally weighted portfolio was constructed and the portfolio return and prediction error were calculated in the same manner as described in section 4. The daily prediction and cumulative prediction errors for both groups of banks for each event are contained in table 3.
For wholesale banks, positive abnormal returns were observed for each of the regulatory changes. For the 1970 removal of ceilings on CD’s, wholesale banks experienced positive abnormal returns of about 5 percent during the 21 day analysis period. In contrast, retail banks experienced negative abnormal performance when ceilings were removed or adjusted on small denomination consumer accot!nts; they experienced a - 3.05 percent abnormal return around the announcement of the MMC and a - 1.45 percent abnormal return for the Wild CardSI
To determine whether the announcement day prediction errors are significant, the t-statistic described in the previous section was calculated for
‘*The balance sheet characteristics of wholesale and retail banks based on call report data immediately prior to the ceiling change are provided below. Note the similarity in liability portfolio characteristics between retail banks and the small banks described in table 1.
1970 1973 1978 -
Whole- Whole- Whole- sale Retail sale Retail sale Retail banks banks banks banks banks banks
Idean size (assets) (in billions) !iaviDgs deposits/ liabilitres
$6.8 $1.5 $9.0’ S2.4 $13.5 $2.5
0.04 0.24 0.05 0.23 0.06 0.17
19By multiplying the percentage change in equity value (CPU by the average ratio of bank equity to total time deposits prior to the ceiling change the implied subsidy or tax can be exprr ised as a percentage of time deposits. For the 1970 event. the increase in wholesale bank market value was equal to 2.2” of time deposits. The introduction of the MMC resulted in a decline in market value of retail Banks equivalent to 0.6”” of time and savings deposits.
Tab
le 3
daily
:P
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and
cum
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edic
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rs
(c 1
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and
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ding
s ch
aage
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. -
1970
CD
19
73 C
D
1973
Mil
d C
ard
1978
MM
C
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~
.-
Day
W
hol
e§ak
R
etai
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&l
wlm
ksa
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Ret
ail
RC
bil
9
FE
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PE
P
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CP
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PE
C
PE
P
E
CP
E
L
PE
C
PE
P
E
CP
E
PE
C
PE
P
E
CP
E
ii -1
0 -0
.04
-0.M
0.
05
0.05
0.
04
0.04
-0
.33
-0.3
3 ,L
0.
40
0.40
-0
.37
-0.3
7 0.
33
0.33
-0
.18
-0.1
8 -9
0.
38
0.34
0.
58
0.63
%
-0
.10
-0.0
6 0.
05
-0.2
8 0.
30
0.70
0.
01
-0.3
6 0.
85
1.18
0.
13
-0.0
5 -8
-0
.28
0.06
-0
.08
0.55
-0
.29
-0.3
5 -0
.50
-0.7
8 0.
34
1.04
0.
24
-0.1
2 -0
.M
1.10
-0
.17
-022
P
-7
-0.4
2 -0
.36
-0.1
5 0.
40
O.Q
2 -0
.33
-0.4
5 -
1.23
0.
49
1.53
0.
28
0.16
-0
.24
0.86
-0
.17
-0.3
9 I
-6
s -0
.64
- 1.
00
0.39
0.
79
-036
-0
.69
0.15
-1
.08
0.07
1.
60
-0.0
9 0.
07
0.05
0.
91
0.22
-0
.17
-.
-5
0.57
-0
.43
-0.0
4 0.
75
OA
M
-0.6
5 0.
02
-1.0
6 0.
31
1.91
-0
.10
-0.0
3 0.
37
1.28
-0
.01
-0.1
8 ;
-4
1.14
0.
71
0.74
1.
49
0.17
-0
.48
0.00
-1
-w
0.18
2.
09
0.35
0.
32
-0.2
3 1.
05
-0.1
1 -0
.29
P
-3
0.25
0.
96
-0.1
8 1.
31
0.03
-
0.45
0.
24
-0.8
2 0.
54
263
fl.3
0 0.
62
-0.1
1 09
4 -0
.18
-0.4
7 z
-2
0.59
1.
55
0.87
21
8 0.
10
-0.3
5 0.
26
-0.5
6 O
-42
3.05
-0
.34
0.28
-0
.20
0.74
-0
.30
-0.7
7 -1
-0
.28
1.27
O
-49
267
-0.5
3 -0
.88
0.47
-0
.09
-0.1
9 2.
86
-0.6
7 -0
.39
o-64
1.
38
-0.0
7 -0
.84
c 0
2.21
3.
48
0.61
3.
28
0.01
-0
.87
-0.3
7 -0
.46
0.38
3.
24
-OS
0 -0
.89
0.18
1.
56
-0.9
9 -1
.83
i
+l
0.02
3.
50
-0.7
8 25
0 0.
25
2 -0
.62
0.20
-0
.26
0.16
3.
40
-0.1
0 -0
.99
0.08
1.
64
-0.2
6 -2
09
+2
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0.67
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N=
18
N
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N
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N
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N
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N
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N
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N
=37
each of the regulatory events analyzed. For the 1970 ceiling change, the t- statistic for wholesale banks is 4.72, significant at the 1 percent level. Foiz retail banks, the announcement of the MMC resulted in a negative and significant abnormal return. The calculated t-statistics is -4.29, significant at the 1 percent level. For the other regulatory changes, the null hypothesis of no abnormal performance cannot be rejected using a single day test statisticto
The decline in the value of retail banks following the introduction of the MMC is consistent with the hypothesis that ceilings on consumer accounts result in a wealth transfer from depositors to shareholders of commercial banksU2’ Moreover, the results presented in table 3 suggest that the effect of ceiling changes differs between wholesale and retail banks. Note that for all of the ceiling changes examined, wholesale banks experienced an increase in value. In contrast, for all but one of the regulatory changes, retail banks experienced a decline in value on announcement of limitation or relaxation of ceiling.
The lack of a statistically significant response at announcement of the Wild Card may be attributable to the opposing effects of the removal of ceilings and elimination of the differential thrifts were permitted to pay on these accounts. The latter action would have led, ceteris paribus. to an increase in the value of retail banks, while the elimination of ceilings would have reduced value.
6. Analysis
The results contained in table 3 are consistent with the hypothesis that ceilings have a differential effect among commercial banks. Banks in the wholesale group were not significantly affected by the liberalization of ceilings while retail institutions were. The evidence concerning the effect of the removal of ceilings in 1970 is consistent with the hypothesis that ceilings on certificates of deposits serve as a tax on the earnings of financial institutions. On the other hand, the decline in the market value of retail commercial banks following the announcement of the Wild Card and MMC is consistent with the hypothesis that binding ceilings ton small denomination consumer deposits provide a subsidy to these institutions.” Moreover, the
“the f-statistic for announcement day of the Wild Card for retail banks is -” 1.69. “Alternatively, as discussed above, the decline in value may represent the addition4 cost
associated with banks altering the mix of implicit and explicit payments to depositors. This argument suggests that the decline in value would be greatest for banks utiiizing the highest proportion of implicit payments prior to ceiling ctidnges. However. no empirical relationship was found between stock pri# adjustment and various proxies for the extent of implicit payments. Dann and James (1982) report similar findings for stock S&L’s.
22An alternative hypothesis, consistent with the decline in value of retail institutions, is that the introduction of the MMC affected the risk characteristics of these institutions by changing the maturity composition of their liability portfolios. However, an analysis of the security price
430 C. James, An analysis Q intra-industry diflerences
differential ret)ponse of wholesale and retail banks to changes in deposit rate ceilings suggests that intra-industry transfers may be important. Note that with the exception of the 1970 removal of ceilings on large CD’s the direction of market value change differed between wholesale and retail banks; wholesale banks experiencing positive abnormal returns and retail bank?; experiencing negative abnormal returns on announcement day.
To formerly test whether the announcement day response differs signticantly between wholesale and retail banks, the difference between the prediction errors of wholesale and retail banks and cumulative differences in prediction errors were calculated around each of the regulatory changes,
As the summary contained in table 4 indicates, with the exception of the 1973 remova,! of ceilings on CD’s, the differences in announcement day prediction errors are significantly different from zero at the 5 percent leve1.23
Table 4
Differences in cumulative prediction terrors and student t-statistics for prediction errors on announcement day of deposit rate ceiling change.
1970 CD 1973 CD Wild Card MMC
Difference in prediction errors on announcement day 1.50 0.38
Cumulative differences in pred: ction error 4.01 0.00
t-stal istic for day zero dilference 3.11” 1.31
‘Bgnificant at 0.01 level (two-tailed test). %gnificant at 0.05 level (two-tailed test).
0.88 1.17
5.20 3.38
2.27b 5.13”
performance of banks around the introduction of the MMC is not consistent with the hypothesis that the change in market value resulted from a change in the bank’s risk characteristics (a~; measured by 8). See James (1981).
“To test whel.her the difference in announcement day responses are different from zero, the following procedure was employed. First, the standard deviation of the prediction errors for wholesale and retail banks were calculated (crPw,bpr). Next, the prediction errors for wholesale and retail banks were standardized using the estimate of the kitandard deviations. By standard&g the prediction errors in this way, two series are created with unit variance. (The prediction error; are assumed to have zero mean). Third, the difference in standardized prediction errors was calculated (&I). To test for difference in announcement day returns, the following test statistic was employed: L* = P&/r&., where
,= -10 r=-10
t#T t#T
By examining the standardized difference in prediction errors one need not assume the variance of the prediction errors of wholesale banks is equal to the variance of the retail bank prediction errors. The results using procedure are virtually identical to results obtained without standardizing, See J#ames (1981).
C. James, An analysis of incra-industry drfirences 431
Finally, it is interesting to compare the response of savings and loan associations to deposit rate changes with the results obtained for retail banks. Since both types of institutions are subject to deposit ceilings and, as table 1 indicates S&L’s and small retail commercial banks hold approximately the same proportion of their deposit ,portfolios in passbook and small denomination time deposits, one would expect to observe a similar response from both types of institutions. In addition, since the possibility that these results were caused by some contemporaneous event and not by deposit rate ceiling changes cannot be ruled out, a similar response for thrift institutions would provide some confirmation that the observed returns’ were not caused by a contemporaneous event affecting only commercial banks.
Dann and James (1982) report changes in the market value of stock saving and loan associations following ceiling changes during the period 1973 to 1978, using a procedure similar to the one outlined in section 4. Negati.ve and significant abnormal returns were found following the announcement of the MMC and the Wild Card. The magnitude of the response was substantially greater than experienced for commercial banks. The cumulative prediction errors for the MMC and the Wild Card were -8.74 and - 2.66 respectively.
To summarize, the evidence suggests that the existence of ceilings confers a subsidy on the owners of both retail commercial banks and savings and loans, although savings and loans, appear to earn the largest subsidy. In addition, significant differences are found between the response of retail and wholesale banks to changes in deposit rate ceilings. The evidence is consistent with the hypothesis thal: rate regulation results in intra-industry wealth transfers.24
7. Conclusion
The evidence presented here is consistent with the: hypothesis that there exist cross-sectional differences in the impact of ceilings among commercial banks. For all of the events analyzed, liberalization of ceilings resulted in positive abnormal returns for wholesale banks. In contrast, declines in the market value of retail commercial banks were observe’d for all but one of the ceiling changes that were studied.
The differential response among commercial banks to regulatory changes provides additional insiglts into the wealth effects of regulation. If differences
24Retail bank and savings and loan lobbying activities appear consistent with the finding that rents accrue to these institutions from deposit rate ceilings on consumer accounts. For example. the Depository Institutions Deregulation Committee recently eliminated the ceiling on small saver certificates. A Federal Reserve staff memo to the Committee reported that a majcrity of
i the comments from savings and loans and small retail commercial banks (with less than $100 million in assets) expressed opposition to the removal of the ceiling while most larger commercial banks expressed support for the removal of the ceiling.
432 C. James, An analysis of intra-industry dl#ercnces
exist in the cost or demand conditions of cartel members, then the wealth effects of regulation will differ among members of the cartel. Failure to account for the differences in the demand and cost conditions among firms in a regulated in&tstry may result in the failure to detect the wealth effects associated with regulation. Therefore, recognition that the demand for regulation may differ among firms within an industry as well as among consumers provides a more general theory of economic regulation.
In addition, the finding of intra-industry wealth transfers has important policy implicatil>ns regarding deregulation. In particular, the deregulation of deposit rate ceilings mandated under the Depository Institutions Deregulation and Monetary Control Act of 1980, may adversely affect thrift institutions and retail oriented commercial banks while benefiting larger wholesale banks. Moreover, to the extent that the observed differential response results from the effect of the removal of ceilings on the competitive structure of bank markets (see footnote 7), additional deregulation, such as interstate branching, may also have a differential effect on commercial banks.
Refwences
Clotklder, Charlies and Charles Lieberman, 1978, On the distributional impact of Federal interest rate restricttons, Journal of Finance, March, 199-213.
Dann, Larry and Christopher James, 1982, The impact of deposit rate ceilings on the market value of thrift institutions, Journal of Finance, forthcoming.
Dimson, Elroy, 1980, Risk measurement when shares are subject to infrequent trading, Journal of Financial Economics, June, 197-226.
Fama, Eugene F., 1976, Foundations of finance (Basic Books, New York). Friedman, Milton, 1970, Controls on interest rates paid by banks, Journal of Money Credit and
Banking, Feb., 15-32 James, Chrsitopher, 1981, An analysis of intra-industry differences in the effect of regulation,
Staff paper, Office of the Comptroller of the Currency, Washington, DC. Jordan, William, 1972, Producer protection, prior market structure and the effects of
government regulation, Journal of Law and Economics, April, 151-176. Kane, Edward, 1970, Short changing the small saver, Journal of Money, Credit and Banking,
Nov, 513-522. King Benjamin, 1966, Market and industry factors in stock price behavior, Journal of Business
39 Suppl, Jan., 139-190. Peltzman, Sam, 1976, Toward a more general theory of regulation, Journal of Law and
Economics, Aug,, 21 l-240. Pyle, David, 1974, Loss of income on savings deposits from interest tate regulation, The Bell
