Credit Market Information Feedback

The 2007-2009 financial crisis and subsequent recession is a reminder of the importance of the role of credit and banks as major credit intermediaries in the macro economy. We examine whether private information on bank-level credit standards, credit demand and asset quality explains changes in a banking firms charter value. There are two channels through which changing asset quality could affect the market value of a bank. First, changing asset quality affects the value of on-balance sheet equity. Second, it may affect the bank equity value through its impact on the banks charter value. Charter value (Buser, Chen and Kane, Journal of Finance, 1981) consists of the capitalized value of real options for future profitable investment opportunities underlying franchise value in the corporate finance literature (Myers, Journal of Financial Economics, 1977) plus the capitalized value of current and expected future safety-net subsidies.