Natural disasters and economic growth: The role of banking market structure

Published in: Journal of Corporate Finance

bank manager

Many regions around the world, in developed and emerging markets, are affected by extreme weather events such as hurricanes, floods, and droughts in a scenario of climate change. Reviving economic growth in areas hit by natural disasters often relies on bank lending due to the incompleteness of insurance markets and subsidies offered by national governments.

In this context, two important questions arise: do banks lend more after a natural disaster? Are all banks equal in lending to businesses and households to help the latter restore their properties?

We have investigated these topics by looking at a sample of US counties similar to provinces in the European context that recover after major hurricanes and tropical storms. What we have observed as a counterintuitive and not expected result is that counties served by banking institutions that have a high contractual power over their customers recover more quickly after the hurricane strike. This is unexpected since most of the literature claims that growth should be higher when the banking market is highly competitive. This view has fostered all the regulatory policies in many countries, including Europe, after the 90ies.

But why do these counties recover more quickly?

We notice that bank market power (which is an indicator of an uncompetitive bank market) pushes banks to lend more to households to restore their properties (real estate lending), but they do not increase commercial lending to businesses or consumer lending.

This is not trivial. Lending after a major hurricane that causes severe damage to the area where the banks operate creates severe problems for those institutions since it becomes harder to evaluate correctly the creditworthiness of borrowers.

Many banks in such a scenario would simply stop lending which would seriously hamper economic recovery. But this is not the case for banks with high market power. They do not stop real estate lending, although this may be risky for them.

What could be the reason for that? We conjecture that these banks are, in general, more profitable and capitalized, so they can extend credit without breaching regulatory capital limits by using the reserves that they have accumulated during normal times. We also find that these banks are generally smaller and located near the customer. So they most probably have superior information about a customer’s true risk, which allows them to quickly evaluate the value of destroyed collateral and extend credit to affected households by quickly assessing their repayment capacity.

A careful reader might notice that there are similarities between these intermediaries and cooperative banks that operate in our communities. These institutions tend to concentrate lending in particular areas, prefer to focus on traditional activities, and thus have an advantage in managing riskier loans due to their screening and monitoring abilities.

Policymakers are frequently concerned about the deleterious effect of market power in banking, both for consumer welfare and economic performance generally. Our findings highlight a dark side of the competition, albeit one that arises after relatively rare natural disasters.

We look at this debate from a different angle, showing that, under certain circumstances, a reasonable degree of bank market power can benefit local economies.

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Authors at the Department of Management

Andi Duqi – Associate Professor of Banking and Finance

Academic disciplines: Risk Management, Private Equity and Venture Capital, Fundamentals of Banking

Teaching areas: Banking and Finance

Research fields:  Bank performance and competition, dividend policy, sustainable and ethical finance

Andi is Associate Professor in Banking and Finance. From 2013 to 2018, he was appointed as an Assistant Professor of Banking and Finance at the University of Sharjah, United Arab Emirates. His research focuses mainly on banking performance, banking efficiency, dividend policy, banking competition, microfinance, and social impact finance. Andi obtained a Ph.D. in Financial Markets and Intermediaries from the University of Bologna in 2012, and he was a post-doc researcher at the same University until 2013. He has been a visiting research fellow at the Bangor Business School and Nottingham Business School, United Kingdom.

Giuseppe Torluccio – Full Professor of Banking and Finance

Academic disciplines: Economics of Financial Intermediation, Economics of Banking, Venture Capital Philanthropy, Entrepreneurial and Social Finance

Teaching areas: Banking and Finance

Research fields:  Credit risk, Risk management, Corporate Finance, Treasury management, corporate risk management, ICT and financial industry, Payment systems, Innovation financing, Project Financing

Giuseppe is a Professor of Banking and Finance. He was appointed as a Faculty of the Centre of excellence at the University of Bologna (Collegio Superiore). Giuseppe has authored publications in financial intermediation, management of credit risk, and business financing. He earned an MBA at the Olin Business School – Washington University in St. Louis. He has been a visiting scholar at Washington University in St. Louis, the College of Business at Arizona State University, and Bangor University UK. He is part of the Faculty Board of the Ph.D. Management program at the University of Bologna. He is involved in many social studies and related activities as Director of Yunus Social Business Centre – University of Bologna, and as a Vice president of Grameen Italia Foundation.