Summary
This paper examines the motives behind equity holding by banks in non-financial firms. It has been argued that banks hold equity in firms primarily for two reasons: to support their debt holding or for returns as capital investments. This paper tries to examine which among these two motives drive equity holdings by Development Financial Institutions in India (DFIs). Results indicate that equity holding by DFIs in India is primarily driven by their interest as creditors. In poorly performing firms, equity holding by DFIs is also driven by debt restructuring in firms in the form of conversion of debt to equity.
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Extract
Motives Behind Equity Holding by Banks: Evidence From India
Introduction
Holding of equity by banks has been argued to be a key distinguishing feature between the German-Japanese banking model on one hand and the Anglo-American model on the other (Aoki and Patrick, 1994). Equity holding by banks was legally banned in the United States in the early twentieth century due to various instances of misuse of these holdings (Kroszner and Rajan, 1994). In contrast. German banks have been allowed to hold equity in firms and have been shown to have various beneficial effects on the performance of firms (Baums, 1994 and Mulbert, 1998). As the primary activity of banks in most countries is lending, both the misuse and the beneficial effects of equity holding by banks are largely driven by their interest as creditors. In other words, equity holding by banks is primarily seen as an instrument for supporting their lending activity in firms. Another reason for taking up equity by banks is the use of these holdings as instruments of capital investment and diversification of their portfolio (Mulbert, 1998). It is argued that banks may use these holdings as investments, which can be liquidated as and when required to smoothen out any fluctuations in their cash flow (Mulbert, 1998). If this is so, equity holding by banks would be driven by the performance of firms. This paper tries to examine which among the two motives, supporting debt holding in firms or returns for capital investment drive equity holding by banks in non-financial firms.Existing studies have primarily focused on two aspects of equity holding by banks. First, there are studies that provide theoretical arguments on why banks hold equity (Mulbert, 1998 and Baums, 1994). secondly, there are studies that empirically examine the effect of equity hold...See the full content of this document
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