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Godfrey Cadogan is a Research Scientist in Risk and Uncertainty at the Institute for Innovation and Technology Management, Ted Rogers School of Management, Ryerson University. His research focus is on application of diverse branches of mathematics such as algebraic topology, number theory, group... More
  • The Risk Premium For Minority Banks Altruistic Portfolios In Underserved Communities 0 comments
    Oct 28, 2012 6:45 AM

    Motivated by behavioral asset pricing theory, we introduce a statistical risk accounting model to characterize the compensating risk premium required to sustain minority banks' (MBs) altruistic motive to provide credit in underserved communities. The research is available at the hyperlink The Risk Premium for Minority Banks Altruistic Portfolios in Underserved Communities, and it is accompanied by charts and other graphics that perhaps tell a better story than that presented here. Our model predicts that increased bank capitalization, and brokered deposit (BD) exceptions, compensate risk when the incremental internal rate of return they induce is negatively correlated with the internal rate of return on extant MB loan portfolios. Thus implying, paradoxically, that loan portfolios levered by increased capital, and brokered deposits, militate against altruistic motives. This suggests that for a given amount of altruism, minority banks are better served by tactical portfolio allocation in an expanded investment opportunity set. Using Federal Reserve Statistical Release (12/2011) on select FFIEC Form 031 (``Call Report") data, we fit a risk-return function for minority banks and estimate the compensating risk premium for return on assets. We provide back of the envelope formula for estimating minority bank profitability based on loan loss ratio, leverage ratio, and operating expense. And we provide a ranking of minority banks for profitability, and price of risk. These results have implications for the efficacy of U.S. Dep't of Treasury's Community Development Financial Institutions (CDFIs) Fund capacity building and bank capitalization initiatives, and de facto brokered deposit programs, as compensating risk mechanisms for minority and women owned banks. For they are excepted under Section 29 of the Federal Deposit Insurance Act, enacted through the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) (eff. 1989), and the Dodd-Frank Wall Street Reform and Consumer Protection Act (eff. July 2010) mandatory evaluation of such programs.

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