The Risk Premium for Minority Banks Altruistic Portfolios in Underserved Communities

1. The Risk Premium for Minority Banks Altruistic Portfolios in Underserved Communities Godfrey Cadogan IITM, Ted Rogers School of Management, Ryerson University * Prepared for 4th World Conference on Remedies to Racial and Ethnic Economic Inequality Roy Wilkins Center for Human Relations and Social Justice Hubert Hunphrey School of Public Policy University of Minnesota–Minneapolis-St. Paul. October 11, 2012 Paper available at http://papers.ssrn.com/abstract=2147347

2. Outline • What is a minority bank and why should we care? • Profiles • Legislation • Data issues • The Model • IRR mimicking term structure of bank bond portfolios • Minority bank zero covariance frontier portfolios • On Pricing Risk Factors for Minority and Nonminority Peer Banks • Asset pricing models for minority and non-minority banks Regulation costs and moral hazard of assisting minority banks • Minority banks exposure to systemic risk • Back-of-the-envelope estimate of minority bank profitability • Minority Banks 2% Risk Premium and Concave Risk Return Tradeoffs

3. What is a minority bank and why should we care? • Section 308 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") requires the Secretary of the Treasury to consult with the Director of the Office of Thrift Supervision and the Chairperson of the FDIC Board of Directors to determine the best methods for preserving and encouraging minority ownership of depository institutions.  • Section 308 of FIRREA defines the term "minority depository institution" as any depository institution where 51 percent or more of the stock is owned by one or more "socially and economically disadvantaged individuals.“ • Congress proposed legislation under FIRREA to preserve the character of Minority banks. Recent Dodd-Frank legislation also impacts minority banks. Too early to tell impact of Dodd-Frank • Altruistic portfolios in underserved communities ostensibly intended to fill a gap left by credit rationing.

5. IRR mimicking term structure of bank bond portfolios • Vasicek (1977) single factor model prices term structure of internal rate of return (IRR) on minority bank bonds based on short term rates

6. Two factor linear asset pricing model for minority banks derived from Vasicek (1977)

7. Evaluating compensating risk

8. Statistical risk accounting

9. Compensating minority banks negative exposure to systemic risk

11. A. Summary statistics for minority banks assets and deposits

16. Conclusion • Not enough time series data on minority banks • High attrition and de novo banks may confound intertemporal comparison • More granular data needed from Federal Reserve Statistical Release) on select FFIEC Form 031 (“Call Report”) data • Minority Bank Deposit Program not enough to compensate risk • Minority banks need expanded investment opportunity set. Whether recent Dodd-Frank legislation could facilitate that process is left to be seen