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Working papers

The ESRB Working Paper Series is managed by the Advisory Scientific Committee. The purpose of the series is to collate high-quality research on systemic risk and macroprudential policy, thus informing the ESRB’s policymaking activities.

Submissions to the Working Paper Series are welcomed when at least one co-author is affiliated with the ESRB or an ESRB member institution, or when the paper has been presented at an ESRB event. To submit a paper for consideration, email your submission as a pdf file to wpseries@esrb.europa.eu

Any views expressed in working papers are those of the authors and do not necessarily reflect the official stance of the ESRB, its member institutions, or any institution with which the authors may be affiliated.

1 March 2024
The market liquidity of interest rate swaps
Boudiaf, Ismael Alexander, Scheicher, Martin, Frieden, Immo

Abstract

JEL Classification

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

This paper studies market liquidity in interest rate swaps (IRS) before and during the global tightening of monetary policy. IRS constitute the single largest derivatives segment globally. Banks and Pension Funds extensively rely on IRS to hedge interest rate risk. Hence, providing an understanding of this market and the drivers of market liquidity is a key research question in the current market context. We use price and volume data from around 338.000 trades in the most active long-horizon swap contract denominated in EUR to construct seven liquidity measures. Taking a comprehensive approach, we ap-ply linear regressions to determine the drivers of variation in liquidity. Our liquidity measures are significantly related to monetary policy, market-wide fixed income liquidity, EURIBOR rate volatility and Dealer behaviour. Indicators for generic market stress such as VIX which are often documented in the literature are not strongly connected to IRS trading conditions.

No. 146
15 February 2024
Public money as a store of value, heterogeneous beliefs and banks: implications of CBDC
Muñoz, Manuel A., Soons, Oscar

Abstract

JEL Classification

E41 : Macroeconomics and Monetary Economics→Money and Interest Rates→Demand for Money
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

The bulk of cash is held for store of value purposes, with such holdings sharply increasing in times of high economic uncertainty and only a fraction of the population choosing to hoard cash. We develop a Diamond and Dybvig model with public money as a store of value and heterogeneous beliefs about bank stability that accounts for this evidence. Only consumers who are sufficiently pessimistic about bank stability hold cash. The introduction of a central bank digital currency (CBDC) as a store of value lowers the storage cost of public money and induces partial bank disintermediation, which is nevertheless mitigated by an increase in relative maturity transformation. This has heterogeneous welfare consequences across the population. While cash holders always benefit by switching to CBDC, each of all other consumers may be better off or not depending on the probability of a bank run, her (and all others’) belief about such probability and the degree of technological superiority of CBDC.

No. 145
15 November 2023
The transmission of macroprudential policy in the tails: evidence from a narrative approach
Lloyd, Simon, Fernández-Gallardo, Álvaro, Manuel, Ed

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We estimate the causal effects of macroprudential policies on the entire distribution of GDP growth for advanced European economies using a narrative-identification strategy in a quantile-regression framework. While macroprudential policy has near-zero effects on the centre of the GDP-growth distribution, tighter policy brings benefits by reducing the variance of future growth, significantly boosting the left tail while simultaneously reducing the right. Assessing a range of channels through which these effects materialise, we find that macroprudential policy particularly operates through ‘credit-at-risk’: it reduces the right tail of future credit growth, dampening booms, in turn reducing the likelihood of extreme GDP-growth outturns.

No. 144
1 August 2023
Quantitative easing, accounting and prudential frameworks, and bank lending
Orame, Andrea, Ramcharan, Rodney, Robatto, Roberto

Abstract

JEL Classification

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
M48 : Business Administration and Business Economics, Marketing, Accounting→Accounting and Auditing→Government Policy and Regulation

Abstract

We study whether regulation that relies on historical cost accounting (HCA) rather than mark-to-market accounting (MMA) to insulate banks’ net worth from financial market volatility affects the transmission of quantitative easing (QE) through the bank lending channel. Using detailed supervisory data from Italian banks and taking advantage of a change in accounting rules, we find that HCA makes banks significantly less responsive to QE than MMA. Hence, while HCA can insulate banks’ balance sheets during periods of distress, it also weakens the effectiveness of unconventional monetary policy in reducing firms’ credit constraints through the bank lending channel.

No. 143
1 July 2023
Fear the Walking Dead? Zombie Firms in the Euro Area and Their Effect on Healthy Firms’ Credit Conditions
Havemeister, Lea Katharina, Horn, Kristian

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

Zombie firms may adversely impact healthy firms through several transmission channels. Besides real spillover effects on productivity or investment, zombies may also cause negative financial spillover effects, where zombies receive credit at more favourable conditions than healthy firms. We investigate characteristics of zombie firms in the euro area and whether they cause spillovers on healthy firms’ credit conditions, focusing on two variables: new credit and interest rates. Contrary to existing findings, our results indicate that zombie firms pay higher interest rates and receive less new credit than healthy firms. The spillover effect of zombie firms on healthy firms’ new credit is not significant. For interest rates, the spillover effect is even reversed: Zombie existence significantly lowers healthy firms’ interest rates. Zombie firms across the euro area are smaller, less profitable, and more leveraged with lower credit quality than healthy firms. Yet, they do not seem to pose significant negative externalities on the credit conditions of healthy firms. Novel loan-by-loan data from the European credit registry (AnaCredit) allows our analysis to be over a broad set of countries and firms, on a new level of granularity. This may explain the divergence of our findings from the existing literature.

No. 142
1 July 2023
The demand for long-term mortgage contracts and the role of collateral
Liu, Lu

Abstract

JEL Classification

D15 : Microeconomics→Household Behavior and Family Economics
E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies
G5 : Financial Economics
G52 : Financial Economics

Abstract

Long-term fixed-rate mortgage contracts protect households against interest rate risk, yet most countries have relatively short interest rate fixation lengths. Using administrative data from the UK, the paper finds that the choice of fixation length tracks the life-cycle decline of credit risk in the mortgage market: the loan-to-value (LTV) ratio decreases and collateral coverage improves over the life of the loan due to principal repayment and house price apprecia-tion. High-LTV borrowers, who pay large initial credit spreads, trade off their insurance motive against reducing credit spreads over time using shorter-term contracts. To quantify demand for long-term contracts, I develop a life-cycle model of optimal mortgage fixation choice. With baseline house price growth and interest rate risk, households prefer shorter-term contracts at high LTV levels, and longer-term contracts once LTV is sufficiently low, in line with the data. The mechanism helps explain reduced and heterogeneous demand for long-term mortgage contracts.

No. 141
1 March 2023
The externalities of fire sales: evidence from collateralized loan obligations
Kundu, Shohini

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Abstract

This paper investigates how covenants, intrinsic to Collateralized Loan Obligation (CLO) indentures, may amplify idiosyncratic shocks, imposing negative externalities on unrelated firms in CLO portfo-lios. Following a negative shock to the oil & gas industry, CLOs with exposure to oil and gas loans are pushed closer to their covenant thresholds and fire-sell unrelated loans in the secondary loan market to alleviate these constraints. These fire sales exert price pressure on the securities of unrelated firms, creating market dislocations. The erosion in the liquidity positions of exposed firms spills over into real economic activity. The findings highlight the real effects from fire sales arising due to contracting frictions.

No. 140
1 March 2023
Financial fragility in open-ended mutual funds: the role of liquidity management tools
Dunne, Peter, Emter, Lorenz, Fecht, Falko, Giuliana, Raffaele, Peia, Oana

Abstract

JEL Classification

G2 : Financial Economics→Financial Institutions and Services
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

We study the role of liquidity management tools (LMTs) in mitigating financial fragility in investment funds during the COVID-19 market distress. We employ a unique dataset that reports the availability of different types of LMTs in a sample of Irish-domiciled corporate bond funds. We find that funds with access to price-based tools such as redemption fees or anti-dilution levies experienced lower net outflows in March 2020, as compared to funds with only quantity-based tools such as redemption gates, temporary suspensions or redemption in kind. This difference is stronger among funds with a high sensitivity of flows to past-performance and reflects both higher gross in-flows and lower gross outflows during this episode. Funds with price-based LMTs also rebalance their portfolios towards less liquid bonds, which results in lower price fragility among bonds held disproportionally by our sample of Irish-domiciled funds.

No. 139
28 September 2022
Corrective regulation with imperfect instruments
Dávila, Eduardo, Walther, Ansgar

Abstract

JEL Classification

H23 : Public Economics→Taxation, Subsidies, and Revenue→Externalities, Redistributive Effects, Environmental Taxes and Subsidies
Q58 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Environmental Economics→Government Policy
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
D62 : Microeconomics→Welfare Economics→Externalities

Abstract

This paper studies optimal second-best corrective regulation, when some agents/activities cannot be perfectly regulated. We show that policy elasticities and Pigouvian wedges are sufficient statistics to characterize the marginal welfare impact of regulatory policies in a large class of environments. We show that a subset of policy elasticities, leakage elasticities, determine optimal second-best policy, and characterize the marginal value of relaxing regulatory constraints. We apply our results to scenarios with unregulated agents/activities, uniform regulation across agents/activities, and costly regulation. We illustrate our results in applications to financial regulation with environmental externalities, shadow banking, behavioral distortions, asset substitution, and fire sales.

No. 138
28 September 2022
The effect of structural risks on financial downturns
Hodula, Martin, Pfeifer, Lukáš, Janků, Jan

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
G15 : Financial Economics→General Financial Markets→International Financial Markets
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We investigate the extent to which various structural risks exacerbate the materialization of cyclical risk. We use a large database covering all sorts of cyclical and structural features of the financial sector and the real economy for a panel of 30 countries over the period 2006Q1–2019Q4. We show that elevated levels of structural risks may have an important role in explaining the severity of cyclical and credit risk materialization during financial cycle contractions. Among these risks, private and public sector indebtedness, banking sector resilience and concentration of real estate exposures stand out. Moreover, we show that the elevated levels of some of the structural risks identified may be related to long-standing accommodative economic policy. Our evidence implies a stronger role for macroprudential policy, especially in countries with higher levels of structural risks.

No. 137
15 August 2022
Macroprudential policy and the role of institutional investors in housing markets
Muñoz, Manuel A., Smets, Frank

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Since the onset of the Global Financial Crisis, the presence of institutional investors in housing markets has steadily increased over time. Real estate funds (REIFs) and other housing investment •rms leverage large-scale buy-to-rent real estate investments that enable them to set prices in rental markets. A significant fraction of this funding is being provided in the form of non-bank lending - which is not subject to regulatory LTV ratios - and REIFs are generally not constrained by leverage limits. We develop a quantitative DSGE model that incorporates the main features of the REIF industry and identify leakages of existing macroprudential policy: (i) already existing countercyclical LTV rules on residential mortgages trigger a credit reallocation towards the REIF sector that can amplify financial and business cycles; while (ii) "non-existent" countercyclical LTV rules on lending to REIFs are particularly effective in taming such cycles. Due to the different mechanisms through which they operate, both types of LTV rules complement each other and jointly yield larger welfare gains (for savers and borrowers) than in isolation.

No. 136
15 August 2022
Interbank credit exposures and financial stability
Schneorson, Oren

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper investigates how interbank credit exposures affect financial stability. Policy makers often see such exposures as undermining stability by exacerbating cascading losses through the financial system. I develop a model that features a trade-off between cascading losses and risk-sharing. In contrast to previous studies I find that reducing interbank connectivity may destabilize the financial system via the bank-run channel. This is because it decreases the risk-sharing benefits of interbank connectivity. A bank-run model features two islands that are connected via a long term debt claim. Varying the size of this claim (interbank connectivity), I study how the decision to `run on the bank' is affected. I run a simulation of the model, calibrated to the U.S. banking system between 1997-2007. I find that large bankruptcy costs are required to trump the risk-sharing benefits of interbank credit exposures.

No. 134
1 July 2022
Are fund managers rewarded for taking cyclical risks?
Ryan, Ellen

Abstract

JEL Classification

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The investment fund sector has expanded dramatically since the crisis of 2008-2009. As the sector grows, so do the implications of its risk-taking for the wider financial system and real economy. This paper provides empirical evidence for the existence of wide- spread risk-taking incentives in the investment fund sector, with a particular focus on incentives for synchronised, cyclical risk-taking which could have systemic effects. Incentives arise from the positive response of investors to returns achieved through cyclical risk-taking and non-linearities in the relationship between fund returns and fund flows, which may keep managers from fully internalising the effects of adverse outcomes on their portfolios. The fact that market discipline may not be sufficient to ensure prudential behaviour among managers, combined with the externalities of this risk-taking for the wider system, creates a clear case for macroprudential regulatory intervention.

No. 135
1 July 2022
Housing and credit misalignments in a two-market disequilibrium framework
Karmelavičius, Jaunius, Mikaliūnaitė-Jouvanceau, Ieva, Petrokaitė, Austėja Petrokaitė

Abstract

JEL Classification

C34 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Truncated and Censored Models, Switching Regression Models
D50 : Microeconomics→General Equilibrium and Disequilibrium→General
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

During the COVID-19 pandemic, house prices and mortgage credit rose at a long unseen pace. It is unclear, however, whether such increases are warranted by the underlying market and macroeconomic fundamentals. This paper offers a new structural two-market disequilibrium model that can be estimated using full-information methods and applied to analyse housing and credit dynamics. Dealing with econometric specification uncertainty, we estimate a large ensemble o f t he two-market disequilibrium model specifications f or Lithuanian monthly data. U sing the model estimates, we identify the historical drivers of Lithuania’s housing and credit demand and supply, as well as price and market quantity variables. The paper provides a novel approach in the financial stability literature to jointly measure house price overvaluation and mortgage credit flow g aps. We find that, by mid-2021, Lithuania was experiencing a heating-up in housing and mortgage credit markets, with home prices overvalued by around 16% and the volume of mortgage credit flow being 20% above its fundamentals.

No. 133
15 March 2022
Fluctuating bail-in expectations and effects on market discipline, risk-taking and cost of capital
Giuliana, Raffaele

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
H81 : Public Economics→Miscellaneous Issues→Governmental Loans, Loan Guarantees, Credits, Grants, Bailouts
C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models

Abstract

Through the compulsory participation of junior investors in bearing losses of their failing bank, the bail-in attempts to limit bail-outs’ side-effects in terms of market discipline, too-big-to-fail, bank-sovereign nexus and risk-taking. This paper assesses the consequences of bail-in expectations along these dimensions ensuring – through a bond pricing study – that bail-in expectations are not confounded by other factors. Using hand-collected details of EU bail-in events, I study both positive and negative exogenous shocks to bail-in expectations, offering three sets of findings. First, bail-in events can reinforce (or weaken) bail-in expectations, as shown by Khwaja-Mian tests (validated by placebo analyses). Second, bail-in expectations promote market discipline, and mitigate too-big-to-fail and bank-sovereign nexus. Third, bail-in effects on bank resilience appear mixed. While it incentivises banks to reduce risk-taking (e.g., increasing risk-weighted equity by a third of Basel III requirement), it also remarkably exacerbates total funding costs through an increase in equity cost (partially off-set by a debt cost reduction).

No. 132
29 December 2021
Life-cycle risk-taking with personal disaster risk
Bagliano, Fabio C., Fugazza, Carolina, Nicodano, Giovanna

Abstract

JEL Classification

D15 : Microeconomics→Household Behavior and Family Economics
E21 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Consumption, Saving, Wealth
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions

Abstract

This paper examines households’ self-insurance in financial markets when a rare personal disaster, such as disability or long-term unemployment, may occur during working years. Personal disaster risk alters lifetime ex-ante investment choices, even if most workers will not experience a disaster. Uncertainty about the size of human capital losses, which characterizes rare disasters, results in lower risk-taking at the beginning of working life, and is crucial in order to match the observed age profiles of US investors from 1992 to 2016.

No. 131
29 December 2021
Empirical analysis of collateral at central counterparties
Grothe, Magdalena, Pancost, N. Aaron, Tompaidis, Stathis

Abstract

JEL Classification

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

This paper studies the risk management of central counterparties (CCPs) using a granular transaction-level dataset. We test whether margining practices are sufficient relative to portfolio risk and whether CCPs reduce margin requirements in a ‟race-to-the-bottom.” We find that, for some CCPs, margin breaches are predictable ex ante, but the portfolios of more interconnected clearing members are associated with higher margin holdings. While margin requirements increased significantly around the onset of the Covid-19 pandemic, controlling for portfolio and macro-financial variables, margin breaches did not. Our results indicate that changes in margins should be analyzed alongside margin breaches.

No. 130
15 December 2021
Prudential policy with distorted beliefs
Dávila, Eduardo, Walther, Ansgar

Abstract

JEL Classification

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy

Abstract

This paper studies leverage regulation and monetary policy when equity investors and/or creditors have distorted beliefs relative to a planner. We characterize how the optimal leverage regulation responds to arbitrary changes in investors’ and creditors’ beliefs and relate our results to practical scenarios. We show that the optimal regulation depends on the type and magnitude of such changes. Optimism by investors calls for looser leverage regulation, while optimism by creditors, or jointly by both investors and creditors, calls for tighter leverage regulation. Monetary policy should be tightened (loosened) in response to either investors’ or creditors’ optimism (pessimism).

No. 129
15 December 2021
The role of systemic risk spillovers in the transmission of Euro Area monetary policy
Skouralis, Alexandros

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F36 : International Economics→International Finance→Financial Aspects of Economic Integration
F45 : International Economics→Macroeconomic Aspects of International Trade and Finance

Abstract

This paper empirically investigates the transmission of systemic risk across the Euro Area by employing a Global VAR model. We find that a union aggregate systemic risk shock results in a sharp decline in output, with two thirds of the response to be attributed to cross-country spillovers. The results indicate that peripheral economies have a disproportionate importance in spreading systemic risk compared to core countries. Then, we incorporate high-frequency monetary surprises into the model and we find evidence of the risk-taking channel of monetary policy. However, the relationship is reversed in the period of the ZLB, when expansionary shocks mitigate systemic risk. Cross-country spillovers account for a significant fraction (17.4%) of systemic risk responses’ variation. We also show that near term guidance reduces systemic risk, whereas the initiation of the QE program has the opposite effect. Finally, the effectiveness of monetary policy exhibits significant asymmetries, with core countries driving the union response.

No. 128
1 December 2021
Banking networks and economic growth: from idiosyncratic shocks to aggregate fluctuations
Vats, Nishant, Kundu, Shohini

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F36 : International Economics→International Finance→Financial Aspects of Economic Integration
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
O47 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Measurement of Economic Growth, Aggregate Productivity, Cross-Country Output Convergence
R11 : Urban, Rural, Regional, Real Estate, and Transportation Economics→General Regional Economics→Regional Economic Activity: Growth, Development, Environmental Issues, and Changes
R12 : Urban, Rural, Regional, Real Estate, and Transportation Economics→General Regional Economics→Size and Spatial Distributions of Regional Economic Activity

Abstract

This paper explores the transmission of non-capital shocks through banking networks. We develop a methodology to construct non-capital (idiosyncratic) shocks, using labor productivity shocks to large firms. We document a change in the relationship between foreign idiosyncratic shocks and domestic economic growth between 1978 and 2000. Contemporaneous changes in banking integration drive this phenomenon as geographically diversified banks divert funds away from economies experiencing negative shocks towards other unaffected economies. Our GIV estimates suggest that a 1% increase in bank loan supply is associated with a 0.05-0.26 pp increase in economic growth. Lastly, this can potentially explain the Great Moderation.

No. 127
1 October 2021
Do liquidity limits amplify money market fund redemptions during the COVID crisis?
Dunne, Peter G., Giuliana, Raffaele

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G15 : Financial Economics→General Financial Markets→International Financial Markets
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G20 : Financial Economics→Financial Institutions and Services→General
F30 : International Economics→International Finance→General

Abstract

Regulation of Money Market Funds (MMFs) in the EU requires some categories of MMFs to consider applying liquidity management tools if they breach a minimum ‘weekly’ liquidity requirement. Anticipation of the application of such tools is a plausible amplifier of run risks. Using a larger European dataset than previously studied, we assess whether proximity to liquidity thresholds explains differences in redemptions both at the start of the COVID-19 crisis and in the following months. We assess this effect for MMFs subject to and exempt from the liquidity regulation. The evidence shows that outflows can be robustly associated with proximity to minimum liquidity requirements in the peak of the crisis for funds required to consider suspending redemptions if breaches occur. In the post-crisis phase the redemption-liquidity relationship does not appear to be specifically related to mandated consideration of the suspension of redemptions. The evidence supports consideration of countercyclical liquidity requirements or buffers that are more usable in times of stress.

No. 126
15 September 2021
Synthetic Leverage and Fund Risk-Taking
Fricke, Daniel

Abstract

JEL Classification

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

Mutual fund risk-taking via active portfolio rebalancing varies both in the cross-section and over time. In this paper, I show that the same is true for funds’ off-balance sheet risk-taking, even after controlling for on-balance sheet activities. For this purpose, I propose a novel measure of synthetic leverage, which can be estimated based on publicly available information. In the empirical application, I show that German equity funds have increased their risk-taking via synthetic leverage from mid-2015 up until early 2019. In the cross-section, I find that synthetically leveraged funds tend to underperform and display higher levels of fragility.

No. 125
15 September 2021
Determinants of the credit cycle: a flow analysis of the extensive margin
Cuciniello, Vincenzo, di Iasio, Nicola

Abstract

JEL Classification

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

Using loan-level data covering almost all loans to households and businesses from banks in Italy over the past 20 years, we offer new empirical evidence that credit declines during a recession primarily because of the reduction in the net creation of borrowers. We then build on a flow approach to decompose the net creation of borrowers into gross flows across three statuses: (i) borrower, (ii) applicant and (iii) neither borrower nor applicant (i.e. inactive firms or households in the bank credit market). Along the macroeconomic dimension of these gross flows, we document four cyclical facts. First, fluctuations in the number of new borrowers (inflows) account for the bulk of volatility in the net creation of borrowers. Second, the volatility of borrower inflows is two times as large as the volatility of obligors exiting from the credit market (outflows). Third, borrower inflows are highly procyclical and tend to lead the business cycle. Fourth, decreases in the probability of a match between borrower and lender during recessions are a leading explanation for the role of borrower inflows.

No. 124
16 August 2021
A Multi-level Network Approach to Spillovers Analysis: An Application to the Maltese Domestic Investment Funds Sector
Meglioli, Francesco, Gauci, Stephanie

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
C58 : Mathematical and Quantitative Methods→Econometric Modeling→Financial Econometrics
G10 : Financial Economics→General Financial Markets→General
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

In this paper we present a new approach to analyse the interconnectedness between a macro-level network and a local-level network. Our methodology is developed on the Diebold and Yilmaz connectedness measure and it considers the presence of entities within a global network which can influence other entities within their own local network but are not relevant enough to influence the entities which do not belong to the same local network. This methodology is then applied to the Maltese domestic investment funds sector and we find that a high-level correlation between the domestic funds can transmit higher spillovers to the local stock exchange index and to the government bond secondary market prices. Moreover, a high correlation among the Maltese domestic investment funds can increase their vulnerability to shocks stemming from financial indices, and therefore, investment funds may potentially become a shock transmission channel.

No. 123
2 August 2021
Risky mortgages, credit shocks and cross-border spillovers
Buesa, Alejandro, De Quinto, Alicia, Población García, Francisco Javier

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
F47 : International Economics→Macroeconomic Aspects of International Trade and Finance→Forecasting and Simulation: Models and Applications
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G51 : Financial Economics

Abstract

This paper describes a novel methodology of measuring risky and conservative mortgage credit using household survey data for 18 European Union countries and the United Kingdom. In addition, we construct time series for both types of credit and embed them into a global vector autoregressive (GVAR) model, so as to study how shocks to both variables affect domestic output and propagate across countries through cross-border banking exposures. The results show that a decrease in risky credit can have long-lasting positive effects on GDP, both in the originating country and its most exposed peers, while a fall in conservative credit is detrimental. In some geographies, negative shocks to both types of credit reduce output, a feature linked to the lower relevance of homeownership which implies that mortgage credit plays a less prominent role in the domestic economy.

No. 122
15 June 2021
Measuring the impact of a bank failure on the real economy: an EU-wide analytical framework
Vacca, Valerio Paolo, Bichlmeier, Fabian, Biraschi, Paolo, Boschi, Natalie, Álvarez, Antonio J. Bravo, Di Primio, Luciano, Ebner, André, Hoeretzeder, Silvia, Ballesteros, Elisa Llorente, Miani, Claudia, Ricci, Giacomo, Santioni, Raffaele, Schellerer, Stefan, Westman, Hanna

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The crisis management framework for banks in the European Union (EU) requires the resolution authorities to identify the existence of a public interest to resolve an ailing bank, rather than to open normal insolvency proceedings (NIPs). The Public Interest Assessment (PIA) determines whether resolution objectives, including the safeguard of financial stability, can be better preserved using resolution tools than NIPs .This paper provides a contribution to the ongoing discussion on the implementation of the PIA, by presenting an analytical framework to quantify the potential impact on the real economy stemming from a bank’s failure under NIPs through the interruption of the lending activity (“credit channel”). The framework is harmonized across the jurisdictions belonging to the Banking Union and aims to improve the quantitative leg of the PIA, to be coupled with qualitative elements. In a first step, we quantify the potential credit shortfall faced by firms and households due to the abrupt closure of a bank. In a second step, the impact of the credit shortfall on real outcomes is estimated via a FAVAR model and via a micro-econometric model. Reference values are provided to assess the relevance of the estimated outcomes. The illustrative results show that such a harmonized approach can be applied across the Banking Union and to banks of heterogeneous size. In case of mid-sized banks, this common analytical framework could reduce the uncertainty regarding the extent to which the failure of the institution could have a negative impact to the real economy if the lending activity is interrupted as possibly the case under NIPs.

No. 121
1 June 2021
Resolving mortgage distress after COVID-19: some lessons from the last crisis
McCann, Fergal, O’Malley, Terry

Abstract

JEL Classification

F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements
F28 : International Economics→International Factor Movements and International Business
G51 : Financial Economics

Abstract

Abstract We analyse micro data on Irish mortgages and distressed households’ balance sheets in the last decade to assess the debt resolution process in the Irish mortgage market in the lead up to the COVID-19 shock. We highlight the widespread engagement of Irish borrowers with debt resolution mechanisms during a decade in which one sixth of mortgage accounts were restructured by 2016. Lenders favoured short-term mortgage modifications at the beginning of the decade and three-quarters of performing mortgages with short-term modifications in 2011-2012 remained performing at end-2017. However, close to half of these cases involved a subsequent longer-term restructure, consistent with concerns that short-term modification alone is not sufficient to ensure mortgage sustainability. In other cases, an over-reliance on unsustainable short-term arrangements translated into longer-term arrears accumulation. Turning to the financial distress of households seeking a resolution to their arrears, we find an average income fall of roughly one third since mortgage origination and that one third had already reduced their non-housing expenditures to below the recommended minimum level used in the personal insolvency system. Finally, we show that larger cuts in repayment burdens and lower ex-post payment-to-income ratios are both highly predictive of successful long-term restructures.

No. 120
1 June 2021
A quantitative analysis of the countercyclical capital buffer
Faria-e-Castro, Miguel

Abstract

JEL Classification

E4 : Macroeconomics and Monetary Economics→Money and Interest Rates
E6 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
G2 : Financial Economics→Financial Institutions and Services

Abstract

What are the quantitative macroeconomic effects of the countercyclical capital buffer (CCyB)? I study this question in a nonlinear DSGE model with occasional financial crises, which is calibrated and combined with US data to estimate sequences of structural shocks. Raising capital buffers during leverage expansions can reduce the frequency of crises by more than half. A quantitative application to the 2007-08 financial crisis shows that the CCyB in the 2:5% range (as in the Federal Reserve's current framework) could have greatly mitigated the financial panic of 2008, for a cumulative gain of 29% in aggregate consumption. The threat of raising capital requirements is effective even if this tool is not used in equilibrium.

No. 119
10 May 2021
Investment funds, monetary policy, and the global financial cycle
Kaufmann, Christoph

Abstract

JEL Classification

F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements
F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission
G15 : Financial Economics→General Financial Markets→International Financial Markets
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

This paper studies the role of international investment funds in the transmission of global financial conditions to the euro area using structural Bayesian vector auto regressions. While cross-border banking sector capital flows receded significantly in the aftermath of the global financial crisis, portfolio flows of investors actively searching for yield on financial markets world-wide gained importance during the post-crisis “second phase of global liquidity” (Shin, 2013). The analysis presented in this paper shows that a loosening of US monetary policy leads to higher investment fund inflows to equities and debt globally. Focussing on the euro area, these inflows do not only imply elevated asset prices, but also coincide with increased debt and equity issuance. The findings demonstrate the growing importance of non-bank financial intermediation over the last decade and have important policy implications for monetary and financial stability.

No. 118
10 May 2021
The impact of macroprudential policies on capital flows in CESEE
Eller, Markus, Hauzenberger, Niko, Huber, Florian, Schuberth, Helene, Vashold, Lukas

Abstract

JEL Classification

C38 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Classification Methods, Cluster Analysis, Principal Components, Factor Models
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
F44 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Business Cycles
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

In line with the recent policy discussion on the use of macroprudential measures to respond to cross-border risks arising from capital flows, this paper tries to quantify to what extent macroprudential policies (MPPs) have been able to stabilize capital flows in Central, Eastern and Southeastern Europe (CESEE) – a region that experienced a substantial boom-bust cycle in capital flows amid the global financial crisis and where policymakers had been quite active in adopting MPPs already before that crisis. To study the dynamic responses of capital flows to MPP shocks, we propose a novel regime-switching factor-augmented vector autoregressive (FAVAR) model. It allows to capture potential structural breaks in the policy regime and to control – besides domestic macroeconomic quantities – for the impact of global factors such as the global financial cycle. Feeding into this model a novel intensity-adjusted macroprudential policy index, we find that tighter MPPs may be effective in containing domestic private sector credit growth and the volumes of gross capital inflows in a majority of the countries analyzed. However, they do not seem to generally shield CESEE countries from capital flow volatility.

No. 117
31 March 2021
The importance of technology in banking during a crisis
Timmer, Yannick, Pierri, Niccola

Abstract

JEL Classification

O3 : Economic Development, Technological Change, and Growth→Technological Change, Research and Development, Intellectual Property Rights
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
D83 : Microeconomics→Information, Knowledge, and Uncertainty→Search, Learning, Information and Knowledge, Communication, Belief

Abstract

We study the implications of information technology (IT) in banking for financial stability, using data on US banks’ IT equipment and the tech-background of their executives. We find that one standard deviation higher pre-crisis IT adoption led to 10% fewer non-performing loans during the global financial crisis. We present several pieces of evidence that indicate a direct role of IT adoption in strengthening bank resilience; these include instrumental variable estimates exploiting the historical location of technical schools. Loan-level analysis reveals that high-IT adoption banks originated mortgages with better performance and did not offload low-quality loans.

No. 116
15 March 2021
Procyclical asset management and bond risk premia
Barbu, Alexandru, Fricke, Christoph, Moench, Emanuel

Abstract

JEL Classification

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects

Abstract

We use unique institutional securities holdings data to examine the trading behaviour of delegated institutional capital and its impact on bond risk premia. We show that institutional fund managers trade strongly procyclically: they actively move into higher yielding, longer duration and lower rated securities as yields fall and spreads compress, and vice versa. Funds more exposed to negative yields increase their risk-taking more strongly, and this effect is particularly pronounced for those offering explicit minimum return guarantees. Institutional funds' investments have large and persistent price impact in both corporate and sovereign bond markets. We provide evidence that this procyclical behaviour is driven by career concerns among institutional fund managers.

No. 115
15 March 2021
Cross-border credit derivatives linkages
Bianchi, Benedetta

Abstract

JEL Classification

F34 : International Economics→International Finance→International Lending and Debt Problems
F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements

Abstract

This paper is a first attempt to include credit derivatives in international macro-financial analysis. We document that gross credit derivatives holdings map to bilateral portfolio investment linkages. On a net basis, our results suggest an asymmetry between sectors and between net buyers and net sellers of CDSs. When a banking system is a net buyer of protection, the protection purchased is proportional to the debt securities held. Conversely, when a banking system is a net seller, the protection sold is proportional to the securities held. For investment funds, we find no aggregate relation between net CDSs and the debt securities held.

No. 114
1 February 2021
Financial crises, macroprudential policy and the reliability of credit-to-GDP gaps
Alessandri, Piergiorgio, Bologna, Pierluigi, Galardo, Maddalena

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The Basel III regulation explicitly prescribes the use of Hodrick-Prescott filters to estimate credit cycles and calibrate countercyclical capital buffers. However, the filter has been found to suffer from large ex-post revisions, raising concerns on its fitness for policy use. To investigate this problem we study credit cycles in a panel of 26 countries between 1971 and 2018. We reach two conclusions. The bad news is that the limitations of the one-side HP filter are serious and pervasive. The good news is that they can be easily mitigated. The filtering errors are persistent and hence predictable. This can be exploited to construct real-time estimates of the cycle that are less subject to ex-post revisions, forecast financial crises more reliably, and stimulate the build-up of bank capital before a crisis.

No. 113
1 December 2020
Financial stability policies and bank lending: quasi-experimental evidence from Federal Reserve interventions in 1920-21
Rieder, Kilian

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
N12 : Economic History→Macroeconomics and Monetary Economics, Industrial Structure, Growth, Fluctuations→U.S., Canada: 1913?
N22 : Economic History→Financial Markets and Institutions→U.S., Canada: 1913?

Abstract

I estimate the comparative causal effects of monetary policy \leaning against the wind" (LAW) and macroprudential policy on bank-level lending and leverage by drawing on a single natural experiment. In 1920, when U.S. monetary policy was still decentralized, four Federal Reserve Banks implemented a conventional rate hike to address financial stability concerns. Another four Reserve Banks resorted to macroprudential policy with the same goal. Using sharp geographic regression discontinuities, I exploit the resulting policy borders with the remaining four Federal Reserve districts which did not change policy stance. Macroprudential policy caused both bank-level lending and leverage to fall significantly (by 11%-14%), whereas LAW had only weak and, in some areas, even perverse effects on these bank-level outcomes. I show that the macroprudential tool reined in over-extended banks more effectively than LAW because it allowed Federal Reserve Banks to use price discrimination when lending to highly leveraged counterparties. The perverse effects of the rate hike in some areas ensued because LAW lifted a pre-existing credit supply friction by incentivizing regulatory arbitrage. My results highlight the importance of context, design and financial infrastructure for the effectiveness of financial stability policies.

No. 112
16 November 2020
Retrenchment of euro area banks and international banking models
Argimón, Isabel, Ortiz, Elena Fernández, Rodriguez-Moreno, Maria

Abstract

JEL Classification

F21 : International Economics→International Factor Movements and International Business→International Investment, Long-Term Capital Movements
F23 : International Economics→International Factor Movements and International Business→Multinational Firms, International Business
G15 : Financial Economics→General Financial Markets→International Financial Markets
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

In this paper, we analyze the importance of international banking models, along the operational and the funding dimensions, for the decline in international positions of European banks since the crisis. Using BIS Consolidated Banking Statistics, we find that the multinational model (higher reliance on local activity) and the decentralized model (higher weight of local funding over local claims) is associated with lower retrenchment. We also find that more business synchronization between the home and the host economy is associated with higher declines in lending after the crisis and that the multinational and decentralized models mitigate such effect. On the other hand, lending to banks is not affected by the correlation of economic cycles between the home and the host country.

No. 111
1 October 2020
Debt holder monitoring and implicit guarantees: did the BRRD improve market discipline?
Cutura, Jannic Alexander

Abstract

JEL Classification

G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
H81 : Public Economics→Miscellaneous Issues→Governmental Loans, Loan Guarantees, Credits, Grants, Bailouts

Abstract

This paper argues that the European Unions Banking Recovery and Resolution Directive (BRRD) improved market discipline in the European bank market for unsecured debt. The different impact of the BRRD on bank bonds provides a quasi-natural experiment that allows to study the effect of the BRRD within banks using a difference-in-difference approach. Identification is based on the fact that (otherwise identical) bonds of a given bank maturing before 2016 are explicitly protected from BRRD bail-in. The empirical results are consistent with the hypothesis that debt holders actively monitor banks and that the BRRD diminished bail-out expectations. Bank bonds subject to BRRD bail-in carry a 10 basis points bail-in premium in terms of the yield spread. While there is some evidence that the bail-in premium is more pronounced for non-GSIB banks and banks domiciled in peripheral European countries, weak capitalization is the main driver.

No. 110
1 September 2020
Gap-filling government debt maturity choice
Eidam, Frederik

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

Do governments strategically choose debt maturity to fill supply gaps across maturities? Building on a new panel data set of more than 9,000 individual Eurozone government debt issues between 1999 and 2015, I find that governments increase long-term debt issues following periods of low aggregate Eurozone long-term debt issuance, and vice versa. This gap-filling behaviour is more pronounced for (1) less financially constrained and (2) higher rated governments. Using the ECB’s three-year LTRO in 2011-2012 as an event study, I find that core governments filled the supply gap of longer maturity debt, which resulted from peripheral governments accommodating banks’ short-term debt demand for “carry trades”. This gap-filling implies that governments act as macro-liquidity providers across maturities, thereby adding significant risk absorption capacity to government bond markets.

No. 109
15 April 2020
A dynamic network model to measure exposure diversification in the Austrian interbank market
Hledik, Juraj, Rastelli, Riccardo

Abstract

JEL Classification

X00 :
X01 :
X02 :
X03 :

Abstract

We design a statistical model for measuring the homogeneity of a financial network that evolves over time. Our model focuses on the level of diversification of financial institutions; that is, whether they are more inclined to distribute their assets equally among partners, or if they rather concentrate their commitments towards a limited number of institutions. Crucially, a Markov property is introduced to capture time dependencies and to make our measures comparable across time. We apply the model on an original dataset of Austrian interbank exposures. The temporal span encompasses the onset and development of the financial crisis in 2008 as well as the beginnings of the European sovereign debt crisis in 2011. Our analysis highlights an overall increasing trend for network homogeneity, whereby core banks have a tendency to distribute their market exposures more equally across their partners.

No. 108
14 February 2020
The network of firms implied by the news
Zheng, Hannan, Schwenkler, Gustavo

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
L11 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Production, Pricing, and Market Structure, Size Distribution of Firms
G10 : Financial Economics→General Financial Markets→General
C82 : Mathematical and Quantitative Methods→Data Collection and Data Estimation Methodology, Computer Programs→Methodology for Collecting, Estimating, and Organizing Macroeconomic Data, Data Access

Abstract

We show that the news is a rich source of data on distressed firm links that drive firm-level and aggregate risks. The news tends to report about links in which a less popular firm is distressed and may contaminate a more popular firm. This constitutes a contagion channel that yields predictable returns and downgrades. Shocks to the degree of news-implied firm connectivity predict increases in aggregate volatilities, credit spreads, and default rates, and declines in output. To obtain our results, we propose a machine learning methodology that takes text data as input and outputs a data-implied firm network.

No. 107
14 February 2020
Regulating financial networks under uncertainty
Ramírez, Carlos

Abstract

JEL Classification

C6 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
G01 : Financial Economics→General→Financial Crises

Abstract

I study the problem of regulating a network of interdependent financial institutions that is prone to contagion when there is uncertainty regarding its precise structure. I show that such uncertainty reduces the scope for welfare-improving interventions. While improving network transparency potentially reduces this uncertainty, it does not always lead to welfare improvements. Under certain conditions, regulation that reduces the risk-taking incentives of a small set of institutions can improve welfare. The size and composition of such a set crucially depend on the interplay between (i) the (expected) susceptibility of the network to contagion, (ii) the cost of improving network transparency, (iii) the cost of regulating institutions, and (iv) investors’ preferences.

No. 106
16 December 2019
Electoral cycles in macroprudential regulation
Müller, Karsten

Abstract

JEL Classification

G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
D72 : Microeconomics→Analysis of Collective Decision-Making→Political Processes: Rent-Seeking, Lobbying, Elections, Legislatures, and Voting Behavior
D73 : Microeconomics→Analysis of Collective Decision-Making→Bureaucracy, Administrative Processes in Public Organizations, Corruption
P16 : Economic Systems→Capitalist Systems→Political Economy

Abstract

Do politics matter for macroprudential policy? I show that changes to macroprudential regulation exhibit a predictable electoral cycle in the run-up to 221 elections across 58 countries from 2000 through 2014. Policies restricting mortgages and consumer credit are systematically less likely to be tightened before elections during credit booms and economic expansions. Consistent with theories of opportunistic political cycles, this pattern is stronger when election outcomes are uncertain or in countries where political interference is more likely. In contrast to monetary policy, I find limited evidence that central banks are uniquely insulated from political cycles in macroprudential policy. These results suggest that political pressures may limit the ability of regulators to “lean against the wind.”

No. 105
16 December 2019
Shadow banking and financial stability under limited deposit insurance
Voellmy, Lukas

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

I study the relation between shadow banking and financial stability in an economy in which banks are susceptible to self-fulfilling runs and in which government-backed deposit insurance is limited. Shadow banks issue only uninsured deposits while commercial banks issue both insured and uninsured deposits. The effect of shadow banking on financial stability is ambiguous and depends on the (exogenous) upper limit on insured deposits. If the upper limit on insured deposits is high, then the presence of a shadow banking sector is detrimental to financial stability; shadow banking creates systemic instability that would not be present if all deposits were held in the commercial banking sector. In contrast, if the upper limit on insured deposits is low, then the presence of a shadow banking sector is beneficial from a financial stability perspective; shadow banks absorb uninsured (and uninsurable) deposits from the commercial banking sector, thereby shielding commercial banks from runs. While runs may occur in the shadow banking sector, the situation without shadow banks and a larger amount of uninsured deposits held at commercial banks is worse.

No. 104
2 December 2019
The effects of capital requirements on good and bad risk-taking
Pancost, N. Aaron, Robatto, Roberto

Abstract

JEL Classification

E21 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Consumption, Saving, Wealth
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

We study optimal capital requirement regulation in a dynamic quantitative model in which nonfinancial firms, as well as households, hold deposits. Firms hold deposits for precautionary reasons and to facilitate the acquisition of production inputs. Our theoretical analysis identifies a novel general equilibrium channel that operates through firms’ deposits and mitigates the cost of increasing capital requirements. We calibrate our model and find that the optimal capital requirement is 18.7% but only 13.6% in a comparable model in which only households hold deposits. Our novel channel accounts for most of the difference.

No. 103
2 December 2019
Interactions between bank levies and corporate taxes: How is the bank leverage affected?
Bremus, Franziska, Schmidt, Kirsten, Tonzer, Lena

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
L51 : Industrial Organization→Regulation and Industrial Policy→Economics of Regulation

Abstract

Regulatory bank levies set incentives for banks to reduce leverage. At the same time, corporate income taxation makes funding through debt more attractive. In this paper, we explore how regulatory levies affect bank capital structure, depending on corporate income taxation. Based on bank balance sheet data from 2006 to 2014 for a panel of EU-banks, our analysis yields three main results: The introduction of bank levies leads to lower leverage as liabilities become more expensive. This effect is weaker the more elevated corporate income taxes are. In countries charging very high corporate income taxes, the incentives of bank levies to reduce leverage turn ineffective. Thus, bank levies can counteract the debt bias of taxation only partially.

No. 102
30 September 2019
Exposition, climax, denouement: Life-cycle evaluation of the recent financial crisis in the EU by linking the ESRB financial crisis database to the European Commission's Macroeconomic Imbalance Procedure Scoreboard
Erhart, Szilard

Abstract

JEL Classification

C40 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→General
G01 : Financial Economics→General→Financial Crises
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The paper investigates the life-cycle of the 2008-2009 financial crisis by linking the Macroeconomic Imbalance Procedure (MIP) Scoreboard of the European Commission to the crisis database of the European Systemic Risk Board (ESRB). The novelty of the analysis is that early warning capacity of MIP indicators is empirically tested in case of various crisis events case by case (i) Currency/Balance-of-Payment/Capital flow events, (ii) Sovereign crisis events, (iii) Banking crisis events and (iv) Significant asset price corrections in EU Member States. Furthermore, we contribute to the literature by studying the predicting power of the MIP Scoreboard in the identification of the overheating in the economy in advance of crises (preventive arm of the MIP). We found that the predictive power of the MIP Scoreboard may be twice as high to capture sovereign and Currency/Balance-of-Payment/Capital flow type of crisis events than its power to capture a banking crisis or serious asset price corrections. We confirm the results of earlier empirical studies that some MIP indicators perform relatively well (current account and net international position) in all specifications. A simple composite indicator based on the threshold breaches of MIP Scoreboard Indicators, performed in most cases as good as the best individual indicator, and hence could be considered as an input to a simple, rule based and accountable decision making.

No. 101
17 September 2019
Macroprudential policy spillovers and international banking - Taking the gravity approach
Norring, Anni

Abstract

JEL Classification

F42 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Policy Coordination and Transmission
G15 : Financial Economics→General Financial Markets→International Financial Markets
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

In this paper I study how the effects of nationally implemented macroprudential policy spill across borders via international lending. For a set of 157 countries, I estimate a gravity model applied to international banking where the use of different macroprudential policy measures enter as friction variables. My findings support the existence of cross-border spillovers from macroprudential policy. Moreover, I find that the overall effect from more macroprudential regulation is highly dependent on the income group of the countries in which banks operate: The effect is of opposite sign for advanced and for emerging economies. I argue that the difference may tell of banks having more opportunities for regulatory arbitrage in emerging market economies.

No. 100
17 September 2019
Fire-sales in frozen markets
Ebrahimy, Ehsan

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
D61 : Microeconomics→Welfare Economics→Allocative Efficiency, Cost?Benefit Analysis
D62 : Microeconomics→Welfare Economics→Externalities
D83 : Microeconomics→Information, Knowledge, and Uncertainty→Search, Learning, Information and Knowledge, Communication, Belief
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

It is challenging to explain the collapse in the price of subprime mortgage-backed securities (MBS) during the Financial Crisis of 2008, using the existing models of fire sale. I present a model to demonstrate that fire sales may happen even when there is a relatively sizable pool of natural buyers and in the absence of asymmetric information, due to a coordination failure among buyers: buyers’ waiting to trade at a lower price tomorrow, can lead to a collapse in the price and trade volume today. In particular, I show that when trade is decentralized and participation is endogenous, a medium level of asset demand and liquidity needs that are expected to increase over time create complementarity among buyers’ decisions to wait. This complementarity makes competitive markets prone to coordination failures and fire sales accompanied by a collapse in the trade volume. Fire sales may also be inefficient. I also discuss various policy options to eliminate the risk of fire sales in such a setup.

No. 99
29 July 2019
Securisation special purpose entities, bank sponsors and derivatives
Fiedor, Paweł, Killeen, Neill

Abstract

JEL Classification

F30 : International Economics→International Finance→General
F36 : International Economics→International Finance→Financial Aspects of Economic Integration
G15 : Financial Economics→General Financial Markets→International Financial Markets
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

This paper documents the use of derivatives by securitisation special purpose entities (SPEs), also known as financial vehicle corporations (FVCs), domiciled in Ireland using transaction-level data established by the European Market Infrastructure Regulation. We show that these entities primarily engaged in interest rate derivatives over the period of 2015-2017. We find that larger entities that already engage in international capital markets are more likely to have derivative exposures. We also show that entities sponsored by banks and non-bank financial institutions are relatively more likely to engage in derivative markets. The characteristics of these bank sponsors are important in determining SPEs' engagement in derivative markets. SPEs' heavy reliance on debt finance coupled with their strong interconnectedness with bank sponsors underscores the importance of continuous monitoring and macroprudential surveillance of their derivative activities.

No. 98
1 July 2019
Bank asset quality and monetary policy pass-through
Kelly, Robert, Byrne, David

Abstract

JEL Classification

D43 : Microeconomics→Market Structure and Pricing→Oligopoly and Other Forms of Market Imperfection
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

The funding mix of European firms is weighted heavily towards bank credit, which underscores the importance of efficient pass-through of monetary policy actions to lending rates faced by firms. Euro area pass-through has shifted from being relatively homogenous to being fragmented and incomplete since the financial crisis. Distressed loan books are a crisis hangover with direct implications for profitability, hampering banks ability to supply credit and lower loan pricing in response to reductions in the policy rate. This paper presents a parsimonious model to decompose the cost of lending and highlight the role of asset quality in diminishing pass-through. Using bank-level data over the period 2008-2014, we empirically test the implications of the model. We show that a one percentage point increase in the impairment ratio lowering short run pass-through by 3 percent. We find that banks with severely impaired balance sheets do not adjust their loan pricing in response to changes in the policy rate at all. We derive a measure of the hidden bad loan problem, the NPL gap, which we define as the excess of non-performing loans over impaired loans. We show that it played a significant role in the fragmentation of euro area pass-through post-crisis.

No. 97
1 July 2019
Rethinking capital regulation: the case for a dividend prudential target
Muñoz, Manuel A.

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G35 : Financial Economics→Corporate Finance and Governance→Payout Policy

Abstract

The paper investigates the effectiveness of dividend-based macroprudential rules in complementing capital requirements to promote bank soundness and sustained lending over the cycle. First, some evidence on bank dividends and earnings in the euro area is presented. When shocks hit their profits, banks adjust retained earnings to smooth dividends. This generates bank equity and credit supply volatility. Then, a DSGE model with key financial frictions and a banking sector is developed to assess the virtues of what shall be called dividend prudential targets. Welfare-maximizing dividend-based macroprudential rules are shown to have important properties: (i) they are effective in smoothing the financial and the business cycle by means of less volatile bank retained earnings, (ii) they induce welfare gains associated to a Basel III-type of capital regulation, (iii) they mainly operate through their cyclical component, ensuring that long-run dividend payouts remain unaffected, (iv) they are flexible enough so as to allow bank managers to optimally deviate from the target (conditional on the payment of a sanction), and (v) they are associated to a sanctions regime that acts as an insurance scheme for the real economy.

No. 96
17 June 2019
Optimally solving banks’ legacy problems
Segura, Anatoli, Suarez, Javier

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G20 : Financial Economics→Financial Institutions and Services→General
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We characterize policy interventions directed to minimize the cost to the deposit guarantee scheme and the taxpayers of banks with legacy problems. Non-performing loans (NPLs) with low and risky returns create a debt overhang that induces bank owners to forego profitable lending opportunities. NPL disposal requirements can restore the incentives to undertake new lending but, as they force bank owners to absorb losses, can also make them prefer the bank being resolved. For severe legacy problems, combining NPL disposal requirements with positive transfers is optimal and involves no conflict between minimizing the cost to the authority and maximizing overall surplus.

No. 95
17 June 2019
Use of credit default swaps by UCITS funds: evidence from EU regulatory data
Guagliano, Claudia, Mazzacurati, Julien, Kenny, Oisin, Braunsteffer, Achim

Abstract

JEL Classification

F30 : International Economics→International Finance→General
G10 : Financial Economics→General Financial Markets→General
G15 : Financial Economics→General Financial Markets→International Financial Markets
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

Using a sample of more than 18,000 Undertakings for Collective Investment in Transferable Securities,or UCITS, this paper aims to provide a first overview of the use of credit default swaps by EU UCITSfunds. We show that UCITS funds only account for a small share of the overall EU credit derivativesmarket. The CDS market is highly concentrated, with thirteen large dealers acting as counterparty to thevast majority of CDS transactions that involve UCITS funds. The use of CDS by UCITS is mainlyconcentrated in fixed-income funds and funds that rely on so-called alternative strategies. Funds that useCDS tend to be much larger on average. The analysis also reveals three salient features in the UCITSfunds’ use of CDS. Firstly, funds with directional strategies, such as fixed-income and allocation funds (ormixed funds), are on aggregate net sellers of CDS. Secondly, a large majority of CDS underlyings areindices, from which funds can gain exposure to multiple entities at once within one sector or region.Lastly, most sovereign single-name CDS are written on emerging market issuers, highlighting the rolethat these instruments can play in facilitating access to less liquid markets.

No. 94
15 May 2019
Do information contagion and business model similarities explain bank credit risk commonalities?
Wang, Dieter, van Lelyveld, Iman, Schaumburg, Julia

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models
C38 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Classification Methods, Cluster Analysis, Principal Components, Factor Models

Abstract

This paper revisits the credit spread puzzle for banks from the perspective of information contagion. The puzzle consists of two stylized facts: Structural determinants of credit risk not only have low explanatory power but also fail to capture common factors in the residuals. We reproduce the puzzle for European bank credit spreads and hypothesize that the puzzle exists because structural models ignore contagion effects. We therefore extend the structural approach to include information contagion through bank business model similarities. To capture this channel, we propose an intuitive measure for portfolio overlap and apply it to the complete asset holdings of the largest banks in the Eurozone. Incorporating this unique network information into the structural model increases explanatory power and removes a systemic common factor from the residuals. Furthermore, neglecting the network likely overstates the importance of structural determinants.

No. 93
15 May 2019
Bank capital forbearance
Martynova, Natalya, Perotti, Enrico, Suarez, Javier

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We analyze the strategic interaction between undercapitalized banks and a supervisor who may intervene by preventive recapitalization. Supervisory forbearance emerges because of a commitment problem, reinforced by fiscal costs and constrained capacity. Private incentives to comply are lower when supervisors have lower credibility, especially for highly levered banks. Less credible supervisors (facing higher cost of intervention) end up intervening more banks, yet producing higher forbearance and systemic costs of bank distress. Importantly, when public intervention capacity is constrained, private recapitalization decisions become strategic complements, leading to equilibria with extremely high forbearance and high systemic costs of bank failure.

No. 92
2 May 2019
The cyclicality in SICR: mortgage modelling under IFRS 9
Gaffney, Edward, McCann, Fergal

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

Banks must make forward-looking provisions for loan losses under new international accounting standards introduced in 2018. In Europe, banks will assign performing exposures to a new “Stage 2” category with a higher provisioning penalty, if they have experienced significant increase in credit risk (SICR). We use a loan-level credit risk model and Irish residential mortgage panel data to assign performing loans into the appropriate stage. Using this technique, we characterise approximately 30 per cent of the performing Irish mortgage portfolio at end-2015 as Stage 2.We then calculate backward-looking, static estimations of Stage 2 mortgages between 2008 and 2015. This exercise suggests that loan stage assignment can be highly pro-cyclical. The share of Stage 2 among performing mortgages rises during the economic downturn to peak in 2013, after which large transitions are assigned from Stage 2 into lower-risk performing loans, as the economy improves.

No. 91
2 May 2019
Has regulatory capital made banks safer? Skin in the game vs moral hazard
Dautović, Ernest

Abstract

JEL Classification

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
O52 : Economic Development, Technological Change, and Growth→Economywide Country Studies→Europe

Abstract

The paper evaluates the impact of a phased-in introduction of capital requirements on equity, risk-taking, and probability of default for a sample of European systemically important banks. Contrary to the case of a one-off introduction of capital requirements, this study does not find evidence of deleveraging through asset sales. A phased-in tightening promotes adjustment to lower leverage via an increase in equity thereby improving resilience and loss absorption capacity. The higher resilience comes at the cost of a portfolio reallocation towards riskier assets. Consistently with models on agency costs and gambling for resurrection, the risk-taking is driven by large and less profitable banks. The net impact on bank probabilities of default is positive albeit statistically insignificant, suggesting that risk-taking may crowd-out solvency.

No. 90
22 March 2019
Effectiveness of policy and regulation in European sovereign credit risk markets: a network analysis
Buse, Rebekka, Schienle, Melanie, Urban, Jörg

Abstract

JEL Classification

G20 : Financial Economics→Financial Institutions and Services→General
G01 : Financial Economics→General→Financial Crises
G17 : Financial Economics→General Financial Markets→Financial Forecasting and Simulation
C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
C55 : Mathematical and Quantitative Methods→Econometric Modeling→Modeling with Large Data Sets?
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We study the impact of changes in regulations and policy interventions on systemic risk among European sovereign entities measured as volatility spillovers in respective credit risk markets. Our unique intraday CDS dataset allows for precise measurement of the effectiveness of these events in a network setting. In particular, it allows discerning interventions which entail significant changes in network cross-effects with appropriate bootstrap confidence intervals. We show that it was mainly regulatory changes with the ban of trading naked sovereign CDS in 2012 as well as the new ISDA regulations in 2014 which were most effective in reducing systemic risk. In comparison, we find that the effect of policy interventions was minor and generally not sustainable. In particular, they only had a significant impact when implemented for the first time and when targeting more than one country. For the volatility spillover channels, we generally find balanced networks with no fragmentation over time.

No. 89
14 March 2019
The effect of possible EU diversification requirements on the risk of banks' sovereign bond portfolios
Craig, Ben, Giuzio, Margherita, Paterlini, Sandra

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Recent policy discussion includes the introduction of diversification requirements for sovereign bond portfolios of European banks. In this paper, we evaluate the possible effects of these constraints on risk and diversification in the sovereign bond portfolios of the major European banks. First, we capture the dependence structure of European countries' sovereign risks and identify the common factors driving European sovereign CDS spreads by means of an independent component analysis. We then analyze the risk and diversification in the sovereign bond portfolios of the largest European banks and discuss the role of “home bias”, i.e., the tendency of banks to concentrate their sovereign bond holdings in their domicile country. Finally, we evaluate the effect of diversification requirements on the tail risk of sovereign bond portfolios and quantify the system-wide losses in the presence of fire-sales. Under our assumptions about how banks respond to the new requirements, demanding that banks modify their holdings to increase their portfolio diversification may mitigate fire-sale externalities, but may be ineffective in reducing portfolio risk, including tail risk.

No. 88
4 March 2019
What drives sovereign debt portfolios of banks in a crisis context?
Lamas, Matías, Mencía, Javier

Abstract

Abstract

We study determinants of sovereign portfolios of Spanish banks over a long time-span, starting in 2008. Our findings challenge the view that banks engaged in moral hazard strategies to exploit the regulatory treatment of sovereign exposures. In particular, we show that being a weakly capitalized bank is not related to higher holdings of domestic sovereign debt. While a strong link is present between central bank liquidity support and sovereign holdings, opportunistic strategies or reach-for-yield behavior appear to be limited to the non-domestic sovereign portfolio of well-capitalized banks, which might have taken advantage of their higher risk-bearing capacity to gain exposure (via central bank liquidity) to the set of riskier sovereign bonds. Furthermore, we document that financial fragmentation in EMU markets has played a key role in reshaping sovereign portfolios of banks. Overall, our results have important implications for the ongoing discussion on the optimal design of the risk-weighted capital framework of banks.

No. 87
7 February 2019
Pockets of risk in European housing markets: then and now
Kelly, Jane, Le Blanc, Julia, Lydon, Reamonn

Abstract

JEL Classification

E5 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
G01 : Financial Economics→General→Financial Crises
G17 : Financial Economics→General Financial Markets→Financial Forecasting and Simulation
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
R39 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→Other

Abstract

Using household survey data, we document evidence of a loosening of credit standards in Euro area countries that experienced a property price boom-and-bust cycle. Borrowers in these countries exhibited significantly higher loan-to-value (LTV) and loan-to-income (LTI) ratios in the run up to the financial crisis, and an increasing tendency towards longer-term loans compared to borrowers in other countries. In recent years, despite the long period of historically low interest rates and substantial house price increases in some countries, we do not find similar credit easing as before the crisis. Instead, we find evidence of a considerable change in borrower characteristics since 2010: new borrowers are older and have higher incomes than before the crisis.

No. 86
15 November 2018
Systemic illiquidity in the interbank network
Langfield, Sam, Liu, Zijun, Ota, Tomohiro, Ferrara, Gerardo

Abstract

JEL Classification

D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We study systemic illiquidity using a unique dataset on banks’ daily cash flows, short-term interbank funding and liquid asset buffers. Failure to roll-over short-term funding or repay obligations when they fall due generates an externality in the form of systemic illiquidity. We simulate a model in which systemic illiquidity propagates in the interbank funding network over multiple days. In this setting, systemic illiquidity is minimised by a macroprudential policy that skews the distribution of liquid assets towards banks that are important in the network.

No. 85
15 October 2018
Structural credit ratios
Bianchi, Benedetta

Abstract

JEL Classification

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
G01 : Financial Economics→General→Financial Crises
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

This paper studies the relation between the credit-to-GDP ratio and macroeconomic trends. We estimate a long run equation on a sample of EU countries; our findings suggest that the macroeconomic factors with which the credit ratio associates most strongly are economic development, the investment share in GDP, and inflation. We then obtain projections for past and future trends. First, we study the evolution of the credit ratio in the past. We find that most of the increase starting in 1985 is associated with economic development and falling inflation, while the decrease of investment may have slowed down this trend. Second, we offer a forward-looking estimate of the structural credit ratio, defined as the long run, or sustainable, component. We offer band estimates based on two alternative assumptions on future economic outcomes, which can be interpreted as a structural and a cyclical view of current macroeconomic dynamics. Estimates of structural credit ratios based on this method are useful to policy makers having to decide on the activation of the countercyclical capital buffer, especially when assessing the sustainability of credit growth.

No. 84
18 September 2018
Reconstructing and stress testing credit networks
Ramadiah, Amanah, Caccioli, Fabio, Fricke, Daniel

Abstract

JEL Classification

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

Financial networks are an important source of systemic risk, but often only partial network information is available. In this paper, we use data on bank-firm credit relationships in Japan and conduct a horse race between different network reconstruction methods in terms of their ability to reproduce the actual credit networks. We then compare the different reconstruction methods in terms of their implied systemic risk levels. In most instances we find that the observed credit network significantly displays the highest systemic risk level. Lastly, we explore different policies to improve the robustness of the system.

No. 83
16 August 2018
Bank resolution and public backstop in an asymmetric banking union
Segura, Anatoli, Vicente, Sergio

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper characterizes the optimal banking union with endogenous participation in a two-country economy in which domestic bank failures may be contemporaneous to sovereign crises, giving rise to risk-sharing motives to mutualize the funding of bail-outs. Raising public funds to conduct a bail-out entails the deadweight loss of distortionary taxation. Bank bail-ins create disruption costs in the economy. When country asymmetry is large, resolution policies exhibit reduced contributions to the public backstop and forbearance in early bank intervention in the fiscally stronger country, facilitating bail-outs in this country.

No. 82
16 August 2018
A profit-to-provisioning approach to setting the countercyclical capital buffer: the Czech example
Pfeifer, Lukáš, Hodula, Martin

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Over the last few years, national macroprudential authorities have developed different strategies for setting the countercyclical capital buffer (CCyB) rate in the banking sector. The existing approaches are based on various indicators used to identify the current phase of the financial cycle. However, to our knowledge, there is no approach that directly takes into consideration banks’ prudential behavior over the financial cycle as well as cyclical risks in the banking sector. In this paper, we propose a new profit-to-provisioning approach that can be used in the macroprudential decision-making process. We construct a new set of indicators that largely capture the risk of cyclicality of profit and loan loss provisions. We argue that banks should conserve a portion of the cyclically overestimated profit (non-materialized expected loss) in their capital during a financial boom. We evaluate the performance of our newly proposed indicators using two econometric exercises. Overall, they exhibit good statistical properties, are relevant to the CCyB decision-making process, and may contribute to a more precise assessment of both systemic risk accumulation and risk materialization. We believe that the relevance of the profit-to-provisioning approach and the related set of newly proposed indicators increases under IFRS 9.

No. 81
2 August 2018
The role of contagion in the transmission of financial stress
Herculano, Miguel C.

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises
C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

I examine the relevance of contagion in explaining financial distress in the US banking system by identifying the component of bank level probabilities that is due to contagion. Identification is achieved after controlling for macrofinancial and bank specific shocks that have similar consequences to contagion. I use a Bayesian spatial autoregressive model that allows for time-dependent network interactions, and find that bank default likelihoods depend, to a large extent, on peer effects that account on average for approximately 35 per cent of total distress. Furthermore, I find evidence of significant heterogeneity amongst banks and some institutions to be systemically more important that others, in terms of peer effects.

No. 80
2 August 2018
Implications of macroeconomic volatility in the Euro area
Hauzenberger, Niko, Böck, Maximilian, Pfarrhofer, Michael, Stelzer, Anna, Zens, Gregor

Abstract

JEL Classification

C30 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→General
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles

Abstract

In this paper we estimate a Bayesian vector autoregressive model with factor stochastic volatility in the error term to assess the effects of an uncertainty shock in the Euro area. This allows us to treat macroeconomic uncertainty as a latent quantity during estimation. Only a limited number of contributions to the literature estimate uncertainty and its macroeconomic consequences jointly, and most are based on single country models. We analyze the special case of a shock restricted to the Euro area, where member states are highly related by construction. We find significant results of a decrease in real activity for all countries over a period of roughly a year following an uncertainty shock. Moreover, equity prices, short-term interest rates and exports tend to decline, while unemployment levels increase. Dynamic responses across countries differ slightly in magnitude and duration, with Ireland, Slovakia and Greece exhibiting different reactions for some macroeconomic fundamentals.

No. 79
19 July 2018
Lending standards and output growth
Kirti, Divya

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

Abstract

While some credit booms are followed by economic underperformance, many are not. Can lending standards help separate good credit booms from bad credit booms contemporaneously? To observe lending standards internationally, I use information from primary debt capital markets. I construct the high-yield (HY) share of bond issuance for a panel of 38 countries. The HY share is procyclical, suggesting that lending standards in bond markets are extrapolative. Credit booms with deteriorating lending standards (rising HY share) are followed by lower GDP growth in the subsequent three to four years. Such booms deserve attention from policy makers.

No. 78
19 July 2018
Analyzing credit risk transmission to the non-financial sector in Europe: a network approach
Gross, Christian, Siklos, Pierre

Abstract

JEL Classification

C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
C38 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Classification Methods, Cluster Analysis, Principal Components, Factor Models
C55 : Mathematical and Quantitative Methods→Econometric Modeling→Modeling with Large Data Sets?
F3 : International Economics→International Finance
G01 : Financial Economics→General→Financial Crises
G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

We use a factor model and elastic net shrinkage to model a high-dimensional network of European CDS spreads. Our empirical approach allows us to assess the joint transmission of bank and sovereign risk to the non-financial corporate sector. Our findings identify a sectoral clustering in the CDS network, where financial institutions are in the center and non-financial entities as well as sovereigns are grouped around the financial center. The network has a geographical component reflected in different patterns of real-sector risk transmission across countries. Our framework also provides dynamic estimates of risk transmission, a useful tool for systemic risk monitoring.

No. 77
2 July 2018
Cyclical investment behavior across financial institutions
Timmer, Yannick

Abstract

JEL Classification

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G15 : Financial Economics→General Financial Markets→International Financial Markets
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

This paper contrasts the investment behavior of different financial institutions in debt securities as a response to past returns. For identification, I use unique security-level data from the German Micro-database Securities Holdings Statistics. Banks and investment funds respond in a pro-cyclical manner to past security-specific holding period returns. In contrast, insurance companies and pension funds act counter-cyclically; they buy when returns have been negative and sell after high returns. The heterogeneous responses can be explained by differences in their balance sheet structure. I exploit within-sector variation in the financial constraint to show that tighter constraints are associated with relatively more pro-cyclical investment behavior.

No. 76
2 July 2018
Evaluating macroprudential policies
Buch, Claudia M., Vogel, Edgar, Weigert, Benjamin

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
F34 : International Economics→International Finance→International Lending and Debt Problems
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

Macroprudential policy is a relatively new policy field. Its goal is to preserve financial stability and to prevent the build-up of systemic risk that may have adverse effects for the functioning of the financial system and for the real economy. New institutions have been tasked with the implementation of macroprudential policies, and new policy instruments have been introduced. Nonetheless, uncertainty about the state of the financial system and the effects and effectiveness of these policy instruments is high. This uncertainty entails two risks: the risk of acting too late (inaction bias) and the risk of choosing an inappropriate instrument or inadequate calibration. In this paper, we argue that both risks can be mitigated if macroprudential policy is embedded in a structured policy process. Such a policy process involves four steps: defining policy objectives for macroprudential policies, choosing intermediate objectives and appropriate indicators, linking instruments to these indicators through ex-ante evaluation studies, and analyzing the effects of these policies through ex-post evaluation studies. We argue that the infrastructure for this policy process can be further improved by providing data for policy evaluation, establishing or strengthening legal mandates for policy evaluation, establishing mechanisms for international cooperation, and building up repositories of evaluation studies.

No. 75
18 May 2018
Insurers as asset managers and systemic risk
Ellul, Andrew, Jotikasthira, Chotibhak, Kartasheva, Anastasia, Lundblad, Christian T., Wagner, Wolf

Abstract

JEL Classification

G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies

Abstract

Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. Using the U.S. life insurance industry as a laboratory, we present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds (“reach-for-yield”). We then calibrate the model to insurer-level data, and show that the VA-writing insurers’ collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20-70% of insurers’ equity capital.

No. 74
15 May 2018
Regulating the doom loop
Alogoskoufis, Spyros, Langfield, Sam

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Euro area governments have committed to break the doom loop between bank risk and sovereign risk. But policymakers have not reached consensus on whether and how to reform the regulatory treatment of banks’ sovereign exposures. To inform policy discussions, this paper simulates portfolio reallocations by euro area banks under scenarios for regulatory reform. Simulations highlight a tension in regulatory design between concentration and credit risk. An area-wide low-risk asset—created by pooling and tranching cross-border portfolios of government debt securities— would resolve this tension by expanding the portfolio opportunity set. Banks could therefore reinvest into an asset that has both low concentration and low credit risk.

No. 73
13 April 2018
Sovereign risk and bank risk-taking
Ari, Anil

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F30 : International Economics→International Finance→General
F34 : International Economics→International Finance→International Lending and Debt Problems
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

I propose a dynamic general equilibrium model in which strategic interactions between banks and depositors may lead to endogenous bank fragility and slow recovery from crises. When banks’investment decisions are not contractible, depositors form expectations about bank risk-taking and demand a return on deposits according to their risk. This creates strategic complementarities and possibly multiple equilibria: in response to an increase in funding costs, banks may optimally choose to pursue risky portfolios that undermine their solvency prospects. In a bad equilibrium, high funding costs hinder the accumulation of bank net worth, leading to a persistent drop in investment and output. I bring the model to bear on the European sovereign debt crisis, in the course of which under-capitalized banks in default-risky countries experienced an increase in funding costs and raised their holdings of domestic government debt. The model is quanti…ed using Portuguese data and accounts for macroeconomic dynamics in Portugal in 20102016. Policy interventions face a trade-o¤ between alleviating banks’funding conditions and strengthening risk-taking incentives. Liquidity provision to banks may eliminate the good equilibrium when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria.

No. 72
13 March 2018
Clearinghouse-Five: determinants of voluntary clearing in European derivatives markets
Fiedor, Paweł

Abstract

JEL Classification

C58 : Mathematical and Quantitative Methods→Econometric Modeling→Financial Econometrics
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

Central clearing is a major part of the policy response to the financial crisis of 2008, aiming to reign in counterparty credit risk in derivatives markets. I perform an empirical study of the incentives for voluntary central clearing of OTC derivative contracts in Europe. Central clearing acts as insurance against counterparty credit risk related to derivative contracts, and is legally mandated for a specific subset of standardized derivative contracts, with a significant portion of the other contracts eligible for voluntary clearing. I show that there exist significant economies of scale in central clearing, in terms of both the size of each contract, and the scale of total clearing activity. I also show that maturity of the contract and international frictions affect voluntary clearing of different types of derivative contracts in different ways, linked to the conventional maturity and payout structures of various types of contracts. Finally, I show that significant amount of clearing happens only for credit and interest rate derivatives, while equity, foreign exchange, and commodity derivatives are rarely centrally cleared. The results validate theoretical literature, and guide future modeling of derivative markets.

No. 71
1 March 2018
Resolving a Non-Performing Loan crisis: the ongoing case of the Irish mortgage market
McCann, Fergal

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

The Irish banking system has in recent years experienced a large build-up in Non-Performing Loans (NPLs) during the crisis followed by a sharp reduction in the 2013-2017 period. In this article I present a recent history of the ongoing resolution of the mortgage arrears crisis in Ireland. Using a large and close to exhaustive panel data set of Irish mortgages from 2008 to 2016, I present a number of new findings on loan transitions between delinquency states, the importance of legacy effects of the crisis in explaining recent entry to arrears, the role of mortgage modification in the reduction in arrears balances, the extent of borrower-lender engagement and the financial vulnerability that remains in pockets of the Irish mortgage market.

No. 70
1 March 2018
The variance risk premium and capital structure
Lotfaliei, Babak

Abstract

JEL Classification

G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
G33 : Financial Economics→Corporate Finance and Governance→Bankruptcy, Liquidation
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

Abstract

This paper investigates how the asset-return variance risk premium changes leverage. I find that the premium lowers leverage by increasing risk-neutral bankruptcy probability and costs in a model where asset returns have stochastic variance with risk premium. Empirically, the model calibrations verify significant reduction in optimal leverage, closer to observed leverage than the model without the premium. In model-free regressions, I also document negative correlation between leverage and the variance premium. The most negative correlation is among investment-grade firms with low asset beta and historical variance but high variance premium because their assets have high exposure to market variance premium.

No. 69
19 February 2018
When gambling for resurrection is too risky
Kirti, Divya

Abstract

JEL Classification

G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Rather than taking on more risk, US insurers hit hard by the crisis pulled back from risk taking, relative to insurers hit less hard by the crisis. Capital requirements alone do not explain this risk reduction: insurers hit hard reduced risk within assets with identical regulatory treatment. State level US insurance regulation makes it unlikely this risk reduction was driven by moral suasion. Other financial institutions also reduce risk after large shocks: the same approach applied to banks yields similar results. My results suggest that, at least in some circumstances, franchise value can dominate, making gambling for resurrection too risky.

No. 68
16 February 2018
Business cycles and the balance sheets of the financial and non-financial sectors
Villacorta, Alonso

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
G01 : Financial Economics→General→Financial Crises

Abstract

I propose and estimate a dynamic model of financial intermediation to study the different roles of the condition of banks’ and firms’ balance sheets in real activity. The net worth of firms determines their borrowing capacity both from households and banks. Banks provide risky loans to multiple firms and use their diversified portfolio as collateral to borrow from households. This intermediation process allows additional funds to flow from households to firms. Banks require net worth for intermediation as they are exposed to aggregate risk. The net worth of banks and firms are both state variables. In normal recessions, firm and bank net worth play the same role, so their sum determines the allocation of capital. During financial crises, shocks to bank net worth have an additional effect beyond that in standard financial frictions’ models. This mechanism works through intermediation and affects activity, even if shocks redistribute net worth from banks to firms. I estimate my model and find that the new mechanism accounts for 40% of the fall in output and 80% of the fall in bank net worth during the Great Recession. Finally, the model is consistent with the different dynamics of the share of bank loans in total firm debt and credit spreads during the recessions of 1990, 2001, and 2008.

No. 67
29 January 2018
Positive liquidity spillovers from sovereign bond-backed securities
Dunne, Peter G.

Abstract

JEL Classification

D47 : Microeconomics→Market Structure and Pricing→Market Design
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G24 : Financial Economics→Financial Institutions and Services→Investment Banking, Venture Capital, Brokerage, Ratings and Ratings Agencies
C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods
C58 : Mathematical and Quantitative Methods→Econometric Modeling→Financial Econometrics

Abstract

This paper contributes to the debate concerning the benefits and disadvantages of introducing a European Sovereign Bond-Backed Securitisation (SBBS) to address the need for a common safe asset that would break destabilising bank-sovereign linkages. The analysis focuses on assessing the effectiveness of hedges incurred while making markets in individual euro area sovereign bonds by taking offsetting positions in one or more of the SBBS tranches. Tranche yields are estimated using a simulation approach. This involves the generation of sovereign defaults and allocation of the combined credit risk premium of all the sovereigns, at the end of each day, to the SBBS tranches according to the seniority of claims under the proposed securitisation. Optimal hedging with SBBS is found to reduce risk exposures substantially in normal market conditions. In volatile conditions, hedging is not very effective but leaves dealers exposed to mostly idiosyncratic risks. These remaining risks largely disappear if dealers are diversified in providing liquidity across country-specific secondary markets and SBBS tranches. Hedging each of the long positions in a portfolio of individual sovereigns results in a risk exposure as low as that borne by holding the safest individual sovereign bond (the Bund).

No. 66
29 January 2018
How effective are sovereign bond-backed securities as a spillover prevention device?
Cronin, David, Dunne, Peter G.

Abstract

JEL Classification

C58 : Mathematical and Quantitative Methods→Econometric Modeling→Financial Econometrics
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G17 : Financial Economics→General Financial Markets→Financial Forecasting and Simulation

Abstract

Brunnermeier et al. (2017) propose the introduction of sovereign bond-backed securities (SBBS) in the euro area. It and other papers address how the securitisation would insulate senior security holders from actual default-related losses. This article generalises the assessment by using the VAR-based Diebold & Yilmaz (2012) spillover index methodology to assess potential attenuation of the spillover of shocks in holding-period returns across asset markets from the introduction of SBBS. This is made possible by employing SBBS yields estimated from historical euro area member state sovereign bond yields using Monte Carlo methods, as described in Schönbucher (2003). The econometric results show that (i) SBBS tranching protects senior SBBS holders by reducing the spillover of shocks from the higher-risk peripheral member states to it; (ii) spillovers from high risk sovereigns to a weighted portfolio are much higher than those to the senior SBBS; (iii) a smaller junior SBBS tranche, and the introduction of a mezzanine security, reduces spillover from it to the senior SBBS; and (iv) rolling window analysis indicates that the spillover of shocks from the junior tranche to the senior tranche declines during a period of financial stress.

No. 65
29 January 2018
Sovereign bond-backed securities: a VAR-for-VaR and Marginal Expected Shortfall assessment
Perea, Maite De Sola, Dunne, Peter G., Puhl, Martin, Reininger, Thomas

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E53 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading

Abstract

The risk reducing benefits of the sovereign bond-backed security (SBBS) proposal of Brunnermeier et al. (2016) have been assessed in terms of the likely losses that different kinds of holders would suffer under simulated default scenarios. However, the effects of mark-to-market losses that may occur when there is rising uncertainty about defaults, or when self-fulfilling destablising dynamics are prevalent, have not yet been examined. We apply the “VAR-for-VaR” method of Manganelli et al. (2015) and the Marginal Expected Shortfall (MES) approach of Brownlees and Engle (2012, 2017) to estimated yields of SBBS to assess how ex ante exposures and marginal contributions to systemic risk are likely to play-out for different SBBS tranches under various securitisation structures. We compare these with exposures/MES of single sovereigns and a diversified portfolio of sovereigns. We find that the senior SBBS has extremely low ex ante tail risk and that, like the low-risk sovereigns, it acts as a hedge against extreme market-wide yield movements. The mezzanine SBBS has tail risk exposure similar to that of Italian and Spanish bonds. Yields on SBBS appear to be adequate compensation for their risks when compared with single sovereigns or a diversified portfolio.

No. 64
16 January 2018
Short-selling bans and bank stability
Beber, Alessandro, Fabbri, Daniela, Pagano, Marco, Simonelli, Saverio

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation

Abstract

In both the subprime crisis and the eurozone crisis, regulators imposed bans on short sales, aimed mainly at preventing stock price turbulence from destabilizing financial institutions. Contrary to the regulators’ intentions, financial institutions whose stocks were banned experienced greater increases in the probability of default and volatility than unbanned ones, and these increases were larger for more vulnerable financial institutions. To take into account the endogeneity of short sales bans, we match banned financial institutions with unbanned ones of similar size and riskiness, and instrument the 2011 ban decisions with regulators’ propensity to impose a ban in the 2008 crisis.

No. 63
16 January 2018
Banks’ maturity transformation: risk, reward, and policy
Bologna, Pierluigi

Abstract

JEL Classification

E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The aim of this paper is twofold: first, to study the determinants of banks’ net interest margin with a particular focus on the role of maturity transformation, using a new measure of maturity mismatch; second, to analyse the implications for banks of the relaxation of a binding prudential limit on maturity mismatch, in place in Italy until the mid-2000s. The results show that maturity transformation is an important driver of the net interest margin, as higher maturity transformation is typically associated with higher net interest margin. However, there is a limit to this positive relationship as ‘excessive’ maturity transformation — even without leading to systemic vulnerabilities — has some undesirable implications in terms of higher exposure to interest rate risk and lower net interest margin.

No. 62
15 December 2017
The demand for central clearing: to clear or not to clear, that is the question
Bellia, Mario, Panzica, Roberto, Pelizzon, Loriana, Peltonen, Tuomas A.

Abstract

JEL Classification

G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

This paper analyses whether the post-crisis regulatory reforms developed by globalstandard-setting bodies have created appropriate incentives for different types of market participants to centrally clear Over-The-Counter (OTC) derivative contracts. Beyond documenting the observed facts, we analyse four main drivers for the decision to clear: 1) the liquidity and riskiness of the reference entity; 2) the credit risk of the counterparty; 3) the clearing member’s portfolio net exposure with the Central Counterparty Clearing House (CCP) and 4) post trade transparency. We use confidential European trade repository data on single-name Sovereign Credit Derivative Swap (CDS) transactions, and show that for all the transactions reported in 2016 on Italian, German and French Sovereign CDS 48% were centrally cleared, 42% were not cleared despite being eligible for central clearing, while 9% of the contracts were not clearable because they did not satisfy certain CCP clearing criteria. However, there is a large difference between CCP clearing members that clear about 53% of their transactions and non-clearing members, even those that are subject to counterparty risk capital requirements, that almost never clear their trades. Moreover, we find that diverse factors explain clearing members’ decision to clear different CDS contracts: for Italian CDS, counterparty credit risk exposures matter most for the decision to clear, while for French and German CDS, margin costs are the most important factor for the decision. Moreover, clearing members use clearing to reduce their exposures to the CCP and largely clear contracts when at least one of the traders has a high counterparty credit risk.

No. 61
15 December 2017
Discriminatory pricing of over-the-counter derivatives
Hau, Harald, Hoffmann, Peter, Langfield, Sam, Timmer, Yannick

Abstract

JEL Classification

G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
D4 : Microeconomics→Market Structure and Pricing

Abstract

New regulatory data reveal extensive discriminatory pricing in the foreign exchange derivatives market, in which dealer-banks and their non-financial clients trade over-the-counter. After controlling for contract characteristics, dealer fixed effects, and market conditions, we find that the client at the 75th percentile of the spread distribution pays an average of 30 pips over the market mid-price, compared to competitive spreads of less than 2.5 pips paid by the bottom 25% of clients. Higher spreads are paid by less sophisticated clients. However, trades on multi-dealer request-for-quote platforms exhibit competitive spreads regardless of client sophistication, thereby eliminating discriminatory pricing.

No. 60
15 December 2017
Crises in the modern financial ecosystem
di Iasio, Giovanni, Pozsar, Zoltan

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We build a moral hazard model to study incentives of financial intermediaries (shortly, bankers) facing a leverage-insurance trade-off in their investment choice. We demonstrate that the choice is affected by two recent transformations of the financial ecosystem bankers inhabit: (i) the rise of institutional savers, such as treasurers of global corporations, which manage huge balances in need for parking space and (ii) the proliferation of balance sheets with asset-liability mismatch, like those of insurance companies and pension funds (ICPFs), which allocate capital to bankers to reach for yield and meet their liabilities offering guaranteed returns. Bankers supply parking space to institutional savers and deliver leverageenhanced returns to ICPFs. When the demand for parking space and the mismatch which ICPFs must bridge are large, the equilibrium allocation is characterized by high leverage and financial crises. We show that post-crisis regulatory reforms, while improving the resiliency of the regulated banking sector, create room for bank disintermediation and do not unambiguously limit systemic risks which can build up in the asset management complex. Both transformations indeed stem from real economy developments (e.g. population ageing, global imbalances, income and wealth inequality, increased sophistication of tax arbitrage). Fiscal and structural reforms that directly address the real economy roots of those secular developments are then essential to complement financial and banking regulations and promote financial stability and balanced growth.

No. 59
1 December 2017
ETF arbitrage under liquidity mismatch
Pan, Kevin, Zeng, Yao

Abstract

JEL Classification

G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

A natural liquidity mismatch emerges when liquid exchange traded funds (ETFs) hold relatively illiquid assets. We provide a theory and empirical evidence showing that this liquidity mismatch can reduce market efficiency and increase the fragility of these ETFs. We focus on corporate bond ETFs and examine the role of authorized participants (APs) in ETF arbitrage. In addition to their role as dealers in the underlying bond market, APs also play a unique role in arbitrage between the bond and ETF markets since they are the only market participants that can trade directly with ETF issuers. Using novel and granular AP-level data, we identify a conflict between APs’ dual roles as bond dealers and as ETF arbitrageurs. When this conflict is small, liquidity mismatch reduces the arbitrage capacity of ETFs; as the conflict increases, an inventory management motive arises that may even distort ETF arbitrage, leading to large relative mispricing. These findings suggest an important risk in ETF arbitrage.

No. 58
15 November 2017
Syndicated loans and CDS positioning
Aldasoro, Iñaki, Barth, Andreas

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper analyzes banks’ usage of CDS. Combining bank-firm syndicated loan data with a unique EU-wide dataset on bilateral CDS positions, we find that stronger banks in terms of capital, funding and profitability tend to hedge more. We find no evidence of banks using the CDS market for capital relief. Banks are more likely to hedge exposures to relatively riskier borrowers and less likely to sell CDS protection on domestic firms. Lead arrangers tend to buy more protection, potentially exacerbating asymmetric information problems. Dealer banks seem insensitive to firm risk, and hedge more than non-dealers when they are more profitable. These results allow for a better understanding of banks’ credit risk management.

No. 57
15 November 2017
Why are banks not recapitalized during crises?
Crosignani, Matteo

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F33 : International Economics→International Finance→International Monetary Arrangements and Institutions
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks reduce private lending to further increase their holdings of domestic government bonds, lowering sovereign yields and supporting the home sovereign debt capacity. The model rationalizes, in the context of the eurozone periphery, the increase in domestic government bond holdings, the reduction of bank credit supply, and the prolonged fragility of the financial sector.

No. 56
1 November 2017
A macro approach to international bank resolution
Schoenmaker, Dirk

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

In the aftermath of the Great Financial Crisis, regulators have rushed to strengthen banking supervision and implement bank resolution regimes. While such resolution regimes are welcome to reintroduce market discipline and reduce the reliance on taxpayer-funded bailouts, the effects on the wider banking system have not been properly considered. This paper proposes a macro approach to resolution, which should consider (i) the contagion effects of bail-in, and (ii) the continuing need for a fiscal backstop to the financial system. For bail-in to work, it is important that bail-inable bank bonds are largely held outside the banking sector, which is currently not the case. Stricter capital requirements could push them out of the banking system. The organisation of the fiscal backstop is crucial for the stability of the global banking system. Single-point-of-entry resolution of international banks is only possible for the very largest countries or for countries working together, including in terms of sharing the burden of a potential bank bailout. The euro area has adopted the latter approach in its Banking Union. Other countries have taken a stand-alone approach, which leads to multiple-point-of-entry resolution of international banks and contributes to fragmentation of the global banking system. For bail-in to work, it is important that bail-inable bank bonds are largely held outside the banking sector, which is currently not the case. Stricter capital requirements could push them out of the banking system. The organisation of the fiscal backstop is crucial for the stability of the global banking system. Single-point-of-entry resolution of international banks is only possible for the very largest countries or for countries working together, including in terms of sharing the burden of a potential bank bailout. The euro area has adopted the latter approach in its Banking Union. Other countries have taken a stand-alone approach, which leads to multiple-point-of-entry resolution of international banks and contributes to fragmentation of the global banking system

No. 55
20 October 2017
Collateral scarcity premia in euro area repo markets
Guagliano, Claudia, Mazzacurati, Julien

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

Collateral plays a very important role in financial markets. Without easy access to high-quality collateral, dealers and market participants would find it more costly to trade, with a negative impact on market liquidity and the real economy through increased financing costs. The role of collateral has become increasingly significant since the global financial crisis, partly due to regulatory reforms. Using bond-level data from both repo and securities lending markets, this paper introduces a new measure of collateral reuse and studies the drivers of the cost of obtaining high-quality collateral, i.e. the collateral scarcity premium, proxied by specialness of government bond repos. We find that the cost of obtaining high-quality collateral increases with demand pressures in the cash market (short-selling activities), even in calm financial market conditions. In bear market conditions ‒ when good collateral is needed the most ‒ this could lead to tensions in some asset market segments. Collateral reuse may alleviate some of these tensions by reducing the collateral scarcity premia. Yet, it requires transparency and monitoring due to the financial stability risks associated. Finally, we find that the launch of the ECB quantitative easing programme has a statistically significant, albeit limited, impact on sovereign collateral scarcity premia, but this impact is offset by the beginning of the ECB Securities Lending Programme.

No. 54
15 September 2017
Networks of counterparties in the centrally cleared EU-wide interest rate derivatives market
Fiedor, Paweł, Lapschies, Sarah, Orszaghova, Lucia

Abstract

JEL Classification

G10 : Financial Economics→General Financial Markets→General
L14 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Transactional Relationships, Contracts and Reputation, Networks
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

We perform a network analysis of the centrally cleared interest rate derivatives market in the European Union, by looking at counterparty relations within both direct (house) clearing and client clearing. Since the majority of the gross notional is transferred within central counterparties and their clearing members, client clearing is often neglected in the literature, despite its significance in terms of net exposures. We find that the client clearing structure is very strongly interconnected and contains on the order of 90% of the counterparty relations in the interest rate derivatives market. Moreover, it is more diverse in terms of geography and sectors of the financial market the counterparties are associated with. Client clearing is also significantly more volatile in time than direct clearing. These findings underline the importance of analysing the structure and stability of both direct and client clearing of the interest rate derivatives market in Europe, to improve understanding of this important market and potential contagion mechanisms within it.

No. 53
1 August 2017
Two Big Distortions: Bank Incentives for Debt Financing
Groenewegen, Jesse, Wierts, Peter

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
H25 : Public Economics→Taxation, Subsidies, and Revenue→Business Taxes and Subsidies

Abstract

Systemically important banks are subject to at least two departures from the neutrality of debt versus equity financing: the tax deductibility of interest payments and implicit funding subsidies. This paper fills a gap in the literature by comparing their mechanism and interaction within a common analytical framework. Findings indicate that both the tax shield and implicit funding subsidy remain large, in the order of up to 1 percent of GDP, despite decreases in recent years. But the underlying mechanisms differ. The tax shield incentivises debt financing as it reduces tax payments to the government. The implicit funding subsidy incentivises debt financing as it lowers private bankruptcy costs. This funding subsidy is passed on to other bank stakeholders. It therefore provides incentives for increases in balance sheet size and risk taking. This, in turn, increases the value of the tax shield. Overall, these results help to explain why systemically important banks are highly leveraged.

No. 52
14 July 2017
Asset encumbrance, bank funding and fragility
Ahnert, Toni, Anand, Kartik, Gai, Prasanna, Chapman, James

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We propose a model of asset encumbrance by banks subject to rollover risk and study the consequences for fragility, funding costs, and prudential regulation. A bank’s choice of encumbrance trades off the benefit of expanding profitable investment funded by cheap long-term secured debt against the cost of greater fragility due to unsecured debt runs. We derive several testable implications about privately optimal encumbrance ratios. Deposit insurance or wholesale funding guarantees induce excessive encumbrance and exacerbate fragility. We show how regulations such as explicit limits on encumbrance ratios and revenueneutral Pigouvian taxes can mitigate the risk-shifting incentives of banks.

No. 51
14 July 2017
The missing links: A global study on uncovering financial network structures from partial data
Anand, Kartik, van Lelyveld, Iman, Banai, Ádám, Friedrich, Soeren, Garratt, Rodney, Hałaj, Grzegorz, Fique, Jose, Hansen, Ib, Martínez Jaramillo, Serafín, Lee, Hwayun, Molina-Borboa, José Luis, Nobili, Stefano, Rajan, Sriram, Salakhova, Dilyara, Silva, Thiago Christiano, Silvestri, Laura, Rubens Stancato de Souza, Sergio

Abstract

JEL Classification

G20 : Financial Economics→Financial Institutions and Services→General
L14 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Transactional Relationships, Contracts and Reputation, Networks
D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory
C63 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Computational Techniques, Simulation Modeling

Abstract

Capturing financial network linkages and contagion in stress test models are important goals for banking supervisors and central banks responsible for micro- and macroprudential policy. However, granular data on financial networks is often lacking, and instead the networks must be reconstructed from partial data. In this paper, we conduct a horse race of network reconstruction methods using network data obtained from 25 different markets spanning 13 jurisdictions. Our contribution is two-fold: first, we collate and analyze data on a wide range of financial networks. And second, we rank the methods in terms of their ability to reconstruct the structures of links and exposures in networks.

No. 50
30 June 2017
Equity versus bail-in debt in banking: an agency perspective
Mendicino, Caterina, Nikolov, Kalin, Suarez, Javier

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill

Abstract

We examine the optimal size and composition of banks’ total loss absorbing capacity (TLAC). Optimal size is driven by the trade-off between providing liquidity services through deposits and minimizing deadweight default costs. Optimal composition (equity vs. bail-in debt) is driven by the relative importance of two incentive problems: risk shifting (mitigated by equity) and private benefit taking (mitigated by debt). Our quantitative results suggest that TLAC size in line with current regulation is appropriate. However, an important fraction of it should consist of bail-in debt because such buffer size makes the costs of risk-shifting relatively less important at the margin.

No. 49
30 June 2017
Wholesale funding dry-ups
Pérignon, Christophe, Thesmar, David, Vuillemey, Guillaume

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

We empirically explore the fragility of wholesale funding of banks, using transaction level data on short-term, unsecured certificates of deposits in the European market. We do not observe any market-wide freeze during the 2008-2014 period. Yet, many banks suddenly experience funding dry-ups. Dry-ups predict, but do not cause, future deterioration of bank performance. Furthermore, in periods of market stress, banks with high future performance tend to increase reliance on wholesale funding. Thus, we fail to find evidence consistent with classical adverse selection models of funding market freezes. Our evidence is in line with theories highlighting heterogeneity between informed and uninformed lenders.

No. 48
14 June 2017
Banking integration and house price comovement
Landier, Augustin, Sraer, David, Thesmar, David

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
F65 : International Economics→Economic Impacts of Globalization→Finance
R30 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→General

Abstract

The correlation across US states in house price growth increased steadily between 1976 and 2000. This paper shows that the contemporaneous geographic integration of the US banking market, via the emergence of large banks, was a primary driver of this phenomenon. To this end, we first theoretically derive an appropriate measure of banking integration across state pairs and document that house price growth correlation is strongly related to this measure of financial integration. Our IV estimates suggest that banking integration can explain up to one fourth of the rise in house price correlation over this period.

No. 47
14 June 2017
The real effects of bank capital requirements
Fraisse, Henri, Lé, Mathias, Thesmar, David

Abstract

JEL Classification

E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We measure the impact of bank capital requirements on corporate borrowing and investment using loanE level data. The Basel II regulatory framework makes capital requirements vary across both banks and across firms, which allows us to control for firm level credit demand shocks and bankE level credit supply shocks. We find that a 1 percentage point increase in capital requirements reduces lending by 10%. Firms can attenuate this reduction by substituting borrowing across banks, but only partially. The resulting reduction in borrowing capacity impacts investment, but not working capital: Fixed assets are reduced by 2.6%, but lending to customers is unaffected.

No. 46
9 June 2017
Simulating fire-sales in a banking and shadow banking system
Calimani, Susanna, Hałaj, Grzegorz, Żochowski, Dawid

Abstract

JEL Classification

C63 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Computational Techniques, Simulation Modeling
D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

We develop an agent based model of traditional banks and asset managers. Our aim is to investigate the channels of contagion of shocks to asset prices within and between the two financial sectors, including the effects of fire sales and their impact on financial institutions’ balance sheets. We take a structural approach to the price formation mechanism as in Bluhm, Faia and Kranen (2014) and introduce a clearing mechanism with an endogenous formation of asset prices. Both types of institutions hold liquid and illiquid assets and are funded via equity and deposits. Traditional banks are interconnected in the money market via mutual interbank claims, where the rate of return is endogenously determined through a tatonnement process. We show how in such a set-up an initial exogenous liquidity shock may lead to a fire-sale spiral. Banks, which are subject to capital and liquidity requirements, may be forced to sell an illiquid security, which impacts its, endogenously determined, market price. As the price of the security decreases, both agents update their equity and adjust their balance sheets by making decisions on whether to sell or buy the security. This endogenous process may trigger a cascade of sales leading to a fire-sale. We find that, first, mixed portfolios banks act as plague-spreader in a context of financial distress. Second, higher bank capital requirements may aggravate contagion since they may incentivise banks to hold similar assets, and choose mixed portfolios business model which is also characterized by lower levels of voluntary capital buffer. Third, asset managers absorb small liquidity shocks but they exacerbate contagion when liquid buffers are fully utilised.

No. 45
9 June 2017
Use of unit root methods in early warning of financial crises
Virtanen, Timo, Tölö, Eero, Virén, Matti, Taipalus, Katja

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

In several recent studies unit root methods have been used in detection of financial bubbles in asset prices. The basic idea is that fundamental changes in the autocorrelation structure of relevant time series imply the presence of a rational price bubble. We provide cross-country evidence for performance of unit-root-based early warning systems in ex-ante prediction of financial crises in 15 EU countries over the past three decades. We find especially high performance for time series that are explicitly related to debt, which issue signals a few years in advance of a crisis. Combining signals from multiple time series further improves the predictions. Our results suggest an early warning tool based on unit root methods provides a valuable accessory in financial stability supervision.

No. 44
2 May 2017
Compressing over-the-counter markets
D'Errico, Marco, Roukny, Tarik

Abstract

JEL Classification

C61 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Optimization Techniques, Programming Models, Dynamic Analysis
D53 : Microeconomics→General Equilibrium and Disequilibrium→Financial Markets
D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory
G01 : Financial Economics→General→Financial Crises
G10 : Financial Economics→General Financial Markets→General
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates

Abstract

In this paper, we show both theoretically and empirically that the size of over-the-counter (OTC) markets can be reduced without affecting individual net positions. First, we find that the networked nature of these markets generates an excess of notional obligations between the aggregate gross amount and the minimum amount required to satisfy each individual net position. Second, we show conditions under which such excess can be removed. We refer to this netting operation as compression and identify feasibility and efficiency criteria, highlighting intermediation as the key element for excess levels. We show that a tradeoff exists between the amount of notional that can be eliminated from the system and the conservation of original trading relationships. Third, we apply our framework to a unique and comprehensive transaction-level dataset on OTC derivatives including all firms based in the European Union. On average, we find that around 75% of market gross notional relates to excess. While around 50% can in general be removed via bilateral compression, more sophisticated multilateral compression approaches are substantially more efficient. In particular, we find that even the most conservative multilateral approach which satisfies relationship constraints can eliminate up to 98% of excess in the markets.

No. 43
2 May 2017
Coherent financial cycles for G-7 countries: Why extending credit can be an asset
Schüler, Yves S., Peltonen, Tuomas A., Hiebert, Paul

Abstract

JEL Classification

C54 : Mathematical and Quantitative Methods→Econometric Modeling→Quantitative Policy Modeling
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G01 : Financial Economics→General→Financial Crises

Abstract

Failing to account for joint dynamics of credit and asset prices can be hazardous for countercyclical macroprudential policy. We show that composite financial cycles, emphasising expansions and contractions common to credit and asset prices, powerfully predict systemic banking crises. Further, the joint consideration yields a more robust view on financial cycle characteristics, reconciling an empirical puzzle concerning cycle properties when using two popular alternative methodologies: frequency decompositions and standard turning point analysis. Using a novel spectral approach, we establish the following facts for G-7 countries (1970Q1-2013Q4): Relative to business cycles, financial cycles differ in amplitude and persistence – albeit with heterogeneity across countries. Average financial cycle length is around 15 years, compared with 9 years (6.7 excluding Japan) for business cycles. Still, country-level business and financial cycles relate occasionally. Across countries, financial cycle synchronisation is strong for most countries; but not for all. In contrast, business cycles relate homogeneously.

No. 42
3 April 2017
A dynamic theory of mutual fund runs and liquidity management
Zeng, Yao

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
G33 : Financial Economics→Corporate Finance and Governance→Bankruptcy, Liquidation
D92 : Microeconomics→Intertemporal Choice→Intertemporal Firm Choice, Investment, Capacity, and Financing

Abstract

I model an open-end mutual fund investing in illiquid assets and show that the fund’s endogenous cash management can generate shareholder runs even with a flexible NAV. The fund optimally re-builds its cash buffers at time t + 1 after outflows at t to prevent future forced sales of illiquid assets. However, cash rebuilding at t + 1 implies predictable voluntary sales of illiquid assets, generating a predictable decline in NAV. This generates a first-mover advantage, leading to runs. A time-inconsistency problem aggravates runs: the fund may want to pre-commit not to re-build cash buffers but cannot credibly do so absent a commitment device.

No. 41
3 April 2017
Financial frictions and the real economy
Pietrunti, Mario

Abstract

JEL Classification

C15 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Statistical Simulation Methods: General
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises

Abstract

This paper investigates in a non-linear setting the impact on the real economy of frictions stemming from the financial sector. We develop a medium scale DSGE model with a banking sector where an occasionally binding constraint on banks’ capital induces a relevant non-linearity. The model - estimated on Italian data from 1999 to 2015 via a likelihood-free method - is able to generate business cycle asymmetries as in actual data that cannot replicated by linear models. Lastly, the role of macroprudential policies in smoothing the cycle is discussed

No. 40
15 March 2017
Mapping the interconnectedness between EU banks and shadow banking entities
Abad, Jorge, D'Errico, Marco, Killeen, Neill, Luz, Vera, Peltonen, Tuomas A., Portes, Richard, Urbano, Teresa

Abstract

JEL Classification

F65 : International Economics→Economic Impacts of Globalization→Finance
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

This paper provides a unique snapshot of the exposures of EU banks to shadow banking entities within the global financial system. Drawing on a rich and novel dataset, the paper documents the cross-sector and cross-border linkages and considers which are the most relevant for systemic risk monitoring. From a macroprudential perspective, the identification of potential feedback and contagion channels arising from the linkages of banks and shadow banking entities is particularly challenging when shadow banking entities are domiciled in different jurisdictions. The analysis shows that many of the EU banks’ exposures are towards non-EU entities, particularly US-domiciled shadow banking entities. At the individual level, banks’ exposures are diversified although this diversification leads to high overlap across different types of shadow banking entities.

No. 39
14 March 2017
Decomposing financial (in)stability in emerging economies
Lepers, Etienne , Sánchez Serrano, Antonio

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F65 : International Economics→Economic Impacts of Globalization→Finance
G01 : Financial Economics→General→Financial Crises
G15 : Financial Economics→General Financial Markets→International Financial Markets
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

The build-up of risks in advanced economies has seen a lot of research efforts in the recent years, while similar research efforts on emerging economies have not been so strong and, when undertaken, have focused mostly on its international dimension. Simultaneously, the financial system of the emerging economies has substantially developed and deepened. In our paper, we construct an index of vulnerabilities in emerging countries, relying solely on data available at international organisations. We group indicators around four poles: valuation and risk appetite, imbalances in the non-financial sector, financial sector vulnerabilities, and global vulnerabilities. On purpose, we depart from early warning models or any other kind of complex econometric constructs. Simplicity and usability are the two key characteristics we have tried to embed into our index of vulnerabilities. We use the results to try to create a narrative of the evolution of vulnerabilities in emerging economies from 2005 to the third quarter of 2015, using innovative data visualisation tools as well as correlations and Granger causalities. We complement our analysis with a comparison between our index of vulnerabilities and the Credit-to-GDP gap.

No. 38
10 March 2017
Flight to liquidity and systemic bank runs
Robatto, Roberto

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
G20 : Financial Economics→Financial Institutions and Services→General

Abstract

This paper presents a general equilibrium, monetary model of bank runs to study monetary injections during financial crises. When the probability of runs is positive, depositors increase money demand and reduce deposits; at the economy-wide level, the velocity of money drops and deflation arises. Two quantitative examples show that the model accounts for a large fraction of (i) the drop in deposits in the Great Depression, and (ii) the $400 billion run on money market mutual funds in September 2008. In some circumstances, monetary injections have no effects on prices but reduce money velocity and deposits. Counterfactual policy analyses show that, if the Federal Reserve had not intervened in September 2008, the run on money market mutual funds would have been much smaller.

No. 37
10 March 2017
SRISK: a conditional capital shortfall measure of systemic risk
Brownlees, Christian, Engle, Robert F.

Abstract

JEL Classification

C22 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models &bull Diffusion Processes
C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models
C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods
G01 : Financial Economics→General→Financial Crises
G20 : Financial Economics→Financial Institutions and Services→General

Abstract

We introduce SRISK to measure the systemic risk contribution of a financial firm. SRISK measures the capital shortfall of a firm conditional on a severe market decline, and is a function of its size, leverage and risk. We use the measure to study top US financial institutions in the recent financial crisis. SRISK delivers useful rankings of systemic institutions at various stages of the crisis and identifies Fannie Mae, Freddie Mac, Morgan Stanley, Bear Stearns and Lehman Brothers as top contributors as early as 2005-Q1. Moreover, aggregate SRISK provides early warning signals of distress in indicators of real activity.

No. 36
13 February 2017
Credit conditions, macroprudential policy and house prices
Kelly, Robert, McCann, Fergal, O'Toole, Conor

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
R31 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→Housing Supply and Markets

Abstract

We provide a micro-empirical link between the large literature on credit and house prices and the burgeoning literature on macroprudential policy. Using loan-level data on Irish mortgages originated between 2003 and 2010, we construct a measure of credit availability which varies at the borrower level as a function of income, wealth, age, interest rates and prevailing market conditions around Loan to Value ratios (LTV), Loan to Income ratios (LTI) and monthly Debt Service Ratios (DSR). We deploy a property-level house price model which shows that a ten per cent increase in credit available leads to an 1.5 per cent increase in the value of property purchased. Coefficients from this model are then used to fit values under scenarios of macroprudential restrictions on LTV, LTI and DSR on credit availability and house prices in Ireland for 2003 and 2006. Our results suggest that macroprudential limits would have had substantial impacts on house prices, and that both the level at which they are set and the timing of their introduction is a crucial determinant of their impact on housing values.

No. 35
13 February 2017
Addressing the safety trilemma: a safe sovereign asset for the eurozone
van Riet, Ad

Abstract

JEL Classification

F33 : International Economics→International Finance→International Monetary Arrangements and Institutions
F34 : International Economics→International Finance→International Lending and Debt Problems
G15 : Financial Economics→General Financial Markets→International Financial Markets
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt
H70 : Public Economics→State and Local Government, Intergovernmental Relations→General

Abstract

At the 25th anniversary of the Maastricht Treaty, this paper reviews the merits of introducing a safe sovereign asset for the eurozone. The triple euro area crisis showed the costly consequences of ignoring the ‘safety trilemma’. Keeping a national safe sovereign asset (the German bund) as the cornerstone of the financial system is incompatible with having free capital mobility and maintaining economic and financial stability in a monetary union. The euro area needs a single safe sovereign asset. However, eurobonds are only foreseen after full fiscal integration. To address the safety trilemma member countries must therefore act as the joint sovereign behind the euro and choose from two options. First, they could establish a credible multipolar system of safe national sovereign assets. For this purpose, they could all issue both senior and junior tranches of each national government bond in a proportion such that the expected safety of the senior tranche is the same across countries while the junior tranche would absorb any sovereign default risk. Additional issuance of national GDP-linked bonds could insure governments against a deep recession that might lead to a self-fulfilling default and thereby help to make the junior tranche less risky. The second option is that the member countries together produce a common safe sovereign asset for a truly integrated and stable monetary union by creating synthetic eurobonds comprising both a safe senior claim and a risky junior claim on a diversified portfolio of national government bonds. This appears a more effective solution to the safety trilemma – especially when euro area governments would also issue national GDP-linked bonds – but it requires flanking measures to control for moral hazard.

No. 34
13 February 2017
Resolution of international banks: can smaller countries cope?
Schoenmaker, Dirk

Abstract

JEL Classification

F30 : International Economics→International Finance→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The stability of a banking system ultimately depends on the strength and credibility of the fiscal backstop. While large countries can still afford to resolve large global banks on their own, small and medium-sized countries face a policy choice. This paper investigates the impact of resolution on banking structure. The financial trilemma model indicates that smaller countries can either conduct joint supervision and resolution of their global banks (based on single point of entry resolution) or reduce the size of their global banks and move to separate resolution of these banks’ national subsidiaries (based on multiple point of entry resolution). Euro-area countries are heading for joint resolution based on burden sharing, while the UK and Switzerland have implemented policies to downsize their banks.

No. 33
22 December 2016
How does risk flow in the credit default swap market?
D'Errico, Marco, Battiston, Stefano, Peltonen, Tuomas A., Scheicher, Martin

Abstract

JEL Classification

G10 : Financial Economics→General Financial Markets→General
G15 : Financial Economics→General Financial Markets→International Financial Markets

Abstract

We develop a framework to analyse the Credit Default Swaps (CDS) market as a network of risk transfers among counterparties. From a theoretical perspective, we introduce the notion of flow-of-risk and provide sufficient conditions for a bow-tie network architecture to endogenously emerge as a result of intermediation. This architecture shows three distinct sets of counterparties: i) Ultimate Risk Sellers (URS), ii) Dealers (indirectly connected to each other), iii) Ultimate Risk Buyers (URB). We show that the probability of widespread distress due to counterparty risk is higher in a bow-tie architecture than in more fragmented network structures. Empirically, we analyse a unique global dataset of bilateral CDS exposures on major sovereign and financial reference entities in 2011 −2014. We find the presence of a bow-tie network architecture consistently across both reference entities and time, and thatt the flow-of-risk originates from a large number of URSs (e.g. hedge funds) and ends up in a few leading URBs, most of which are non-banks (in particular asset managers). Finally, the analysis of the CDS portfolio composition of the URBs shows a high level of concentration: in particular, the top URBs often show large exposures to potentially correlated reference entities.

No. 32
21 December 2016
Financial contagion with spillover effects: a multiplex network approach
Peralta, Gustavo, Crisóstomo, Ricardo

Abstract

JEL Classification

C63 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Computational Techniques, Simulation Modeling
D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory
G01 : Financial Economics→General→Financial Crises
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation

Abstract

This paper presents a comprehensive model of financial contagion encompassing both direct and indirect transmission channels. We introduce direct contagion through a 2-layered multiplex network to account for the distinct dynamics resulting from collateralized and uncollateralized transactions. Moreover, the spillover effects of fire sales, haircut prociclicality and liquidity hoarding are specifically considered through indirect transmission channels. This framework allows us to analyze the determinants of systemic crisis and the resilience of different financial network configurations. Our first experiment demonstrates the benefits of counterparty diversification as a way of reducing systemic risk. The second experiment highlights the positive effect of higher initial capital and liquidity levels, while stressing the potentially counterproductive impact of rapidly increasing the minimum capital and liquidity ratios, particularly in times of stress. The third experiment examines the possibility of controlling the maximum haircut rates, although the impact of this measure is modest compared to other alternatives. Finally, our last experiment evidences the fundamental role played by fire sales and market liquidity in either leading or mitigating systemic crises.

No. 31
21 December 2016
The (unintended?) consequences of the largest liquidity injection ever
Crosignani, Matteo, Faria-e-Castro, Miguel, Fonseca, Luís

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank’s three-year Long-Term Refinancing Operation incentivized Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This “collateral trade” effect is large, as banks purchased short-term bonds equivalent to 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening.

No. 30
17 November 2016
Exposure to international crises: trade vs. financial contagion
Grant, Everett

Abstract

JEL Classification

E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
F40 : International Economics→Macroeconomic Aspects of International Trade and Finance→General
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
F44 : International Economics→Macroeconomic Aspects of International Trade and Finance→International Business Cycles
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

I identify new patterns in countries’ economic performance over the 2007-2014 period based on proximity through distance, trade, and finance to the US subprime mortgage and Eurozone debt crisis areas. To understand the causes of the cross-country variation, I develop an open economy model with two transmission channels that can be shocked separately: international trade and finance. The model is the first to include a government and heterogeneous firms that can default independently of one another and has a novel endogenous cost of sovereign default. I calibrate the model to the average experiences of countries near to and far from the crisis areas. Using these calibrations, disturbances on the order of those observed during the late 2000s are separately applied to each channel to study transmission. The results suggest credit disruption as the primary contagion driver, rather than the trade channel. Given the substantial degree of financial contagion, I run a series of counterfactuals studying the efficacy of capital controls and find that they would be a useful tool for preventing similarly severe contagion in the future, so long as there is not capital immobility to the degree that the local sovereign can default without suffering capital flight.

No. 29
14 November 2016
Predicting vulnerabilities in the EU banking sector: the role of global and domestic factors
Behn, Markus, Detken, Carsten, Peltonen, Tuomas A., Schudel, Willem

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We estimate a multivariate early-warning model to assess the usefulness of private credit and other macro-financial variables in predicting banking sector vulnerabilities. Using data for 23 European countries, we find that global variables and in particular global credit growth are strong predictors of domestic vulnerabilities. Moreover, domestic credit variables also have high predictive power, but should be complemented by other macro-financial indicators like house price growth and banking sector capitalization that play a salient role in predicting vulnerabilities. Our findings can inform decisions on the activation of macroprudential policy measures and suggest that policy makers should take a broad approach in the analytical models that support risk identification and calibration of tools.

No. 26
20 October 2016
Using elasticities to derive optimal bankruptcy exemptions
Dávila, Eduardo

Abstract

JEL Classification

D52 : Microeconomics→General Equilibrium and Disequilibrium→Incomplete Markets
E21 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Consumption, Saving, Wealth
D14 : Microeconomics→Household Behavior and Family Economics→Household Saving; Personal Finance

Abstract

This paper studies the optimal determination of bankruptcy exemptions for risk averse borrowers who use unsecured contracts but have the possibility of defaulting. I show that, in a large class of economies, knowledge of four variables is sufficient to determine whether a bankruptcy exemption level is optimal, or should be increased or decreased. These variables are: the sensitivity to the exemption level of the interest rate schedule offered by lenders to borrowers, the borrowers’ leverage, the borrowers’ bankruptcy probability, and the change in bankrupt borrowers’ consumption. An application of the framework to US data suggests that the optimal bankruptcy exemption is higher than the current average bankruptcy exemption, but of the same order of magnitude.

No. 28
20 October 2016
Financial intermediation, resource allocation, and macroeconomic interdependence
Ozhan, Galip Kemal

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
G15 : Financial Economics→General Financial Markets→International Financial Markets
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

This paper studies the role of the financial sector in a↵ecting domestic resource allocation and cross-border capital flows. I develop a quantitative, two-country, macroeconomic model in which banks face endogenous and occasionally binding leverage constraints. Banks lend funds to be invested in tradable or non-tradable sector capital and there is international financial integration in the market for bank liabilities. I focus on news about economic fundamentals as the key source of fluctuations. Specifically, in the case of positive news on the valuation of non-traded sector capital that turn out to be incorrect at a later date, the model generates an asymmetric, belief-driven boom-bust cycle that reproduces key features of the recent Eurozone crisis. Bank balance sheets amplify and propagate fluctuations through three channels when leverage constraints bind: First, amplified wealth e↵ects induce jumps in import-demand (demand channel). Second, changes in the value of non-tradable sector assets alter bank lending to tradable sector firms (intra-national spillover channel). Third, domestic and foreign households re-adjust their savings in domestic banks, and capital flows further amplify fluctuations (international spillover channel). A common central bank’s unconventional policies of private asset purchases and liquidity facilities in response to unfulfilled expectations are successful at ameliorating the economic downturn.

No. 27
20 October 2016
(Pro?)-cyclicality of collateral haircuts and systemic illiquidity
Glaser, Florian, Panz, Sven

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
G01 : Financial Economics→General→Financial Crises

Abstract

Procyclicality of collateral haircuts and margins has become a widely proclaimed behavior and is currently discussed not only by academic literature but also by regulatory authorities in Europe. Procyclicality of haircuts is assumed to be a trigger of liquidity spirals due to its tightening effect of collateral portfolio values in times of market distress. However, empirical evidence on this topic is quite sparse and the discussions are primarily driven by insights derived from theoretical models. Nonetheless, oversight bodies are discussing macroprudential haircut add-ons in order to curb with the potential effects of procyclicality in distressed periods. Based on a unique data set provided by a large European Central Counterparty we construct a measure of systemic illiquidity of bond collaterals and analyze the relationship between haircuts, the development of periods with explosive behavior and systemic illiquidity. We estimate the noise of bond yields to measure systemic illiquidity with and without considering haircuts. We then apply an explosive roots bubble detection technique to identify irrational periods of each of these two time series and to a combination of both. Finally, we propose a quantitative trigger and design for macroprudential haircut add-ons. Our results confirm that (1) bond collateral markets face irrational, i.e. bubble-like illiquidity during periods of systemic distress. The results indicate that (2) haircuts are not amplifying or increasing with systemic illiquidity. (3) The proposed haircut add-on mechanism exhibits desirable features to mitigate systemic illiquidity during lasting periods of distress.

No. 23
19 September 2016
Liquidity transformation in asset management: Evidence from the cash holdings of mutual funds
Chernenko, Sergey, Sunderam, Adi

Abstract

JEL Classification

G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors

Abstract

We study liquidity transformation in mutual funds using a novel data set on their cash holdings To provide investors with claims that are more liquid than the underlying assets, funds engage in substantial liquidity management. Specifically, they hold substantial amounts of cash, which they use to accommodate inflows and outflows rather than transacting in the underlying portfolio assets. This is particularly true for funds with illiquid assets and at times of low market liquidity. We provide evidence suggesting that mutual funds’ cash holdings are not large enough to fully mitigate price impact externalities created by the liquidity transformation they engage in.

No. 22
19 September 2016
Arbitraging the Basel securitization framework: Evidence from German ABS investment
Efing, Matthias

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G24 : Financial Economics→Financial Institutions and Services→Investment Banking, Venture Capital, Brokerage, Ratings and Ratings Agencies
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper provides evidence for regulatory arbitrage within the class of asset-backed securities (ABS) based on individual asset holding data of German banks. I find that banks operating with tight regulatory constraints exploit the low risk-sensitivity of rating-contingent capital requirements for ABS. Unlike unconstrained banks they systematically pick the securities with the highest yield and the lowest collateral performance among ABS with the same regulatory risk weight. This reaching for yield allows constrained banks to increase the return on the capital required for an ABS investment by a factor of four.

No. 21
19 September 2016
ESBies: Safety in the tranches
Brunnermeier, Markus K., Langfield, Sam, Pagano, Marco, Reis, Ricardo, Van Nieuwerburgh, Stijn, Vayanos, Dimitri

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The euro crisis was fueled by the diabolic loop between sovereign risk and bank risk, coupled with cross-border flight-to-safety capital flows. European Safe Bonds (ESBies), a union-wide safe asset without joint liability, would help to resolve these problems. We make three contributions. First, numerical simulations show that ESBies would be at least as safe as German bunds and approximately double the supply of euro safe assets when protected by a 30%-thick junior tranche. Second, a model shows how, when and why the two features of ESBies—diversification and seniority—can weaken the diabolic loop and its diffusion across countries. Third, we propose a step-by-step guide on how to create ESBies, starting with limited issuance by public or private-sector entities.

No. 25
19 September 2016
Macroeconomic effects of secondary market trading
Neuhann, Daniel

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

This paper develops a theory of the secondary market trading of financial securitities in which endogenous asset market dynamics generate periods of growing aggregate credit volumes and falling credit standards even in the absence of “financial shocks.” Falling credit standards in turn lead to excess risk exposure in the aggregate, precipitating future crises. The credit cycle is triggered by low interest rates, and longer booms lead to sharper crises. Saving gluts and expansionary monetary policy thus lead to financial fragility over time. Pro-cyclical regulation of secondary market traders, such as asset managers or hedge funds, can improve welfare even when such traders are not levered.

No. 24
19 September 2016
Macroprudential policy with liquidity panics
Garcia-Macia, Daniel, Villacorta, Alonso

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We analyze the optimality of macroprudential policies in an environment where the role of the banking sector is to efficiently allocate liquid assets across firms. Informational frictions in the banking sector can lead to an interbank market freeze. Firms react to the breakdown of the banking system by inefficiently accumulating liquid assets by themselves. This reduces the demand for bank loans and bank profits, which further disrupts the financial sector and increases the probability of a freeze, inducing firms to hoard even more liquid assets. Liquidity panics provide a new rationale for stricter liquidity requirements, as this policy alleviates the informational frictions in the banking sector and paradoxically can end up increasing aggregate investment. On the contrary, policies encouraging bank lending can have the opposite effect.

No. 20
8 August 2016
Multiplex interbank networks and systemic importance – An application to European data
Aldasoro, Iñaki, Alves, Iván

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
D85 : Microeconomics→Information, Knowledge, and Uncertainty→Network Formation and Analysis: Theory
C67 : Mathematical and Quantitative Methods→Mathematical Methods, Programming Models, Mathematical and Simulation Modeling→Input?Output Models

Abstract

Research on interbank networks and systemic importance is starting to recognise that the web of exposures linking banks balance sheets is more complex than the single-layer-of-exposure approach. We use data on exposures between large European banks broken down by both maturity and instrument type to characterise the main features of the multiplex structure of the network of large European banks. This multiplex network presents positive correlated multiplexity and a high similarity between layers, stemming both from standard similarity analyses as well as a core-periphery analyses of the different layers. We propose measures of systemic importance that fit the case in which banks are connected through an arbitrary number of layers (be it by instrument, maturity or a combination of both). Such measures allow for a decomposition of the global systemic importance index for any bank into the contributions of each of the sub-networks, providing a useful tool for banking regulators and supervisors in identifying tailored policy instruments. We use the dataset of exposures between large European banks to illustrate that both the methodology and the specific level of network aggregation matter in the determination of interconnectedness and thus in the policy making process.

No. 19
25 July 2016
Strategic complementarity in banks’ funding liquidity choices and financial stability
Silva, André

Abstract

JEL Classification

G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper examines whether banks’ liquidity and maturity mismatch decisions are affected by the choices of competitors and the impact of these coordinated funding liquidity policies on financial stability. Using a novel identification strategy where interactions are structured through decision networks, I show that banks do consider their peers’ liquidity choices when determining their own. This effect is asymmetric and not present in bank capital choices. Importantly, I find that these strategic funding liquidity decisions increase both individual banks’ default risk and overall systemic risk. From a macroprudential perspective, the results highlight the importance of explicitly regulating systemic liquidity risk.

No. 18
13 July 2016
Cyclical investment behavior across financial institutions
Timmer, Yannick

Abstract

JEL Classification

F32 : International Economics→International Finance→Current Account Adjustment, Short-Term Capital Movements
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G15 : Financial Economics→General Financial Markets→International Financial Markets
G20 : Financial Economics→Financial Institutions and Services→General

Abstract

This paper examines the investment behavior of different financial institutions in debt securities with a particular focus on their response to price changes. For identification, we use security-level data from the German Microdatabase Securities Holdings Statistics. Our results suggest that banks and investment funds may destabilize the market by responding in a pro-cyclical manner to price changes. In contrast, insurance companies and pension funds buy securities when their prices fall and vice versa. While investment funds and banks sell securities that are trading at a discount and whose prices are falling, they buy securities that are trading at premium and whose prices are rising. The opposite is the case for insurance companies and pension funds. This counter-cyclical investment behavior of insurance companies and pension funds may stabilize markets whenever prices have been pushed away from fundamentals. Since our results suggest that institutions with impermanent balance sheet characteristics may exacerbate price dynamics, it is of crucial importance for financial stability to monitor the investor base as well as the balance sheets of both levered and non-levered investors.

No. 17
12 July 2016
Assessing the costs and benefits of capital-based macroprudential policy
Behn, Markus, Gross, Marco, Peltonen, Tuomas A.

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We develop an integrated Early Warning Global Vector Autoregressive (EW-GVAR) model to quantify the costs and benefits of capital-based macroprudential policy measures. Our findings illustrate that capital-based measures are transmitted both via their impact on the banking system’s resilience and via indirect macro-financial feedback effects. The feedback effects relate to dampened credit and asset price growth and, depending on how banks move to higher capital ratios, can account for up to a half of the overall effectiveness of capitalbased measures. Moreover, we document significant cross-country spillover effects, especially for measures implemented in larger countries. Overall, our model helps to understand how and through which channels changes in capitalization affect bank lending and the wider economy and can inform policy makers on the optimal calibration and timing of capital-based macroprudential instruments.

No. 16
28 June 2016
Bank recapitalizations and lending: A little is not enough
Homar, Timotej

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper analyzes the effect of bank recapitalizations on lending, funding and asset quality of European banks between 2000 and 2013. Controlling for market implied capital shortfall of banks, we find that banks that receive a sufficiently large recapitalization increase lending, attract more deposits and clean up their balance sheets. In contrast, banks that receive a small recapitalization relative to their capital shortfall reduce lending and shrink assets. These results suggest recapitalizations need to be large enough to lead to new lending.

No. 15
28 June 2016
Credit default swap spreads and systemic financial risk
Giglio, Stefano

Abstract

JEL Classification

G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

This paper measures the joint default risk of financial institutions by exploiting information about counterparty risk in credit default swaps (CDS). A CDS contract written by a bank to insure against the default of another bank is exposed to the risk that both banks

default. From CDS spreads we can then learn about the joint default risk of pairs of banks. From bond prices we can learn the individual default probabilities. Since knowing individual and pairwise probabilities is not sufficient to fully characterize multiple default

risk, I derive the tightest bounds on the probability that many banks fail simultaneously.

No. 14
28 June 2016
Catering to investors through product complexity
Célérier, Claire, Vallée, Boris

Abstract

JEL Classification

I22 : Health, Education, and Welfare→Education and Research Institutions→Educational Finance, Financial Aid
G10 : Financial Economics→General Financial Markets→General
D18 : Microeconomics→Household Behavior and Family Economics→Consumer Protection
D12 : Microeconomics→Household Behavior and Family Economics→Consumer Economics: Empirical Analysis

Abstract

This study investigates the rationale for issuing complex securities to retail investors. We focus on a large market of investment products targeted exclusively at households: retail structured products in Europe. We develop an economic measure of product complexity in this market via a text analysis of 55,000 product payoff formulas. Over the 2002–2010 period, product complexity increases, risky products become more common, and product headline rates diverge from the prevailing interest rates as the latter decline. The complexity of a product is positively correlated with its headline rate and risk. Complex products appear more profitable to the banks distributing them, have a lower expost performance, and are more frequently sold by banks targeting low-income households. These empirical facts are consistent with banks strategically using product complexity to cater to yield-seeking households.

No. 13
9 June 2016
Banks' exposure to interest rate risk and the transmission of monetary policy
Gomez, Matthieu, Landier, Augustin, Sraer, David, Thesmar, David

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy

Abstract

We show that the cash-flow exposure of banks to interest rate risk, or income gap, affects the transmission of monetary policy shocks to bank lending and real activity. We first use a large panel of U.S. banks to show that the sensitivity of bank profits to interest rates increases significantly with measured income gap, even when banks use interest rate derivatives. We then document that, in the cross-section of banks, income gap predicts the sensitivity of bank lending to interest rates. The effect of income gap is larger or similar in magnitudes to that of previously identified factors, such as leverage, bank size or even asset liquidity. To alleviate the concern that this result is driven by the endogenous matching of banks and firms, we use loan-level data and compare the supply of credit to the same firm by banks with different income gap. This analysis allows us to trace the impact of banks’ income gap on firm borrowing capacity, investment and employment, which we find to be significant.

No. 12
3 June 2016
Extreme risk interdependence
Polanski, Arnold, Stoja, Evarist

Abstract

JEL Classification

C12 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Hypothesis Testing: General
C14 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Semiparametric and Nonparametric Methods: General
C52 : Mathematical and Quantitative Methods→Econometric Modeling→Model Evaluation, Validation, and Selection

Abstract

We define tail interdependence as a situation where extreme outcomes for some variables are informative about such outcomes for other variables. We extend the concept of multiinformation to quantify tail interdependence, decompose it into systemic and residual interdependence and measure the contribution of a constituent to the interdependence of a system. Further, we devise statistical procedures to test: a) tail independence, b) whether an empirical interdependence structure is generated by a theoretical model and c) symmetry of the interdependence structure in the tails. We outline some additional extensions and illustrate this framework by applying it to several datasets.

No. 11
2 May 2016
Bank exposures and sovereign stress transmission
Altavilla, Carlo, Pagano, Marco, Simonelli, Saverio

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F30 : International Economics→International Finance→General
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt

Abstract

Using novel monthly data for 226 euro-area banks from 2007 to 2015, we investigate the causes and effects of banks’ sovereign exposures during and after the euro crisis. First, in the vulnerable countries, the publicly owned, recently bailed out and less strongly capitalized banks reacted to sovereign stress by increasing their domestic sovereign holdings more than other banks, suggesting that their choices were affected both by moral suasion and by yield-seeking. Second, their exposures significantly amplified the transmission of risk from the sovereign and its impact on lending. This amplification of the impact on lending cannot be ascribed to spurious correlation or reverse causality.

No. 10
2 May 2016
Systemic risk in clearing houses: Evidence from the European repo market
Boissel, Charles, Derrien, François, Örs, Evren, Thesmar, David

Abstract

JEL Classification

E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages

Abstract

How do crises affect Central clearing Counterparties (CCPs)? We focus on CCPs that clear and guarantee a large and safe segment of the repo market during the Eurozone sovereign debt crisis. We start by developing a simple framework to infer CCP stress, which can be measured through the sensitivity of repo rates to sovereign CDS spreads. Such sensitivity jointly captures three effects: (1) the effectiveness of the haircut policy, (2) CCP member default risk (conditional on sovereign default) and (3) CCP default risk (conditional on both sovereign and CCP member default). The data show that, during the sovereign debt crisis of 2011, repo rates strongly respond to movements in sovereign risk, in particular for GIIPS countries, indicating significant CCP stress. Our model suggests that repo investors behaved as if the conditional probability of CCP default was very large.

No. 9
2 May 2016
Regime-dependent sovereign risk pricing during the euro crisis
Delatte, Anne-Laure, Fouquau, Julien, Portes, Richard

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
F34 : International Economics→International Finance→International Lending and Debt Problems
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
H63 : Public Economics→National Budget, Deficit, and Debt→Debt, Debt Management, Sovereign Debt
C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models

Abstract

Previous work has documented a greater sensitivity of long-term government bond yields to fundamentals in Euro area stress countries during the euro crisis, but we know little about the driver(s) of regimeswitches. Our estimates based on a panel smooth threshold regression model quantify and explain them: 1) investors have penalized a deterioration of fundamentals more strongly from 2010 to 2012; 2) a key indicator of regime switch is the premium of the financial credit default swap index: the higher the bank credit risk, the higher the extra premium on fundamentals; 3) after ECB President Draghi’s speech in July 2012, it took one year to restore the non-crisis regime and suppress the extra premium.

No. 8
20 April 2016
Double bank runs and liquidity risk management
Ippolito, Filippo, Peydró, José-Luis, Polo, Andrea, Sette, Enrico

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

By providing liquidity to depositors and credit line borrowers, banks are exposed to doubleruns on assets and liabilities. For identification, we exploit the 2007 freeze of the European interbank market and the Italian Credit Register. After the shock, there are sizeable, aggregate double-runs. In the cross-section, pre-shock interbank exposure is (unconditionally) unrelated to post-shock credit line drawdowns. However, conditioning on firm observable and unobservable characteristics, higher pre-shock interbank exposure implies more post-shock drawdowns. We show that is the result of active pre-shock liquidity risk management by more exposed banks granting credit lines to firms that run less in a crisis.

No. 7
12 April 2016
Bail-in expectations for European banks: Actions speak louder than words
Schäfer, Alexander, Schnabel, Isabel, Weder di Mauro, Beatrice

Abstract

JEL Classification

G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

The declared intention of policy makers is that future bank restructuring should be conducted through bail-in rather than bail-out. Over the past years there have been a few cases of European banks being restructured where creditors were bailed in. This paper exploits these events to investigate the market reactions of stock prices and credit default swap (CDS) spreads of European banks in order to gauge the extent to which it is expected that bail-in will indeed become the new regime. We find evidence of increased CDS spreads and falling stock prices most notably after the bail-in in Cyprus. However, bail-in expectations appear to depend on the sovereign’s fiscal strength, i. e., reactions are stronger for banks in countries with limited fiscal space for bail-out. Moreover, actual bail-ins lead to stronger market reactions than the legal implementation of bank resolution regimes, supporting the saying that actions speak louder than words.

No. 6
24 March 2016
Cross-country exposures to the Swiss franc
Bénétrix, Agustín S., Lane, Philip R.

Abstract

JEL Classification

F31 : International Economics→International Finance→Foreign Exchange
O24 : Economic Development, Technological Change, and Growth→Development Planning and Policy→Trade Policy, Factor Movement Policy, Foreign Exchange Policy

Abstract

This paper first documents the foreign currency exposures of Switzerland in the 2002-2012 period. We find that the large scale of the Swiss international balance sheet means that movements in the Swiss Franc generate large cross-border valuation

effects. Second, we examine the Swiss Franc holdings of the rest of the world and highlight differences in exposures between advanced and emerging economies.

No. 5
24 March 2016
Securities trading by banks and credit supply: Micro-evidence from the crisis
Abbassi, Puriya, Iyer, Rajkamal, Peydró, José-Luis, Tous, Francesc R.

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We analyze securities trading by banks during the crisis and the associated spillovers to the supply of credit. We use a proprietary dataset that has the investments of banks at the security level for 2005-2012 in conjunction with the credit register from Germany. We find that – during the crisis – banks with higher trading expertise (trading banks) increase their investments in securities, especially in those that had a larger price drop, with the strongest impact in low-rated and long-term securities. Moreover, trading banks reduce their credit supply, and the credit crunch is binding at the firm level. All of the effects are more pronounced for trading banks with higher capital levels. Finally, banks use central bank liquidity and government subsidies like public recapitalization and implicit guarantees mainly to support trading of securities. Overall, our results suggest an externality arising from fire sales in securities markets on credit supply via the trading behavior of banks.

No. 4
11 March 2016
Capital market financing, firm growth, and firm size distribution
Didier, Tatiana, Levine, Ross, Schmukler, Sergio L.

Abstract

JEL Classification

F65 : International Economics→Economic Impacts of Globalization→Finance
G00 : Financial Economics→General→General
G10 : Financial Economics→General Financial Markets→General
G31 : Financial Economics→Corporate Finance and Governance→Capital Budgeting, Fixed Investment and Inventory Studies, Capacity
G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
L25 : Industrial Organization→Firm Objectives, Organization, and Behavior→Firm Performance: Size, Diversification, and Scope

Abstract

How many and which firms issue equity and bonds in domestic and international markets, how do these firms grow relative to non-issuing firms, and how does firm performance vary along the firm size distribution (FSD)? To evaluate these questions, we construct a new dataset by matching data on firm-level capital raising activity with balance sheet data for 45,527 listed firms in 51 countries. Three main patterns emerge from the analysis. (1) Only a few large firms issue equity or bonds, and among them a small subset has raised a large proportion of the funds raised during the 1990s and 2000s. (2) Issuers grow faster than non-issuers in terms of assets, sales, and employment, i.e., firms do not simply use securities markets to adjust their financial accounts. (3) The FSD of issuers evolves differently from that of non-issuers, tightening among issuers and widening among non-issuers.

No. 3
11 March 2016
How excessive is banks’ maturity transformation?
Segura, Anatoli, Suarez, Javier

Abstract

JEL Classification

G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

We quantify the gains from regulating maturity transformation in a model of banks which finance long-term assets with non-tradable debt. Banks choose the amount and maturity of their debt trading off investors’ preference for short maturities with the risk of systemic crises. Pecuniary externalities make unregulated debt maturities inefficiently short. The calibration of the model to Eurozone banking data for 2006 yields that lengthening the average maturity of wholesale debt from its 2.8 months to 3.3 months would produce welfare gains with a present value of euro 105 billion, while the lengthening induced by the NSRF would be too drastic.

No. 2
23 February 2016
Macroprudential supervision: From theory to policy
Schoenmaker, Dirk, Wierts, Peter

Abstract

JEL Classification

E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

Financial supervision focuses on the aggregate (macroprudential) in addition to the individual (microprudential). But an agreed framework for measuring and addressing financial imbalances is lacking. We propose a holistic approach for the financial system as a whole, beyond banking. Building on our model of financial amplification, the financial cycle is the key variable for measuring financial imbalances. The cycle can be curbed by leverage restrictions that might vary across countries. We make concrete policy proposals for the design of macroprudential instruments to simplify the current framework and make it more consistent.

No. 1
23 February 2016
Macro-Financial Stability Under EMU
Lane, Philip R.

Abstract

JEL Classification

E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E65 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Studies of Particular Policy Episodes
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation

Abstract

This paper examines the cyclical behaviour of country-level macro-financial variables under EMU. Monetary union strengthened the covariation pattern between the output cycle and the financial cycle, while macro-financial policies at national and area-wide levels were insufficiently counter-cyclical during the 2003-2007 boom period. We critically examine the policy reform agenda required to improve macro-financial stability.