Bank Capital and Risk: Cautionary or Precautionary?
Do riskier banks have more capital? Banking companies with more equity capital are better protected against failure, all else equal, because they can absorb more losses before becoming insolvent. As a result, banks with riskier income and assets would hopefully choose to fund themselves with relatively more equity and less debt, giving them a larger equity cushion against potential losses. In this post, we use a top-down stress test model of the U.S. banking system?the Capital and Loss Assessment under Stress Scenarios (CLASS) model?to assess whether banks that are forecast to lose capital in ...
How Does Supervision Affect Banks?
Supervisors monitor banks to assess the banks? compliance with rules and regulations but also to ensure that they engage in safe and sound practices (see our earlier post What Do Banking Supervisors Do?). Much of the work that bank supervisors do is behind the scenes and therefore difficult for outsiders to measure. In particular, it is difficult to know what impact, if any, supervisors have on the behavior of banks. In this post, we describe a new Staff Report in which we attempt to measure the impact that supervision has on bank performance. Does more attention by supervisors lead to lower ...
Cyber Risk and the U.S. Financial System: A Pre-Mortem Analysis
We model how a cyber attack may be amplified through the U.S. financial system, focusing on the wholesale payments network. We estimate that the impairment of any of the five most active U.S. banks will result in significant spillovers to other banks, with 38 percent of the network affected on average. The impact varies and can be larger on particular days and geographies. When banks respond to uncertainty by liquidity hoarding, the potential impact in forgone payment activity is dramatic, reaching more than 2.5 times daily GDP. In a reverse stress test, interruptions originating from banks ...
The CLASS Model: A Top-Down Assessment of the U.S. Banking System
Central banks and bank supervisors have increasingly relied on capital stress testing as a supervisory and macroprudential tool. Stress tests have been used by central banks and supervisors to assess the resilience of individual banking companies to adverse macroeconomic and financial market conditions as a way of gauging additional capital needs at individual firms and as a means of assessing the overall capital strength of the banking system. In this post, we describe a framework for assessing the impact of various macroeconomic scenarios on the capital and performance of the U.S. banking ...
Comparing Bank and Supervisory Stress Testing Projections
Stress tests are important tools for assessing whether financial institutions have enough capital to operate in bad economic conditions. In addition to being useful for understanding capital weaknesses at individual firms, coordinated stress tests can also provide insight into the vulnerabilities facing the banking industry as a whole. In this post, we look at 2013 stress test projections made by eighteen large U.S. bank holding companies under the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act and compare them with supervisory projections made by the Federal ...
Bank Capital and Real GDP Growth
We study the relationship between bank capital ratios and the distribution of future real GDP growth. Growth in the aggregate bank capital ratio corresponds to a smaller left tail of GDP—smaller crisis probability—but at the cost of a smaller right tail of growth outcomes—smaller probability of exuberant growth. This trade-off persists at horizons of up to eight quarters, highlighting the long-range consequences of changes in bank capital. We show that the predictive information in bank capital ratio growth is over and above that contained in real credit growth, suggesting importance ...
Tax Reform's Impact on Bank and Corporate Cyclicality
The Tax Cuts and Jobs Act (TCJA) is expected to increase after-tax profits for most companies, primarily by lowering the top corporate statutory tax rate from 35 percent to 21 percent. At the same time, the TCJA provides less favorable treatment of net operating losses and limits the deductibility of net interest expense. We explain how the latter set of changes may heighten bank and corporate borrower cyclicality by making bank capital and default risk for highly levered corporations more sensitive to economic downturns.
Evaluating the quality of fed funds lending estimates produced from Fedwire payments data
A number of empirical analyses of interbank lending rely on indirect inferences from individual interbank transactions extracted from payments data using algorithms. In this paper, we conduct an evaluation to assess the ability of identifying overnight U.S. fed funds activity from Fedwire payments data. We find evidence that the estimates extracted from the data are statistically significantly correlated with banks' fed funds borrowing as reported on the FRY-9C. We find similar associations for fed funds lending, although the correlations are lower. To be conservative, we believe that the ...
State-of-the-Field Conference on Cyber Risk to Financial Stability
The Federal Reserve Bank of New York partnered with Columbia University’s School of International and Public Affairs (SIPA) for the second annual State-of-the-Field Conference on Cyber Risk to Financial Stability on December 14-15, 2020. Hosted virtually due to the COVID-19 pandemic, the conference took place amidst the unfolding news of a cyberattack against a major cybersecurity vendor and software vendor, underscoring vulnerabilities from cyber risk.
The private premium in public bonds
This paper is the first to document the presence of a private premium in public bonds. We find that spreads are 31 basis points higher for public bonds of private companies than for bonds of public companies, even after controlling for observable differences, including rating, financial performance, industry, bond characteristics and issuance timing. The estimated private premium increases to 40-50 basis points when a propensity matching methodology is used or when we control for fixed issuer effects. Despite the premium pricing, bonds of private companies are no more likely to default or be ...