The cost of bank regulatory capital
The Basel I Accord introduced a discontinuity in required capital for undrawn credit commitments. While banks had to set aside capital when they extended commitments with maturities in excess of one year, short-term commitments were not subject to a capital requirement. The Basel II Accord sought to reduce this discontinuity by extending capital standards to most short-term commitments. We use these differences in capital standards around the one-year maturity to infer the cost of bank regulatory capital. Our results show that following Basel I, undrawn fees and all-in-drawn credit spreads on ...
Depositor Discipline of Risk-Taking by U.S. Banks
The recent financial crisis caused the largest rise in the number of bank failures since the unprecedented banking crisis of the 1980s and early 1990s. This post examines how depositors responded to the amplified risks of bank failure over the last three decades. We show that uninsured depositors discipline troubled banks by withdrawing their funds. Focusing on the recent financial crisis, we find that banks experienced an outflow of uninsured time deposits after the near-failure of Bear Stearns and bankruptcy of Lehman Brothers. This depositor risk sensitivity subsided after the Federal ...
Why Large Bank Failures Are So Messy and What to Do about It?
If the Lehman Brothers failure proved anything, it was that large, complex bank failures are messy; they destroy value and can destabilize financial markets. We certainly don’t mean to trivialize matters by calling large bank failures “messy,” as it their messiness, particularly the destabilizing aspect, that creates the “too-big-to-fail” problem. In our contribution to the Economic Policy Review volume, we venture an explanation about why large bank failures are so messy and discuss a policy that can make them less so.
The Cost of Regulatory Capital
Banks contend that equity capital is expensive and that an increase in capital requirements will adversely impact bank services, including the volume and cost of mortgages and corporate loans. For example, JPMorgan CEO Jamie Dimon said in 2017 that “It is clear that the banks have too much capital…and more of that capital can be safely used to finance the economy.” In a recent staff report, we compare the different treatments of short-term credit commitments under the Basel I and Basel II Accords to assess the effect of capital regulation on banks’ cost of capital.
Are All CLOs Equal?
Asset securitization is an important source of corporate funding in capital markets. Collateralized loan obligations (CLOs) are securitization structures that allow syndicated bank lenders and bond underwriters to repackage business loans and sell them to investors as securities. CLOs are actively overseen by a collateral manager that has the responsibility to trade loans in the portfolio to benefit from gains and mitigate losses from credit exposures. Because CLOs include a diverse portfolio of loans, a single firm that commingles its lending role with the collateral management role can reap ...
How Liquidity Standards Can Improve Lending of Last Resort Policies
Prior to the Great Recession, the focus of bank regulation was on bank capital with little consensus about the need for liquidity regulation. This view was in contrast with an existing body of academic research that pointed to inefficiencies in environments with strictly private provision of liquidity, via either interbank markets or credit line agreements. In spite of theoretical results pointing to the possible benefits of liquidity regulation for reducing fire sales in crises or the risk of panics due to coordination failures, a common view was that its costs might exceed its benefits, ...
Monetary Policy and the Run Risk of Loan Funds
Loan funds are open-end mutual funds holding predominantly corporate leveraged loans. We document empirically that loan funds are significantly more susceptible to run risk than any other category of debt funds, including corporate bond funds. Most importantly, we establish a link between loan funds’ flows and monetary policy, based on the institutional characteristics of their portfolio holdings. We find robust evidence indicating a pro-cyclical relationship between monetary policy and loan-fund flows. This relationship, however, is asymmetric: weaker for policy-rate increases and stronger ...
Insurance Companies and the Growth of Corporate Loan Securitization
Collateralized loan obligation (CLO) issuances in the United States increased by a factor of thirteen between 2009 and 2019, with the volume of outstanding CLOs more than doubling to approach $647 billion by the end of that period. While researchers and policy makers have been investigating the impact of this growth on the cost and riskiness of corporate loans and the potential implications for financial stability, less attention has been paid to the drivers of this phenomenon. In this post, which is based on our recent paper, we shed light on the role that insurance companies have played in ...
Why Do Central Banks Have Discount Windows?
Though not literally a window any longer, the “discount window” refers to the facilities that central banks, acting as lender of last resort, use to provide liquidity to commercial banks. While the need for a discount window and lender of last resort has been debated, the basic rationale for their existence is that circumstances can arise, such as bank runs and panics, when even fundamentally sound banks cannot raise liquidity on short notice. Massive discount window borrowing in the immediate aftermath of the September 11 terrorist attack on the United States clearly illustrates the ...