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Discussion Paper
Is Bitcoin Really Frictionless?
Bitcoin is the most popular virtual currency yet developed. Proponents assert that bitcoin can remove frictions involved in payment and settlement systems by eliminating the need for the financial intermediaries that exist in traditional currencies. In this blog post, we show that while bitcoin transfers themselves are relatively frictionless for the user, there are significant frictions when bitcoins trade in exchange markets resulting in meaningful and persistent price differences across bitcoin exchanges. These exchange-related frictions reduce the incentive of market participants to use ...
Report
Dealers and the Dealer of Last Resort: Evidence from the Agency MBS Markets in the COVID-19 Crisis
When market disruptions began in March 2020, dealers maintained their usual liquidity provision in the agency MBS market by absorbing cash inventory and hedging inventory risk with forward contracts. Nevertheless, cash and forward prices diverged sharply and began to converge only after the Federal Reserve implemented nonstandard purchase operations that promptly removed MBS from dealers’ balance sheets. Further cross-dealer analyses identify supplemental leverage ratio requirements as a key constraint on dealers’ balance sheets. Finally, customer selling increased precisely when price ...
Newsletter
Teaching the Linkage Between Banks and the Fed: R.I.P. Money Multiplier
The money multiplier has been a standard concept in introductory economics classes for decades, but changes in the way the Fed implements monetary policy has made the model obsolete. This issue provides information about the linkages between the Fed and the banking system and provides teaching suggestions.
Discussion Paper
Bank-Intermediated Arbitrage
Since the 2007-09 financial crisis, the prices of closely related assets have shown persistent deviations—so-called basis spreads. Because such disparities create apparent profit opportunities, the question arises of why they are not arbitraged away. In a recent Staff Report, we argue that post-crisis changes to regulation and market structure have increased the costs to banks of participating in spread-narrowing trades, creating limits to arbitrage. In addition, although one might expect hedge funds to act as arbitrageurs, we find evidence that post-crisis regulation affects not only the ...
Report
Regulatory Arbitrage Within the Firm
Regulation shapes the boundaries of firms. When prudential standards bind asymmetrically across subsidiaries of an integrated organization, internal capital markets become a mechanism for regulatory arbitrage. We study this in U.S. banking, where holding companies encompass both heavily regulated depository institutions and lightly regulated nonbank affiliates. Following Basel III in 2015, holding companies extract equity from nonbank subsidiaries to recapitalize their banks. Bank subsidiaries accumulate 5-8 percentage points more excess capital than comparable standalone banks through ...
Discussion Paper
How Basel III Changes Where Capital Sits: Nonbank Subsidiaries as Equity Reservoirs
When Basel III’s binding capital minimums took effect for U.S. banks in January 2015, a bank holding company (BHC) whose depository subsidiary fell short of the new standards had two options. It could raise fresh equity in external markets, a costly option. Or, if it owned equity-rich nonbank affiliates, it could simply move capital from one subsidiary to another. The second route satisfies the regulator, avoids issuance costs, and leaves consolidated equity exactly where it was. In this second post of our series, we show that this is precisely what organizationally complex BHCs did in ...
Discussion Paper
Capitalizing on Nonbanks: Regulatory Arbitrage Within Bank Holding Companies
When economists and policymakers talk about nonbank finance, they usually have in mind activity that takes place outside the banking system in institutions that compete with banks for the provision of financial intermediation services, such as fintech lenders, money market funds, private credit vehicles, insurers, and broker-dealers. A substantial share of U.S. nonbank financial activity, however, takes place inside bank holding companies (BHCs), conducted by nonbank subsidiaries that operate alongside regulated commercial banks under common ownership and integrated management. In this first ...
Discussion Paper
Nonbank Subsidiaries and the Hidden Fragility of Internal Capital Markets Reallocation
Banks became safer after Basel III. Whether it made the broader organization safer is less clear. We document that bank subsidiaries accumulated capital, improved asset quality, and reduced risk. But holding companies built that capital largely by drawing on their nonbank affiliates. Did the reallocation reduce risk for the organization as a whole or merely move it to a less visible part of the firm? Our evidence points to the latter: the same internal capital markets that helped banks meet tighter requirements left nonbank affiliates with thinner buffers and riskier business models, and a ...