Leverage Ratio Arbitrage All Over Again
Leverage limits as a form of capital regulation have a well-known, potential bug: If banks can’t lever returns as desired, they can boost returns on equity by shifting toward riskier, higher yielding assets. That reach for yield is the leverage rule “arbitrage.” But would banks do that? In a previous post, we discussed evidence from our working paper that banks did do just that in response to the new leverage rule that took effect in 2018. This post discusses new findings in our revised paper on when and how banks arbitraged.
Interest Rates or Haircuts? Prices Versus Quantities in the Market for Collateralized Risky Loans
Markets for risky loans clear on two dimensions - an interest rate (or equivalently a spread above the riskless rate) and a specification of the amount of collateral per dollar of lending. The latter is summarized by the margin or "haircut" associated with the loan. Some key models of endogenous collateral constraints imply that the primary equilibrating force will be in the form of haircuts rather than movements in interest rate spreads. Indeed, an important benchmark model, derived in a two-state world, implies that haircuts will adjust to render all lending riskless, and that a loss of ...
Time variation in asset price responses to macro announcements
Although the effects of economic news announcements on asset prices are well established, these relationships are unlikely to be stable. This paper documents the time variation in the responses of yield curves and exchange rates using high-frequency data from January 2000 through August 2011. Significant time variation in news effects is present for those announcements that have the largest effects on asset prices. The time variation in effects is explained by economic conditions, including the level of policy rates at the time of the news release, and risk conditions: Government bond yields ...
What Happens When Regulatory Capital Is Marked to Market?
Minimum equity capital requirements are a key part of bank regulation. But there is little agreement about the right way to measure regulatory capital. One of the key debates is the extent to which capital ratios should be based on current market values rather than historical ?accrual? values of assets and liabilities. In a new research paper, we investigate the effects of a recent regulatory change that ties regulatory capital directly to the market value of the securities portfolio for some banks.
The LIBOR Countdown Has Not Stopped
Remarks at the IMN Virtual Investors' Conference on LIBOR.
Thoughts on cybersecurity from a supervisory perspective: remarks at SIPA’s Cyber Risk to Financial Stability: State-of-the-Field Conference 2019, Federal Reserve Bank of New York, New York City
Remarks at SIPA?s Cyber Risk to Financial Stability: State-of-the-Field Conference 2019, Federal Reserve Bank of New York, New York City.
Domestic bond markets and inflation
This paper explores the relationship between inflation and the existence of a local, nominal, publicly-traded, long-maturity, domestic-currency bond market. Bond holders are exposed to capital losses through inflation and therefore represent a potential anti-inflationary force; we ask whether their influence is apparent both theoretically and empirically. We develop a simple theoretical model with heterogeneous agents where the issuance of such bonds leads to political pressure on the government to choose a lower inflation rate. We then check this prediction empirically using a panel of data, ...
International Stock Comovements with Endogenous Clusters
We examine international stock return comovements of country-industry portfolios. Our model allows comovements to be driven by a global and a cluster component, with the cluster membership endogenously determined. Results indicate that country-industry portfolios tend to cluster mainly within geographical areas that can include one or more countries. The cluster compositions substantially changed over time, with the emergence of clusters among European countries from the early 2000s. The cluster component was the main driver of country-industry portfolio returns for most of the sample, except ...
Climate Risk and the Fed: Preparing for an Uncertain Certainty
While the severity and scope of a changing climate remains unclear, the consensus is that it poses a significant risk to the global economy and financial system. As monetary policymakers, the Fed’s job is to navigate this uncertainty by anticipating the potential changes and understanding their implications. The following is adapted from remarks by the president of the Federal Reserve Bank of San Francisco to the Peterson Institute for International Economics on June 22.
Foreign Investment, Regulatory Arbitrage, and the Risk of U.S. Banking Organizations
This study investigates the implications of cross-country differences in banking regulation and supervision for the international subsidiary locations and risk of U.S. bank holding companies (BHCs). We find that U.S. BHCs are more likely to operate subsidiaries in countries with weaker regulation and supervision and that such location decisions are associated with elevated BHC risk and higher contribution to systemic risk. The quality of BHCs? internal controls and risk management play an important role in these location choices and risk outcomes. Overall, our study suggests that U.S. banking ...