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on Central Banking |
| By: | Charles A.E. Goodhart; Anil K Kashyap; Dimitrios P. Tsomocos; Alexandros P. Vardoulakis |
| Abstract: | This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when net worth of potential buyers is low, the ensuing price dynamics can be described as a fire sale. The proposed framework can assess five different policy options that officials have advocated for combating defaults, credit crunches and fire sales, namely: limits on loan to value ratios, capital requirements for banks, liquidity coverage ratios for banks, dynamic loan loss provisioning for banks, and margin requirements on repurchase agreements used by shadow banks. The paper aims to develop some general intuition about the interactions between the tools and to determine whether they act as complements and substitutes. |
| JEL: | G38 L51 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17909&r=cba |
| By: | Larsson, Bo (Dept. of Economics, Stockholm University); Wijkander, Hans (Dept. of Economics, Stockholm University) |
| Abstract: | The financial crisis that erupted 2007-2008 has reinforced demand for regulation of banks. The Basle III accord which is to be implemented January first 2013 encompasses two types of regulations with the goal to enforce more prudence among banks. One is capital adequacy regulation which stipulates a lowest ratio between bank capital and bank assets. The other is constraints on dividends and bonuses payments. Banking on these regulations to raise prudence regarding risk taking among banks may lead to disappointment. Within a dynamic model of a value maximizing bank we find that both regulations lower bank value, also in situations where regulations do not bind. None of the regulations leads to increased optimal ratio between common equity and lending. Capital adequacy regulation reinforces credit squeeze when binding. More frequent dividend payouts leads to higher equilibrium bank capital. |
| Keywords: | Banking; Dynamic Banking; Banking regulation; Capital adequacy; Dividends |
| JEL: | C61 G21 G22 |
| Date: | 2012–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2012_0003&r=cba |
| By: | Gustavo Adler; Camilo Ernesto Tovar Mora; Pedro Castro |
| Abstract: | Heavy foreign exchange intervention by central banks of emerging markets have lead to sizeable expansions of their balance sheets in recent years—accumulating foreign assets and non-money domestic liabilities (the latter due to sterilization operations). With domestic liabilities being mostly of short-term maturity and denominated in local currency, movements in domestic monetary policy interest rates can have sizable effects on central bank's net worth. In this paper we examine empirically whether balance sheet considerations influence the conduct of monetary policy. Our methodology involves the estimation of interest rate rules for a sample of 41 countries and testing whether deviations from the rule can be explained by a measure of central bank financial strength. Our findings, using linear and nonlinear techniques, suggests that central bank financial strength can be a statistically significant factor explaining large negative interest rate deviations from "optimal" levels. |
| Keywords: | Capital , Central banks , Developed countries , Emerging markets , Monetary policy , |
| Date: | 2012–02–28 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/60&r=cba |
| By: | Gianni De Nicoló; Marcella Lucchetta |
| Abstract: | This paper formulates a novel modeling framework that delivers: (a) forecasts of indicators of systemic real risk and systemic financial risk based on density forecasts of indicators of real activity and financial health; (b) stress-tests as measures of the dynamics of responses of systemic risk indicators to structural shocks identified by standard macroeconomic and banking theory. Using a large number of quarterly time series of the G-7 economies in 1980Q1-2010Q2, we show that the model exhibits significant out-of sample forecasting power for tail real and financial risk realizations, and that stress testing provides useful early warnings on the build-up of real and financial vulnerabilities. |
| Keywords: | Economic indicators , Financial risk , Forecasting models , Group of seven , Time series , |
| Date: | 2012–02–28 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/58&r=cba |
| By: | Powell, Andrew (Inter American Development Bank); Maier, Antonia (University of Warwick); Miller, Marcus (University of Warwick) |
| Abstract: | The recent financial crisis has forced a rethink of banking regulation and supervision and the role of nancial innovation. We develop a model where prudent banks may signal their type through high capital ratios. Capital regulation may ensure separation in equilibrium but deposit insurance will tend to increase the level of capital required. If supervision detects risky behaviour ex ante then it is complementary to capital regulation. However, nancial innovation may erode supervisors' ability to detect risk and capital levels should then be higher. But regulators may not be aware their capacities have been undermined. We argue for a four-prong policy response with higher bank capital ratios, enhanced supervision, limits to the use of complex financial instruments and Coco's. Our results may support the institutional arrangements proposed recently in the UK. |
| Keywords: | Bank Regulation; Financial Crises; Information; Signaling. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:cge:warwcg:75&r=cba |
| By: | Tobias Körner |
| Abstract: | In this paper, a law reform is evaluated that aimed at improving the corporate governance of German savings banks by tightening accountability and legal liability of outside directors. The causal effect of this reform on bank risk is identified by difference-in-differences and triple differences strategies. The estimation results show that savings banks subject to the reform increased capital and liquidity ratios. Hence, they have become less vulnerable to unexpected losses and liquidity shocks. This indicates that the low occurrence of outside director litigation reflects incentive effects of current liability regimes. |
| Keywords: | Corporate governance; outside directors; legal liability; bank risk |
| JEL: | G21 G38 K20 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0313&r=cba |
| By: | Cheick Kader M'Baye (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure - Lyon) |
| Abstract: | Under what conditions should a central bank adopt an inflation targeting regime ? This is the main question we address in this paper. A large part of the literature puts forward that these regimes should have to be adopted, as they yield higher macroeconomic performances. We analyze the issue of optimal inflation targeting in a new theoretical framework, which conciliates the interaction between the degree of price stickiness, and the degree of strategic complementarities in fi-rms' price setting. We show that adopting a target for inflation, crucially depends on the sequential but complementary importance of the model's parameters. In particular, we show that strategic complementarities appear to be the fi-rst driving force. When they are low, the central bank must adopt an inflation targeting regime whatever the importance of other parameters in the model. By contrast, when the degree of strategic complementarities is high, adopting a target for in ation depends on both the degree of price stickiness and the precision of central bank's information about the fundamentals of the economy. When prices are exible enough, adopting an inflation target is never optimal. However, when prices are strongly sticky, and the central bank holds precise information about the fundamentals, the central bank should adopt an explicit target for inflation. |
| Keywords: | Inflation targeting ; price stickiness ; heterogeneous information ; strategic complementarities |
| Date: | 2012–03–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00677671&r=cba |
| By: | Olivier Armantier; Scott Nelson; Giorgio Topa; Wilbert van der Klaauw; Basit Zafar |
| Abstract: | Understanding the formation of consumer inflation expectations is considered crucial for managing monetary policy. This paper investigates how consumers form and update their inflation expectations using a unique “information” experiment embedded in a survey. We first elicit respondents’ expectations for future inflation either in their own consumption basket or for the economy overall. We then randomly provide a subset of respondents with inflation-relevant information: either past-year food price inflation, or a median professional forecast of next-year overall inflation. Finally, inflation expectations are re-elicited from all respondents. This design creates unique panel data that allow us to identify the effects of new information on respondents’ inflation expectations. We find that respondents revise their inflation expectations in response to information, and do so meaningfully: revisions are proportional to the strength of the information signal, and inversely proportional to the precision of prior inflation expectations. We also find systematic differences in updating across demographic groups and by question wording, underscoring how different types of information may be more or less relevant for different groups, and how the observed impact of information may depend on methods used to elicit inflation expectations. |
| Keywords: | Inflation (Finance) ; Consumer behavior ; Information theory ; Consumer surveys |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:543&r=cba |
| By: | Marc P. Giannoni |
| Abstract: | This paper compares the properties of interest rate rules such as simple Taylor rules and rules that respond to price-level fluctuations—called Wicksellian rules—in a basic forward-looking model. By introducing appropriate history dependence in policy, Wicksellian rules perform better than optimal Taylor rules in terms of welfare and robustness to alternative shock processes, and they are less prone to equilibrium indeterminacy. A simple Wicksellian rule augmented with a high degree of interest rate inertia resembles a robustly optimal rule—that is, a monetary policy rule that implements the optimal plan and is also completely robust to the specification of exogenous shock processes. |
| Keywords: | Interest rates ; Inflation (Finance) ; Taylor's rule ; Price levels ; Monetary policy |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:546&r=cba |
| By: | Alessio Anzuini (Bank of Italy); Marco J. Lombardi (European Central Bank); Patrizio Pagano (Bank of Italy) |
| Abstract: | Global monetary conditions are often cited as a driver of commodity prices. This paper investigates the empirical relationship between US monetary policy and commodity prices by means of a standard VAR system, commonly used in analysing the effects of monetary policy shocks. The results suggest that expansionary US monetary policy shocks drive up the broad commodity price index and all of its components. While these effects are significant, they do not, however, appear to be overwhelmingly large. This finding is confirmed under different identification strategies for the monetary policy shock. |
| Keywords: | monetary policy shock, oil prices, VAR |
| JEL: | E31 E40 C32 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_851_12&r=cba |
| By: | Joshua Chan (College of Business and Economics, Australian National University); Gary Koop (Department of Economics, University of Strathclyde); Simon Potter (Federal Reserve Bank of New York) |
| Abstract: | This paper introduces a new model of trend (or underlying) inflation. In contrast to many earlier approaches, which allow for trend inflation to evolve according to a random walk, ours is a bounded model which ensures that trend inflation is constrained to lie in an interval. The bounds of this interval can either be fixed or estimated from the data. Our model also allows for a time-varying degree of persistence in the transitory component of inflation. The bounds placed on trend inflation mean that standard econometric methods for estimating linear Gaussian state space models cannot be used and we develop a posterior simulation algorithm for estimating the bounded trend inflation model. In an empirical exercise with CPI inflation we find the model to work well, yielding more sensible measures of trend inflation and forecasting better than popular alternatives such as the unobserved components stochastic volatility model. |
| Keywords: | Constrained inflation, non-linear state space model, underlying inflation, inflation targeting, inflation forecasting, Bayesian |
| JEL: | E31 E37 C11 C53 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:str:wpaper:1202&r=cba |
| By: | Francis Vitek; Scott Roger |
| Abstract: | This paper examines the transitional macroeconomic costs of a synchronized global increase in bank capital adequacy requirements under Basel III, as well as a capital increase covering globally systemically important banks. The analysis, using an estimated multi-country model, contributed to the work of the Macroeconomic Assessment Group analysis, especially in estimating the potential international spillovers associated with a global increase in capital requirements. The magnitude of the effects found in this analysis is relatively modest, especially if monetary policies have scope to ease in response to a widening of interest rate spreads by banks. |
| Keywords: | Banks , Capital , Cross country analysis , Economic models , Monetary policy , Spillovers , |
| Date: | 2012–02–08 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/44&r=cba |
| By: | Laura Valderrama; German Lopez-Espinosa; Antonio Moreno; Antonio Rubia |
| Abstract: | In this paper we identify some of the main factors behind systemic risk in a set of international large-scale complex banks using the novel CoVaR approach. We find that short-term wholesale funding is a key determinant in triggering systemic risk episodes. In contrast, we find no evidence that a larger size increases systemic risk within the class of large global banks. We also show that the sensitivity of system-wide risk to an individual bank is asymmetric across episodes of positive and negative asset returns. Since short-term wholesale funding emerges as the most relevant systemic factor, our results support the Basel Committee’s proposal to introduce a net stable funding ratio, penalizing excessive exposure to liquidity risk. |
| Keywords: | Economic models , Financial institutions , Financial risk , International banks , Liquidity , |
| Date: | 2012–02–09 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/46&r=cba |
| By: | Lamont Black; Lieu Hazelwood |
| Abstract: | One of the largest responses of the U.S. government to the recent financial crisis was the Troubled Asset Relief Program (TARP). TARP was originally intended to stabilize the financial sector through the increased capitalization of banks. However, recipients of TARP funds were then encouraged to make additional loans despite increased borrower risk. In this paper, we consider the effect of the TARP capital injections on bank risk taking by analyzing the risk ratings of banks’ commercial loan originations during the crisis. The results indicate that, relative to non-TARP banks, the risk of loan originations increased at large TARP banks but decreased at small TARP banks. Interest spreads and loan levels also moved in different directions for large and small banks. For large banks, the increase in risk-taking without an increase in lending is suggestive of moral hazard due to government ownership. These results may also be due to the conflicting goals of the TARP program for bank capitalization and bank lending. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1043&r=cba |
| By: | Ralph De Haas (European Bank for Reconstruction and Development (EBRD)); Yevgeniya Korniyenko (Bank of England); Elena Loukoianova (International Monetary Fund (IMF)); Alexander Pivovarsky (European Bank for Reconstruction and Development (EBRD)) |
| Abstract: | We use data on 1,294 banks in Emerging Europe to analyze how bank ownership and the so-called Vienna Initiative impacted credit growth during the 2008-09 crisis. As part of the Vienna Initiative western European banks signed country-specific commitment letters in which they pledged to maintain exposures and to support their subsidiaries in Emerging Europe. We show that in general both domestic and foreign banks sharply curtailed credit during the crisis, but that foreign banks that participated in the Vienna Initiative were relatively stable lenders. We find no evidence of negative spillovers from countries where banks signed commitment letters to countries where they did not. |
| Keywords: | Foreign banks, Vienna Initiative, financial crisis, state support |
| JEL: | C23 F36 G21 P34 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:anc:wmofir:62&r=cba |
| By: | Mariya Teteryatnikova |
| Abstract: | Systemic risk and the scale of systemic breakdown in the banking system are the key concern for central banks charged with safeguarding overall financial stability. This paper focuses on the risk and potential impact of system-wide defaults in the frequently observed ”tiered” banking system, where relatively few first-tier head institutions are connected with second-tier ”peripheral” banks and are also connected with each other, while the peripheral banks are almost exclusively connected with the head banks. The banking network is constructed from a number of banks which are linked by interbank exposures with a certain predefined probability. In this framework, the tiered structure is represented either by a network with negative correlation in connectivity of neighboring banks, or alternatively, by a network with a scale-free distribution of connectivity across banks. The main finding of the paper highlights the advantages of tiering within the banking system in terms of both the resilience of the banking network to systemic shocks and the extent of necessary government intervention should a crisis evolve. Specifically, the tiered network structure, showing negative correlations in bank connectivity, is found to be less prone to systemic breakdown than other structures, showing either positive or zero correlations. Moreover, in the scale-free tiered system, the resilience of the system to shocks increases as the level of tiering grows. Also, the targeted bail-out policy of the government aimed at rescuing the most connected failing banks in the first place, is expected to be more effective and induce lower costs in a tiered system with high level of tiering. |
| JEL: | C63 D85 G01 G21 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:vie:viennp:1203&r=cba |
| By: | Anginer, Deniz; Demirguc-Kunt, Asli; Zhu, Min |
| Abstract: | Using bank level measures of competition and co-dependence, the authors show a robust positive relationship between bank competition and systemic stability. Whereas much of the extant literature has focused on the relationship between competition and the absolute level of risk of individual banks, they examine the correlation in the risk taking behavior of banks, hence systemic risk. They find that greater competition encourages banks to take on more diversified risks, making the banking system less fragile to shocks. Examining the impact of the institutional and regulatory environment on systemic stability shows that banking systems are more fragile in countries with weak supervision and private monitoring, with generous deposit insurance and greater government ownership of banks, and public policies that restrict competition. Furthermore, lack of competition has a greater adverse effect on systemic stability in countries with low levels of foreign ownership, weak investor protections, generous safety nets, and where the authorities provide limited guidance for bank asset diversification. |
| Keywords: | Banks&Banking Reform,Access to Finance,Debt Markets,Emerging Markets,Financial Intermediation |
| Date: | 2012–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:5981&r=cba |
| By: | Marcello Miccoli (Bank of Italy) |
| Abstract: | This paper builds a dynamic model of the information flow between partially informed financial institutions and a public agency. The financial institutions decide how to allocate their portfolio between a risk-free technology with a known payoff and a risky technology whose payoff is unknown. The public agency learns about the value of the unknown payoff by observing with measurement error the actions of the financial institutions and decides whether to communicate the information at the agency's disposal. The paper characterizes the optimal public communication plan and shows that full transparency (taken as the release of information whenever it is collected) is not always optimal. Instead, optimal plans involve delayed communication, the amount of delay depending on the precision of private information and the size of the agency's measurement error. The explanation of the result lies in the collection process of public information: while releasing information improves the welfare of the agents, it also decreases the informational content of their actions, hampering the agency's learning and reducing the benefits of future public communication. |
| Keywords: | value of information, learning, pubblic communication. |
| JEL: | D80 D83 E58 E61 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_856_12&r=cba |
| By: | Ross Levine; Luc Laeven; Martin Goetz |
| Abstract: | This paper assesses the impact of the geographic diversification of bank holding company (BHC) assets across the United States on their market valuations. Using two novel identification strategies based on the dynamic process of interstate bank deregulation, we find that exogenous increases in geographic diversity reduce BHC valuations. These findings are consistent with the view that geographic diversity makes it more difficult for shareholders and creditors to monitor firm executives, allowing corporate insiders to extract larger private benefits from firms. |
| Keywords: | Bank regulations , Banking , Commercial banks , Corporate governance , |
| Date: | 2012–02–15 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/50&r=cba |
| By: | Thorsten Beck (Tilburg University and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Tao Chen (The Chinese University of Hong Kong); Chen Lin (The Chinese University of Hong Kong and Hong Kong Institute for Monetary Research); Frank M. Song (The University of Hong Kong) |
| Abstract: | "Everybody talks about financial innovation, but (almost) nobody empirically tests hypotheses about it." Frame and White (2004) The financial turmoil from 2007 onwards has spurred renewed debates on the "bright" and "dark" sides of financial innovation. Using bank-, industry- and country-level data for 32, mostly high-income, countries between 1996 and 2006, this paper is the first to explicitly assess the relationship between financial innovation in the banking sector and (i) real sector growth, (ii) real sector volatility, and (iii) bank fragility. We find evidence for both bright and dark sides of financial innovation. On the one hand, we find that a higher level of financial innovation is associated with a stronger relationship between a country's growth opportunities and capital and GDP per capita growth and with higher growth rates in industries that rely more on external financing and depend more on innovation. On the other hand, we find that financial innovation is associated with higher growth volatility among industries more dependent on external financing and on innovation and with higher idiosyncratic bank fragility, higher bank profit volatility and higher bank losses during the recent crisis. |
| Keywords: | Financial Innovation, Financial R&D Intensity, Bank Risk Taking, Financial Crisis, Industrial Growth, Finance and Growth |
| JEL: | G2 G15 G28 G01 O3 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:052012&r=cba |
| By: | Rodolfo Maino; Kalin Tintchev |
| Abstract: | This paper presents an integrated framework for assessing systemic risk. The framework models banks’ capital asset ratios as a function of future losses and credit growth using a generalized method of moments to calibrate shocks to credit quality and credit growth. The analysis is complemented by a simple measure of systemic risk, which captures tail risk comovement among banks in the system. The main contribution of this paper is to advance a simple framework to integrate systemic risk scenarios that assess the impact of aggregate and idiosyncratic factors. The analysis is based on CreditRisk+, which uses analytical techniques—similar to those applied in the insurance industry - to estimate banks’ credit portfolio loss distributions, making no assumptions about the cause of default. |
| Keywords: | Banking systems , Credit expansion , Credit risk , Economic models , External shocks , Risk management , |
| Date: | 2012–02–16 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/53&r=cba |
| By: | Pierre Henry-Labordere (SOCIETE GENERALE - Equity Derivatives Research Societe Generale - Société Générale) |
| Abstract: | The purpose of this paper is to design an algorithm for the computation of the counterparty risk which is competitive in regards of a brute force ''Monte-Carlo of Monte-Carlo" method (with nested simulations). This is achieved using marked branching diffusions describing a Galton-Watson random tree. Such an algorithm leads at the same time to a computation of the (bilateral) counterparty risk when we use the default-risky or counterparty-riskless option values as mark-to-market. Our method is illustrated by various numerical examples. |
| Keywords: | Counterparty risk valuation; BSDE; branching diffusions; semi-linear PDE; Galton-Watson tree |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00677348&r=cba |
| By: | Qian, Rong |
| Abstract: | This paper examines how a country's weak institutions and polarized government can affect the likelihood of its default on sovereign debt. Using a data set of 90 countries, it shows that strong institutions are associated with fewer sovereign default crises. In addition, when institutions are weak, a more polarized government tends to default more often. To explain these findings, the author develops a model showing the dynamics between the quality of institutions, the level of government polarization and sovereign default risk. Countries default more often when they lack rules and strong institutions to curb the influence of powerful groups on government policies. That is because in a polarized government, each powerful group makes decisions without considering the impact on other groups. Simulations of the model show that more than half the cross-country variation in sovereign default frequencies can be explained by institutional quality and the degree of government polarization observed in the data. |
| Keywords: | Debt Markets,Bankruptcy and Resolution of Financial Distress,Economic Theory&Research,Access to Finance,Emerging Markets |
| Date: | 2012–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:5993&r=cba |