255 posts on "Financial Institutions"
October 15, 2018
Did Banks Subject to LCR Reduce Liquidity Creation?
Banks traditionally provide loans that are funded mostly by deposits and thereby create liquidity, which benefits the economy. However, since the loans are typically long-term and illiquid, whereas the deposits are short-term and liquid, this creation of liquidity entails risk for the bank because of the possibility that depositors may “run” (that is, withdraw their deposits on short notice). To mitigate this risk, regulators implemented the liquidity coverage ratio (LCR) following the financial crisis of 2007-08, mandating banks to hold a buffer of liquid assets. A side effect of the regulation, however, is a reduction in liquidity creation by banks subject to LCR, as we find in our recent paper.
Posted at 7:00 am in Banks, Federal Reserve, Financial Institutions, Financial Intermediation, Liquidity, Regulation | Permalink | Comments (1)
October 12, 2018
Leverage Rule Arbitrage
Classic arbitrage involves the same asset selling at different prices; the leverage rule arbitrage we study here involves assets of different risk levels requiring the same amount of capital. The supplementary leverage ratio (SLR) rule, finalized by U.S. regulators in September 2014, requires a minimum ratio of capital to assets at the largest U.S. banks. The floor is higher for more systemically important banks, but not for banks with riskier assets. That non-risk-based aspect of SLR was intentional, since the leverage limit was meant to backstop (“supplement”) risk-based capital rules in case banks underestimate their asset risk and overstate their capital strength. As policymakers have noted and bankers have warned, if the leverage rule is the binding capital requirement, banks can “arbitrage” the rule by selling safer assets and replacing them with riskier, higher-yielding ones. The findings of our recent staff report are consistent with those concerns.
October 2, 2018
Resolving “Too Big to Fail”
Many market participants believe that large financial institutions enjoy an implicit guarantee that the government will step in to rescue them from potential failure. These “Too Big to Fail” (TBTF) issues became particularly salient during the 2008 crisis. From the government’s perspective, rescuing these financial institutions can be important to avoid harm to the financial system. The bailouts also artificially lower the risk borne by investors and the financing costs of big banks. The Dodd-Frank Act attempts to remove the incentive for governments to bail out banks in the first place by mandating that each large bank file a “living will” that details its strategy for a rapid and orderly resolution in the event of material distress or failure without disrupting the broader economy. In our recent New York Fed staff report, we look at whether living wills are effective at reducing the cost of implicit TBTF bailout subsidies.
Posted at 7:00 am in Crisis, Financial Institutions, Financial Intermediation, Nonbank (NBFI), Regulation, Systemic Risk | Permalink
September 12, 2018
Do You Know How Your Treasury Trades Are Cleared and Settled?
The Treasury Market Practices Group (TMPG) recently released a consultative white paper on clearing and settlement processes for secondary market trades of U.S. Treasury securities. The paper describes in detail the many ways Treasury trades are cleared and settledinformation that may not be readily available to all market participantsand identifies potential risk and resiliency issues. The work is designed to facilitate discussion as to whether current practices have room for improvement. In this post, we summarize the current state of clearing and settlement for secondary market Treasury trades and highlight some of the risks described in the white paper.
May 7, 2018
Have the Biggest U.S. Banks Become Less Complex?
The global financial crisis, and the ensuing Dodd-Frank Act, identified size and complexity as determinants of banks’ systemic importance, increasing the potential risks to financial stability. While it’s known that big banks haven’t shrunk, the question that remains is: have they simplified? In this post, we show that while the largest U.S. bank holding companies (BHCs) have somewhat simplified their organizational structures, they remain very complex. The industries spanned by entities within the BHCs have shifted more than they have declined, and the countries in which some large BHCs have entities still include numerous “secrecy” or tax-haven locations.
Posted at 7:00 am in Banks, Financial Institutions, Financial Intermediation, Regulation | Permalink | Comments (1)
March 26, 2018
Dealer Trading and Positioning in Floating Rate Notes
In January 2014, the U.S. Treasury Department made its first sale of Floating Rate Notes (FRNs), securities whose coupon rates vary over time depending on the course of short-term rates. Now that a few years have passed, we have enough data to analyze dealer trading and positioning in FRNs. In this post, we assess the level of trading and positioning, concentration across issues, and auction cycle effects, comparing these properties to those of other types of Treasury securities.
March 7, 2018
Do Low Rates Encourage Yield Seeking by Money Market Funds?
The term “reach for yield” refers to investors’ tendency to buy riskier assets in hopes of securing higher returns. Do low rates on safe assets encourage such yield-seeking behavior, particularly among U.S. prime money market funds (MMFs)? In a paper forthcoming in the Journal of Financial Economics, I develop a model of MMF competition to understand whether competitive pressure leads these funds to reach for yield in a low-rate environment like the current one. I test the model’s predictions on the 2002-08 period and show that, after controlling for changes in risk premia, declines in risk-free rates actually reduced MMF risk-taking, leading to a “reach for safety.”
February 28, 2018
Dealer Participation in the TSLF Options Program
Our previous post described the workings of the Term Securities Lending Facility Options Program (TOP), which offered dealers options for obtaining short-term loans over month- and quarter-end dates during the global financial crisis of 2007-08. In this follow-up post, we examine dealer participation in the TOP, including the extent to which dealers bid for options, at what fees, and whether they exercised their options. We also provide evidence on how uncertainty in dealers’ funding positions was related to the demand for the liquidity options.
February 26, 2018
Options of Last Resort
During the global financial crisis of 2007-08, collateral markets became illiquid, making it difficult for dealers to obtain short-term funding to finance their positions. As lender of last resort, the Federal Reserve responded with various programs to promote liquidity in these markets, including the Primary Dealer Credit Facility and the Term Securities Lending Facility (TSLF). In this post, we discuss an additional and rarely discussed liquidity facility introduced by the Fed during the crisis: the TSLF Options Program (TOP). The TOP was unique among crisis-period liquidity facilities in its provision of options. A follow-up post will analyze dealer participation in the TOP.
February 12, 2018
Does More “Skin in the Game” Mitigate Bank Risk‑Taking?
It is widely said that a lack of “skin in the game” would distort lenders’ incentives and cause a moral hazard problem, that is, excessive risk-taking. If so, does more skin in the game—in the form of extended liability—reduce bankers’ risk-taking? In order to examine this question, we investigate historical data prior to the Great Depression, when bank owners’ liability for losses in the event of bank failure differed by state and primary regulator. This post describes our preliminary findings.
Posted at 7:00 am in Banks, Credit, Economic History, Financial Institutions, Regulation, Systemic Risk | Permalink | Comments (3)
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