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The post-crisis regulatory reform efforts to improve capital and liquidity positions of regulated institutions provide incentives for banks to change not only the structure of their own balance sheets but also how they interact with their customers and other market participants more generally. A 2015 PwC study on global financial market liquidity, for example, noted that “[a]s banks respond to the new regulatory environment, they have sought to make more efficient use of capital and liquidity resources, by reducing the markets they serve and streamlining their operations.” In this blog post, we provide an overview of three recent New York Fed staff reports that study the impact that post-crisis regulation has had on the willingness and ability of regulated firms to participate in U.S. over-the-counter (OTC) markets.
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.
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.
Andreas Fuster, Matthew Plosser, and James Vickery
The Consumer Financial Protection Bureau (CFPB), created in 2011, is a key element of post-crisis U.S. financial regulation, as well as the subject of intense debate. While some have praised the agency, citing the benefits of consumer financial protection, others argue that its activities involve high compliance costs, increase uncertainty and legal risk, and ultimately reduce the availability of financial services for consumers. We present new evidence on whether the CFPB’s supervisory and enforcement activities have significantly affected the supply of mortgage credit, or had other effects on bank risk-taking and profitability.
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.
Several academic papers have documented investors’ willingness to pay a premium to hold money-like assets and focused on its implications for financial stability. In a New York Fed staff report, we estimate such premium using a quasi-natural experiment, the recent reform of the money market fund (MMF) industry by the Securities and Exchange Commission (SEC).
The financial crisis of 2007-08 and the ensuing recession, the most severe since the 1930s, prompted a wave of regulatory reforms: tighter bank capital and liquidity rules, new failed bank resolution procedures, a stand-alone consumer protection agency, greater transparency in money market funds, central clearing of derivatives, and others as well. As these reforms have gradually taken effect, a healthy debate has emerged in the policy and academic communities over their efficacy in achieving their intended goals and possible unintended consequences.
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.
One goal of the Dodd-Frank Act of 2010 was to end “too big to fail.” Toward that goal, the Act required systemically important financial institutions to submit detailed plans for an orderly resolution (“living wills”) and authorized the FDIC to create an alternative resolution procedure. In response, the FDIC has developed a “single point of entry” (SPOE) strategy, under which healthy parent companies bear the losses of their failing subsidiaries. Since SPOE makes the parent company responsible for subsidiaries’ losses, we would expect that parents have become riskier, relative to their subsidiaries, since the announcement of the SPOE strategy in December 2013. Do bond raters and investors share this view?
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.
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