The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.
The New York Fed engages with individuals, households and businesses in the Second District and maintains an active dialogue in the region. The Bank gathers and shares regional economic intelligence to inform our community and policy makers, and promotes sound financial and economic decisions through community development and education programs.
Gara Afonso, Filippo Curti, Ping McLemore, and Atanas Mihov
Cyber risk poses a major threat to financial stability, yet financial institutions still lack consensus on the definition of and terminology around cyber risk and have no common framework for confronting these hazards. This impedes efforts to measure and manage such risk, diminishing institutions’ individual and collective readiness to handle system-level cyber threats. In this blog post, we describe the proceedings of a recent workshop where leading risk managers, academics, and policy makers gathered to discuss proposals for countering cyber risk. This workshop is part of a joint two-phase initiative run by the Federal Reserve Banks of Richmond and New York and the Fed’s Board of Governors to harmonize cyber risk identification, classification, and measurement practices.
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.
Diego Aragon, Anna Kovner, Vanesa Sanchez, and Peter Van Tassel
The Tax Cuts and Jobs Act (TCJA) is expected to increase after-tax profits for most companies, primarily by lowering the top corporate statutory tax rate from 35 percent to 21 percent. At the same time, the TCJA provides less favorable treatment of net operating losses and limits the deductibility of net interest expense. We explain how the latter set of changes may heighten bank and corporate borrower cyclicality by making bank capital and default risk for highly levered corporations more sensitive to economic downturns.
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.
Nicola Cetorelli, Gerard Dages, Paul Licari, and Afshin Taber
The Committee on the Global Financial System, made up of senior officials from central banks around the world and chaired by New York Fed President William Dudley, recently released a report on “Structural Changes in Banking after the Crisis.” The report includes findings from a wide-ranging study documenting the significant structural adjustments in banking systems around the world in response to regulatory, technological, and market changes after the crisis, while also assessing their implications for financial stability, credit provision, and capital markets activity. It includes a new banking database spanning over twenty-one countries from 2000 to 2016 that could serve as a valuable reference for further analysis. Overall, the study concludes that the changed regulatory and market environment since the crisis has led banks to alter their business models and balance sheets in ways that make them more resilient but also less profitable, while continuing their role as intermediaries providing financial services to the real economy.
The 2007-09 financial crisis highlighted weaknesses in the over‑the‑counter (OTC) derivatives markets and the increased risk of contagion due to the interconnectedness of market participants in these markets. As a response, the global regulatory community introduced a number of reforms to both the market structure and the regulatory environment. The intent of these innovations was to improve the functioning of OTC markets but some market participants have suggested that some of the new regulations may have had unintended consequences. In this post, we discuss some key takeaways from a recent two-day conference on “Over‑the‑Counter Derivatives and Recent Regulatory Changes,” where policymakers, academics, practitioners, and other experts convened to discuss the evolution of OTC derivatives markets after the crisis.
Nicola Cetorelli, Fernando Duarte, and Thomas Eisenbach
Update: A technical appendix has been added to the post.
According to conventional wisdom, an open-ended investment fund that has a floating net asset value (NAV) and no leverage will never experience a run and hence never have to fire-sell assets. In that view, a decline in the value of the fund’s assets will just lead to a commensurate and automatic decline in the fund’s equity—end of story. In this post, we argue that the conventional wisdom is incomplete and then explore some of the systemic risk consequences of investment funds’ vulnerabilities to fire-sale spillovers.
In a recently released New York Fed staff report, we present a forward-looking monitoring program to identify and track time-varying sources of systemic risk. Our program distinguishes between shocks, which are difficult to prevent, and the vulnerabilities that amplify shocks, which can be addressed. Drawing on a substantial body of research, we identify leverage, maturity transformation, interconnectedness, complexity, and the pricing of risk as the primary vulnerabilities in the financial system. The monitoring program tracks these vulnerabilities in four sectors of the economy: asset markets, the banking sector, shadow banking, and the nonfinancial sector. The framework also highlights the policy trade-off between reducing systemic risk and raising the cost of financial intermediation by taking pre-emptive actions to reduce vulnerabilities.
This post is the fifth in a series of six Liberty Street Economics posts on liquidity issues.
One of the most innovative and potentially far-reaching consequences of regulatory reform since the financial crisis has been the development of liquidity regulations for the banking system. While bank regulation traditionally focuses on requiring a minimum amount of capital, liquidity requirements impose a minimum amount of liquid assets. In this post, we provide a conceptual framework that allows us to evaluate the impact of liquidity requirements on economic growth, the creation of systemic risk, and household welfare. Importantly, the framework addresses both liquidity requirements and capital requirements, thus allowing the study of trade-offs and complementarities between these regulatory tools. The reader will find a more detailed discussion in our recent staff report “Liquidity Policies and Systemic Risk.”
The financial crisis of 2007-09 highlighted the central role that financial intermediaries play in the propagation and amplification of shocks. Intermediaries increase leverage during the boom, which then makes them more vulnerable to adverse economic developments. In this post, we review evidence on the balance-sheet behavior of financial intermediaries and describe a channel that allows intermediaries to increase leverage during booms when asset market volatility tends to be low, which in turn forces them to dramatically reduce leverage once volatility increases. As shown during the financial crisis of 2007-08, the contraction of intermediary leverage is accompanied by increases in borrowing rates for households and a contraction of credit. The formal modeling of this amplification mechanism allows a welfare analysis of the tightness of regulatory capital requirements. We find that while loose capital constraints generate excessive risk-taking by intermediaries, tight funding constraints inhibit intermediaries’ risk-sharing and investment functions, which then lowers welfare.
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.
The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
Economic Research Tracker
Liberty Street Economics is now available on the iPhone® and iPad® and can be customized by economic research topic or economist.
We encourage your comments and queries on our posts and will publish them (below the post) subject to the following guidelines:
Please be brief: Comments are limited to 1500 characters.
Please be quick: Comments submitted after COB on Friday will not be published until Monday morning.
Please be aware: Comments submitted shortly before or during the FOMC blackout may not be published until after the blackout.
Please be on-topic and patient: Comments are moderated and will not appear until they have been reviewed to ensure that they are substantive and clearly related to the topic of the post. We reserve the right not to post any comment, and will not post comments that are abusive, harassing, obscene, or commercial in nature. No notice will be given regarding whether a submission will or will not be posted.
The LSE editors ask authors submitting a post to the blog to confirm that they have no conflicts of interest as defined by the American Economic Association in its Disclosure Policy. If an author has sources of financial support or other interests that could be perceived as influencing the research presented in the post, we disclose that fact in a statement prepared by the author and appended to the author information at the end of the post. If the author has no such interests to disclose, no statement is provided. Note, however, that we do indicate in all cases if a data vendor or other party has a right to review a post.