Stress tests: The small print matters

Dirk Tasche.

Stress testing is ubiquitous in today’s banking supervision regime. The stress test results are eagerly anticipated and received by the public and can have serious consequences for banks presenting ‘bad’ numbers. The public discussion of the stress scenarios seems to be focussed on their economic meaning (here is an example). The statistical smallprint relating to stress tests receives much less public attention. I pick up two modelling choices for closer inspection:

  • Stress scenarios are meant to be point scenarios.
  • Stress test results tend to be presented as single values.

I demonstrate that depending on the understanding of the scenario and the representation of the results, there is a wide range of plausible outcomes of a stress test.

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Is sterling ever a fashionable currency?

Jihyoung Yi.

Despite the fact that the US dollar and the euro are the most traded currencies in terms of shares of average daily turnover (2013, BIS), my analysis suggests that foreign exchange rate (FX) market trends are usually driven by other currencies.  Most notably, ‘commodity’ currencies (such as the Australian dollar and Mexican peso) and ‘carry-trade’ currencies (such as the Swiss franc and Japanese yen) tend to be the main drivers. In contrast, sterling typically does not often drive currency movements – FX strategists often consider that it is rare for sterling to be ‘the story’ amongst the speculative community in the FX market.  But this is not always the case.  This blog post zooms in on a selection of sub-periods to show when particular currencies, including sterling, became ‘focal’.

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How do firms adjust to falls in demand?

Srdan Tatomir.

How do firms response to falls in demand for their products in the real world?  Do they cut wages?  Or are they able only to freeze them?  What other methods can they use to adjust their labour costs?  And does any of this matter? The answer to the final question is emphatically yes. How firms adjust the quantity and cost of their labour input, particularly in response to a downturn, is relevant for monetary policy. If firms are unable to cut wages – what economists call ‘downward nominal wage rigidity’ (DNWR) – then they have to reduce the number of employees, increasing unemployment, further depressing output and  weighing on inflation.

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When banks say ‘No’: how the credit crunch lowered UK productivity

Jeremy Franklin, May Rostom & Gregory Thwaites.

In the aftermath of the 2007/8 financial crisis bank lending to firms fell back sharply and investment plummeted.  And at the same time, growth in labour productivity and wages fell, with neither fully recovering since (Chart 1).  Are these facts causally linked, and if so, in which direction?  Did firms stop borrowing because they had no good uses for the money, or did banks cut lending, making it harder for firms to do business?  In a new paper, we find a way to distinguish between the two.  We measure how changes in the amount firms were able to borrow affected how much they invested, how much their workers produced and earned, and how likely firms were to survive.

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What do Agents’ company visit scores say about the weakness of wage growth?

Simon Caunt, David England and Imogen Shepherd.

AWE growth has picked up over the past year but stalled in recent months, remaining some way below pre-recession levels.  Should we expect that weakness to continue?  One way to gauge wage pressures is through the company visit scores (CVS) the Bank’s Agents assign for businesses they meet.  Agents score a range of variables, including turnover, employment and costs, -5 to +5, generally according to growth.  An anonymised CVS dataset is published on the Bank’s website.  Here we look at what CVS say about prospects for pay, considering factors such as recruitment difficulties, low inflation, public sector pay and the National Living Wage.  Overall, we think this evidence points to continued modest rates of wage growth over the coming year.

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Rescuing a SIFI, Halting a Panic: the Barings Crisis of 1890

Eugene White.

The collapse of Northern Rock in 2007 and Bear Sterns, Lehman Brothers, and AIG in 2008 renewed the debate over how a lender of last resort should respond to a troubled systemically important financial institution (SIFI). Based on research in the Bank of England Archive, this post re-examines a crisis in 1890 when the Bank, supported by central bank cooperation, rescued Baring Brothers & Co. and quashed a banking panic and a currency crisis, while mitigating moral hazard.  This rescue is significant because it combined features similar to those mandated by recent U.K., U.S., and European reforms to ensure an orderly liquidation of SIFIs and increase the accountability of senior management (e.g. Title II of the Dodd-Frank Act (2010); the U.K. “Senior Managers Regime”).

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Saving Liquidity in a Liquidity-abundant World: Why don’t banks use less liquidity when making high-value payments?

David Seaward.

CHAPS banks have oodles of liquidity and are not afraid to use it, as quantitative easing has meant banks accumulated unprecedented quantities of reserves. And in this liquidity-abundant world, banks are less likely to be concerned with how well they use tools for liquidity saving in the Bank’s Real-Time Gross Settlement (RTGS) infrastructure. And besides, the timings of liquidity-hungry payments are stubborn. They can’t always be retimed to optimise liquidity usage, and this means that the potential for liquidity savings in RTGS from the Bank’s Liquidity Savings Mechanism (LSM) is limited.

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From Berlin to Basel: what can 1930s Germany teach us about banking regulation?

Tobias Neumann.

Two of the country’s largest banks collapse.  The subsequent panic brings the banking system to its knees and only a costly government bail-out prevents even greater catastrophe.  A radical re-think of regulation is needed.  No, it’s not London or New York in 2008.  It is Berlin in the 1930s.  It’s when risk-weighted capital regulation was born, notably to be used alongside a range of other tools; for example, liquidity requirements and such modern ideas as bonus deferrals and capital conservation.  But the idea that no single regulatory measure is likely to be sufficient on its own was forgotten.  In 2008 it had to be painfully re-learned making this episode a striking example of the importance of studying past financial crises.

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