The 1866 collapse of Overend Gurney sparked widespread panic as investors flocked to banks and other institutions demanding their money back. Failure to provide substantial liquidity threatened to bring down the entire financial system. The Governors of the Bank of England asked the Chancellor to relax the constraints of the 1844 Bank Charter Act, by granting an indemnity to allow the issue of unbacked currency. The Chancellor’s reply, and the policy response it initiated, would save the day, and go down in central banking history as pivotal in the foundation of the “lender of last resort”, a function which has been fundamental to central banking practice ever since.
A railway boom in America’s Midwest goes spectacularly bust. Sixty-two of New York’s commercial banks close – out of sixty-three. Meanwhile in Britain, a decade gilt-edged by gold discoveries in Australia and fuelled by the Crimean War was beginning to lose its lustre. Thus the scene was set for the first global financial crisis shaking markets in New York, London, Paris and across the world. A crisis so severe it forced the Bank of England to “break the law” to survive.
Huaxiang Huang and Ryland Thomas.
The financial crisis of 1847 has often been dubbed “The trial of the Bank Charter Act of 1844 (Morgan (1952)). The Act sought to remedy the errors of crises past by trying to prevent the overissue of banknotes that many had felt was the major cause of previous crises in 1825 and 1837. The Act gave the Bank of England an effective monopoly in the issue of new bank notes and those additional notes had to be backed one for one with gold. But this had a crucial unintended consequence: it made it difficult for the Bank to act as a lender of last resort. When the crisis struck, the limits imposed by the Act effectively had to be suspended.
Colm Aodh Manning.
For the past three years, the Bank of England (the Bank) has carried out an annual ‘stress test’ of the UK’s largest banks. To do this, it designed a narrative-based stress scenario in 2014 and 2015. The goal was to determine the banking sector’s resilience to pertinent threats, like recessions or a sharp fall in house prices. However, changing scenarios each year makes it difficult to judge how banks’ overall vulnerability to risks changes over time. Since the crisis we learned that risks build in the good times and capital in the banking system should rise to reflect this. This is why – beginning this year – the Bank has also run an Annual Cyclical Scenario (ACS).
Peter Eckley and Liam Kirwin.
In the world of bank capital regulation, minimum requirements grab all the headlines. But actual capital resources are what absorb unexpected losses. Banks and building societies typically hold resources substantially in excess of requirements – called the capital surplus. One reason is to avoid breaching the minimum due to unforeseen shocks. Another is to build resources in anticipation of requirements arising from growth or regulatory change. The chart shows how capital surpluses (on total requirements including Pillars 1 and 2, and all types of capital) have varied in recent decades. It is based on historical data from regulatory returns.
Saleem Bahaj, Jonathan Bridges, Cian O’Neill & Frederic Malherbe.
It’s not just what you do; it’s when you do it – many decisions in life have “state contingent” costs and benefits. The payoffs from haymaking depend crucially upon the weather. Putting fodder away for a rainy day can be quick, cheap and prudent when skies are blue. But results may take a soggy and unproductive turn, if poorly timed. The financial climate is similarly important when assessing the costs and benefits of macroprudential policy changes. We argue that it is best to build the countercyclical capital buffer when the macroeconomic sun is shining. We find strong empirical evidence to support our claim.
Christopher Hackworth, Nicola Shadbolt and David Seaward.
While official housing market statistics are relatively timely and high frequency, they usually come with a lag of at least one month. So indicators that lead official estimates are helpful for identifying turning points, or any ‘shocks’ to the economy.
Sometimes the obvious questions are the hardest to answer. In this post I ask how much of what the Bank and the financial industry in general write can actually be read by a broad audience. Based on my findings, I suggest that both must try harder if claims of accessibility are to be meaningful.
Arzu Uluc and Tomasz Wieladek.
Following the global financial crisis of 2007-08, financial reform introduced time-varying capital requirements to raise the resilience of the financial system. But do we really understand how this policy works and the impact it is likely to have on UK banks’ largest activity, mortgage lending? In a recent paper we investigated the UK experience of time-varying microprudential capital requirements before the financial crisis. We found that an increase in this requirement intended to make a bank more resilient actually induced it to shift into riskier mortgage lending.
Francesc R. Tous, Puriya Abbassi, Rajkamal Iyer, José-Luis Peydró.
What are the consequences of proprietary trading? Banks typically hold and trade a significant amount of securities, and during the financial crisis, many of these securities suffered strong price declines. How did banks react? This is precisely what we investigate for the case of Germany in a recently published paper. We find that some banks increased their investments in securities, especially for those securities that suffered price drops. This strategy delivered high returns; but at the same time, these banks pulled back on lending to the real economy, since during the financial crisis they could not easily raise new (long-term) funding. Our findings suggest that proprietary trading during a crisis can lead to less lending to the real sector.