What does the UK experience tell us about cyclicality in banks’ risk appetite?

Matthew Osborne, Alistair Milne & Ana-Maria Fuertes.

Does the risk appetite of banks vary over the cycle? Our recent research paper sheds light on this issue by examining the time-varying correlation between banks’ capital ratios and lending rates which cannot be explained by bank characteristics, such as capital requirements, portfolio risk, size and market share, or macroeconomic factors. The relationship notably differs between episodes of rapid credit expansion (“good times”), and episodes of crisis with moderate or negative credit growth (“bad times”). This is difficult to reconcile with traditional theories of bank intermediation, but is consistent with recent theories emphasising cyclical variation in bank leverage and risk appetite.

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Recycling is good for the liquidity environment: Why ending QE shouldn’t stop banks from being able to make CHAPS payments

Evangelos Benos & Gary Harper.

Since QE began, banks have had a lot more liquidity to make payments. But some have argued (in a nutshell) that banks are reliant on this extra liquidity to make their CHAPS payments and it would be difficult to remove it from the system. Our analysis shows that banks don’t need a great deal of liquidity to make their payments simply because they recycle such a high proportion of them. In practical terms, banks do not rely on high reserves balances to make their CHAPS payments so unwinding QE shouldn’t have any impact on banks’ ability to do just that. We also briefly go over the potential reasons for this such as the CHAPS throughput rules, the Liquidity Savings Mechanism, and the tiered structure of CHAPS.

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The growth of peer-to-peer lending platforms and prospects for banks’ disintermediation – hype or real threat?

Paolo Siciliani.

Peer-to-peer lending platforms (P2P platforms) emerged after the financial crisis by catering for pent-up demand for unsecured borrowing from individuals and small businesses. Ten years after the conception of P2P platforms, the question is whether they may soon start to penetrate more mainstream lending markets and thereby challenge high street lenders. For example, according to the latest survey compiled by Nesta, P2P lending for the year 2015 was the equivalent of 3.9% of new loans lent to SMEs, although the outstanding stock of P2P lending is much lower. This post considers how seriously in practice to take this threat to the traditional banking model.

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Shocks Happen: Are Retail Deposits the Answer?

John Hill and Jeremy Chiu.

In September 2007, Northern Rock became the victim of the UK’s first bank-run since 1878. Northern Rock had lost access to the wholesale markets on which it relied for its funding. Bank funding has remained a key issue for policymakers in the wake of the crisis, and has been the subject of new rules designed to promote funding resilience. Today, banks are more reliant on retail deposits for their funding, but this could present other issues for the dynamics of retail deposits that are less well understood. In this post, we introduce some of our own research that shows that banks are unable to raise deposits quickly in order to plug funding gaps opened up by adverse shocks.

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Bank liquidity requirements: How to get more bang for your buck

Iñaki Aldasoro, Ester Faia, Gerardo Ferrara, Sam Langfield, Zijun Liu and Tomohiro Ota.

We make the case for a macroprudential approach to liquidity requirements in the cross-section of banks. Currently, the liquidity coverage requirement is applied uniformly across banks. This microprudential approach overlooks externalities: owing to their size, complexity and position in the interbank funding network, some banks can cause inordinate damage to the rest of the banking system. When externalities are taken into account, we show that these systemically important banks should be subject to more stringent liquidity requirements. This cross-sectional macroprudential approach promises “more bang for the buck”: systemic risk can be reduced without increasing the stringency of liquidity requirements for the banking system as a whole.

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International business cycle synchronization: what is the role of financial linkages?

Ambrogio Cesa-Bianchi, Jean Imbs and Jumana Saleheen.

It is a well-known fact that financial integration has increased dramatically over the past few decades. Has this rise led to higher or lower business cycle synchronization? The answer depends crucially on the source of the shock. In response to common shocks, financial integration tends to lower business cycle synchronization. But in response to a country-specific shock, business cycles are more synchronised between countries that are more ﬁnancially integrated.

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Modelling banking sector shocks and unconventional policy: new wine in old bottles?

James Cloyne, Ryland Thomas and Alex Tuckett.

The financial crisis has thrown up a huge number of empirical challenges for academic and professional economists. The search is on for a framework with a rich enough variety of financial and real variables to examine both the financial shocks that caused the Great Recession and the unconventional policies, such as Quantitative Easing (QE), that were designed to combat it. In a new paper we show how using an older structural econometric modelling approach can be used to provide insights into these questions in ways other models currently cannot. So what are the advantages of going back to an older tradition of modelling?
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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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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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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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