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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The cheque republic: money in a modern economy with no banks.

Ben Norman and Peter Zimmerman.

What happens when a country’s banking system shuts down? Just how damaging is it to the economy? During the 20th century, the Republic of Ireland’s banking system suffered industrial disputes, some of which caused the main banks to close for several months. When Greek banks closed temporarily last year, some commentators (e.g. Independent (2015), FT (2015)) recalled how, previously, the Irish public ingeniously circumvented the banking system and kept economic activity going. Using material in the Bank of England’s Archive relating to the 1970 dispute, we shed light on how halcyon those days really were.

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Could new SME lending policies be bad for start-ups?

Paolo Siciliani.

Since the financial crisis a focus for policy has been to increase the flow of lending to small and medium-sized enterprises (SMEs): encouraging lending to SMEs is seen as crucial to economic recovery. One of the more recent proposals is to force large banks to share credit data on their SME customers with rival lenders. The idea is that, by reducing the informational advantage that large banks currently have over their rivals, this could encourage new entrants and growth in SME lending by smaller lenders, which in turn should improve the diversity and hence resilience of the supply of credit to SMEs. However, this post argues that the kind of sharing of SME credit data being envisaged could squeeze lending to SMEs without a credit history.

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Fixing bankers’ pay: punish bad risk management, not bad risk outcomes

Misa Tanaka and John Thanassoulis.

Post-crisis, a number of jurisdictions have introduced remuneration regulations in order to reduce bankers’ incentives to take excessive risks. The UK is pioneering the use of bonus clawbacks under which bankers are asked to pay back their bonuses if certain circumstances materialise at a future date. In our latest paper, we show that clawback can encourage better incentives as long as bankers believe that they will be held liable for failures of risk management, and not simply for poor outcomes. Having a transparent mechanism in place to apply clawbacks is therefore critical. If bankers fear that clawback will be wielded too generally upon bad business outcomes, then it could end up making them excessively risk averse.

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What can we discover from average mortgage rate stats?

Hannah Phaup.

What’s the point of an ‘average’ mortgage rate, and why does it matter to the Bank of England? Mortgage rates often hit the news with headline-grabbing low rates, or rate increases for certain mortgage products. An average mortgage rate strips away the extremes, and as I will outline can represent both what is available to the average borrower, and what is experienced.

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Regulatory arbitrage in action: evidence from cross-border lending and macroprudential policy

Dennis Reinhardt and Rhiannon Sowerbutts.

We find evidence that certain types of macroprudential regulation are avoided by borrowing from abroad. Borrowing by the non-bank sector from abroad increases after an increase in capital requirement, but not after an increase in lending standards. This is likely to be because of the way that the two regulations are applied and is supportive of strong frameworks for reciprocating capital regulation.

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Financial inclusion and central banks

David Bholat, Julia Kowalski and Simon Milward.

Financial inclusion means every adult having access to fair and affordable savings, transactional banking, credit and insurance. It also requires consumers of financial services to be literate around their use. Whilst this sounds unobjectionably positive, expanding access to financial products can create new risks for financial institutions, financial stability and the financially excluded themselves. Policymakers around the world are grappling with how to balance financial stability with the broader goal of financial inclusion, and have responded in different ways. We believe central banks both in developed and developing countries can play a valuable role in promoting financial inclusion and that they need to consider financial inclusion if they are to promote the good of all the people they serve.

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Are reserves still “special”?

Matthew Osborne and Mathew Sim.

Are central bank reserves still ‘special’?

Historically, reserves have been “special” for several reasons: they are the ultimate means of settling payments between banks; they are the main medium through which central banks make monetary policy decisions “happen”; and crucially, central banks have a monopoly supply. Some of this specialness has now reduced, at least in the traditional sense. But, as this blog post goes on to explain, new liquidity standards suggest a new and important role for central bank reserves, which will create challenges as monetary policy is normalised. Finally, control over supply of reserves could also be a useful macroprudential policy tool.

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What do we know about non-bank interconnectedness?

Zijun Liu and Jamie Coen.

Non-banks are clearly important in the financial system – according to the FSB, global non-bank financial intermediation grew to $75 trillion in 2013, roughly half of banking system assets. But how are they connected to banks, and what risks does this pose? Using a new granular dataset on the exposures of banks to non-banks, we gained some important insights into what these interconnections look like in the UK. Banks’ direct credit exposures to non-banks are currently small, but there is evidence that some non-bank financial institutions have entered the core of the repo network. We found little evidence in our dataset that hedge funds are conducting risky credit intermediation, but other non-bank financial institutions seem to be leveraging up via the repo market.

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It’s a model – but is it looking good? When banks’ internal models may be more style than substance.

Tobias Neumann.

Most large banks assess the capital they need for regulatory purposes using ‘internal models’. The idea is that banks are in a better position to judge the risks on their own balance sheets. But there are two fundamental problems that can arise when it comes to modelling. The first is complexity. We live in a complex world, but does that mean a complex model is always the best way of dealing with it? Probably not. The second problem is a lack of ‘events’ (eg defaults). If we cannot observe an event, it is difficult to model it credibly, so internal models may not work well.

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