Category Archives: Financial Stability

Financial services exports and financial openness: two sides of the same coin

Carlos Eduardo van Hombeeck

The UK has a comparative advantage in financial services. But specialisation in this activity brings with it the challenge of the large gross capital flows that are linked to financial services exports.

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Filed under Bitesize, Financial Stability, International Economics

Who’s driving consumer credit growth?

Ben Guttman-Kenney, Liam Kirwin, Sagar Shah

Consumer credit growth has raised concern in some quarters. This type of borrowing – which covers mainstream products such as credit cards, motor finance, personal loans and less mainstream ones such as rent-to-own agreements – has been growing at a rapid 10% a year. What’s been driving this credit growth, and how worried should policymakers be?

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Filed under Financial Stability, Macroeconomics, Macroprudential Regulation, Microprudential Regulation

Sterling weakness: FX mismatch risks in the UK corporate sector

Rajveer Berar

What could falls in sterling mean for UK firms’ ability to sustain foreign currency (FX) debt obligations? The value of sterling began falling around two years ago and dropped further after the EU referendum – remaining around these lower values ever since. There is every possibility that sterling may stay low for the foreseeable future – creating both potential winners and losers. In this piece, I investigate one particular channel for losses related to sterling weakness: whether UK firms could find meeting their FX debt obligations more challenging. By reviewing market intelligence, market prices and derivatives databases, I find limited evidence that sterling weakness has yet produced any significant changes to UK firms’ ability to manage their FX debt obligations.

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Filed under Currency, Financial Stability, Macroeconomics

Do investors amplify or cushion corporate bond market sell-offs?

Robert Czech and Matt Roberts-Sklar

The market for corporate debt plays a crucial role in the global financial system by providing funding to the real economy. However, little is known about investment behaviour in the secondary corporate bond market. When bond yields rise, how do investors react? Do they buy more bonds, perhaps leading to an offsetting downward‎ pressure on yields? Or do they sell bonds, potentially amplifying the yield rise? For the sterling corporate bond market we find that asset managers generally buy bonds after an increase in yields. But, based on their behaviour during the 2013 ‘taper tantrum’, we find that their behaviour flips in stressed market conditions: they sell bonds, perhaps exacerbating the sell-off.

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Filed under Financial Markets, Financial Stability

Will Pay Clawback Tame Damaging Risk-Taking In The City?

Misa Tanaka and John Thanassoulis

In the 2007-8 global financial crisis, a number of banks were bailed out by taxpayers while their most senior employees were paid extraordinary bonuses up to that point (E.g. here, here and here). The resulting public outcry led to new regulations allowing clawback of bonuses earned on the back of decisions that subsequently damage their banks and the wider economy. But will these rules work? Our theoretical research shows that sophisticated banks can game clawback regulations by altering pay contracts so as to incentivise bankers to take risks that benefit shareholders but that are excessive for society. The entire pay package matters, and so, understanding how it shapes risk-taking incentives is as important as monitoring compliance with clawback rules.

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Filed under Banking, Financial Stability, Macroprudential Regulation

The decline of solvency contagion risk

Marco Bardoscia, Paolo Barucca, Adam Brinley Codd and John Hill

The failure of Lehman Brothers on 15 September 2008 sent shockwaves around the world.  But the losses at Lehman Brothers were only the start of the problem.  The price of their bonds halved, almost overnight.  Other institutions that held Lehman’s debt faced huge losses, and markets feared that those losses could trigger further failures. The good news is that our latest research suggests that risks within the UK banking system from one such contagion channel, “solvency contagion”, have declined sharply since 2008. We have developed a new model which quantifies risk from this channel, and helps us understand why it has fallen.  Regulators are using the model to monitor this particular source of risk as part of the Bank’s annual concurrent stress test exercise.

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Filed under Financial Stability, Macroprudential Regulation, New Methodologies

Reducing counterparty credit risk in uncleared markets – but what are the costs?

Darren Massey

When you rent a house, the landlord – your counterparty – will take a security deposit as prepayment to cover potential costs such as unpaid rent or bills. New regulations introduced in major jurisdictions will require major participants in uncleared over-the-counter derivatives (OTCDs) markets to uniformly exchange initial margin – a more complicated version of a security deposit. Much like a rental deposit, OTCD parties must agree the deposit amount, who should hold the funds, and crucially, when a claim can be made. And just like the rental deposit, the protection provided brings new challenges and risks. This blog outlines some of these risks in the OTCD market, and as the framework is implemented, suggests that firms and regulators should consider these risks.

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Filed under Financial Markets, Financial Stability, Macroprudential Regulation, Market Infrastructure

Insurance companies: amplifiers or the white knights of financial markets?

Graeme Douglas, Nicholas Vause and Joseph Noss

Risky asset prices plummeted following the collapse of Lehman Brothers in 2008. Whilst driven partly by deteriorations in fundamental news, these falls were amplified by ‘flighty’ investors that sold at the first signs of trouble. Conventional wisdom dictates that life insurers, with their long-term investment horizons, are better placed than most to ‘lean against the wind’ by looking through short-term fluctuations in asset prices. They could thereby stabilise prices when others are selling. But the structure of regulations can greatly influence insurers’ investment incentives. Using our model of insurers’ asset allocations, we find that new ‘Solvency II’ regulations reduce UK life insurers’ willingness to act as the white knights of financial markets, particularly in the face of falling interest rates.

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Filed under Financial Markets, Financial Stability, Insurance, Macroprudential Regulation

10 Years after Northern Rock – is the UK more or less likely to see another bank run?

Stephen Clarke

(Northern Rock image – Lee Jordan – Flickr, reproduced from wikimedia commons under CCA licence)

Ten years ago this month, queues of people started to form early in the morning outside Northern Rock branches across the UK, to withdraw their money out of fear that their bank would soon collapse.  As the day wore on panic spread, and the run continued until when the government stepped in to guarantee all Northern Rock deposits. It was the UK’s first retail bank run since the 19th century and one of the first symptoms of the global financial crisis.  This anniversary is an appropriate time to reflect on those events, but also to look forward and assess how things have moved on in the last decade, and whether something similar could ever happen again.

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Filed under Economic History, Financial Stability, Macroprudential Regulation, Microprudential Regulation