Banks come in different shapes and sizes. Do prudential regulations that work well for big banks work as well for small ones? To help us find out, we measure the effectiveness of some key regulatory ratios as predictors of bank failure. We do so using ‘receiver operating characteristic’ – or ‘ROC’ – analysis of simple threshold rules. When we do this, we find that we can use the ratios we test to make better predictions for large banks than for small ones. This provides evidence that an efficient set of regulations for large banks might not be as efficient for small ones.
Dario Bonciani, David Gauthier and Derrick Kanngiesser
Following the global financial crisis in 2008, central banks around the world introduced tighter banking regulations to increase the resilience of the financial sector and reduce the risks of severe financial disruptions during economic downturns. This fact has motivated a large body of literature to assess the role that macroprudential (MacroPru) policies play in mitigating the severity of recessions. One common finding is that the benefits of MacroPru are relatively minor within standard dynamic stochastic general equilibrium (DSGE) models. In a new paper, we show that MacroPru becomes significantly more important in a model that accounts for the long-term negative consequences of financial disruptions.
Repo markets form part of the plumbing of the financial system. They allow participants to borrow cash against collateral and buy back this collateral at a higher price at the end of the transaction. When there is a blockage in repo it has repercussions on financial markets. Since 2014 there have been significant changes in repo functioning, causing policymakers to question why these changes are happening and what it means for financial stability. Our paper addresses these questions. We find fluctuations in repo were driven by changes in dealers’ supply in the pre-Covid period 2014–18. We subsequently consider the possible role that the introduction of the leverage ratio played in the willingness of intermediaries to respond to demands for cash.
Marcus Buckmann, Paula Gallego Marquez, Mariana Gimpelewicz and Sujit Kapadia
Bank failures are very costly for society. Following the 2007/2008 global financial crisis, international regulators introduced a package of new banking regulations, known as Basel III. This includes a wider range of capital and liquidity requirements to protect banks from different risks. But could the additional complexity be unnecessary or even increase risks, as some have argued? In a recent staff working paper, we assess the value of multiple regulatory requirements by examining how different combinations of metrics might have helped prior to the 2007/2008 crisis in gauging banks that subsequently failed. Our results generally support the case for a small portfolio of different regulatory metrics: having belts and braces (or suspenders) can strengthen the resilience of the banking system.
Emerging markets (EMs) have become more exposed to the global financial cycle in recent years. Positive liquidity shocks – that is, a loosening of global funding market conditions – have led to exchange rate appreciations, reductions in long-term bond yields, stock market booms, and increased gross capital flows to EMs (Bhattarai et al (2018)). Negative liquidity shocks on the other hand constitute a tightening of financial conditions, reducing lending and real investment (Bruno and Shin (2015) and Avdjiev et al (2018)).
This year marks 25 years since the failure of Barings Bank. On Sunday 26 February 1995, the 200-year old merchant bank blew up thanks to derivatives trading, which it believed was both risk-free and highly profitable. It was neither of these things. The firm’s star trader was illicitly pursuing a strategy akin to ‘picking up pennies in front of a steam-roller‘. The steamroller arrived in the form the Kobe earthquake. The star trader’s losses ballooned and he doubled up on his bets, unsuccessfully. Barings went bankrupt. The episode captured the public imagination, and helped lead to the creation of a new regulator in the UK.
What was the root cause of the financial crisis? Ask any economist or banker and undoubtedly they will at some point mention leverage (see e.g. here, here and here). Yet when a capital requirement based on leverage — the leverage ratio requirement — was introduced, fierce criticism followed (see e.g. here and here). Drawing on the insights from a working paper, and thinking about the main criticism — that a leverage ratio requirement could cause excessive risk-taking — this seems not to have been the case.
Have post-crisis reforms of banking regulation made banks and lending more resilient to the shock from Covid-19 and if so by how much? This blog takes one specific example – countercyclical capital buffers (CCyBs) – and shows that policy makers in a range of countries were able to quickly release these capital requirements, enabling banks to use the cumulated buffers. This released capital may in turn potentially help banks to support lending. And it will likely benefit lending in the country releasing requirements on buffers as well as banks’ lending to other countries, leading to potential positive international spillovers (see e.g. discussion of spillovers due to macroprudential policies by the ECB and others).
Zahid Amadxarif, James Brookes, Nicola Garbarino, Rajan Patel and Eryk Walczak
The banking reforms that followed the financial crisis of 2007-08 led to an increase in UK banking regulation from almost 400,000 to over 720,000 words. Did the increase in the length of regulation lead to an increase in complexity?
Zahid Amadxarif,Paula Gallego Marquez and Nic Garbarino
“We’ve done a lot to lower prudential barriers to entry into the banking sector […] but have we done enough to lower the equivalent barriers to growth?” asked PRA CEO Sam Woods in a recent speech. To make regulation proportionate, policymakers adapt regulatory requirements to the risks posed by each firm. But regulators face a trade-off between addressing systemic risks in a proportionate way and limiting regulatory complexity. New thresholds can create complexity and cliff-edge effects that can discourage healthy firms from growing. We identify regulatory thresholds for UK banks and building societies using textual analysis on a new dataset that contains the universe of prudential rules.