Do banks need belts and braces?

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.

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How competitive are UK insurance markets?

Fraser Drew, David Humphry, Michael Straughan and Eleanor Watson

For most of us buying insurance nowadays, price comparison websites offer plenty of choice. But how much competition in insurance markets is there? There are very few studies that address this question (see here for a summary), unlike for banking where there is a wide literature. We take an exploratory approach to address the question, applying benchmarks used in competition research to a unique set of reporting data across multiple UK insurance regulatory regimes, with the hope of stimulating further work. We find competition generally works well in UK life and non-life insurance markets, despite increases in life market concentration over the past 25 years. However, competition regulators have found practices in specific markets that harm consumers.

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The leverage ratio: a balance between risk and safety

Jonathan Smith

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.

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Setting boundaries: finding thresholds in bank regulation

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.

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How to see it coming: predicting bank distress with machine learning

Joel Suss and Henry Treitel

The need to see it coming

The great American baseball sage, Yogi Berra, is thought to have once remarked: ‘It’s tough to make predictions, especially about the future’. That is certainly true, but thankfully the accelerating development and deployment of machine learning methodologies in recent years is making prediction easier and easier. That is good news for many sectors and activities, including microprudential regulation. In this post, we show how machine learning can be applied to help regulators. In particular, we outline our recent research that develops an early warning system of bank distress, demonstrating the improved performance of machine learning techniques relative to traditional approaches.

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Fluttering and falling: banks’ capital requirements for credit valuation adjustment (CVA) risk since 2014

Giulio Malberti and Thom Adcock

The financial crisis exposed banks’ vulnerability to a type of risk associated with derivatives: credit valuation adjustment (CVA) risk. Despite being a major driver of losses – around $43 billion across 10 banks according to one estimate – there had been no capital requirement to cushion banks against these losses. New rules in 2014 changed this.

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New banking regulation: is it affecting the clearing of derivatives?

Jonathan Smith and Gerardo Ferrara

Just like the beginning of an unforeseen family argument, two key tenets of the post-crisis reforms have unexpectedly started to butt heads: the leverage ratio capital requirement and the mandatory requirement to centrally clear certain over-the-counter (OTC) derivatives.

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How do bonus structures affect risk and effort choices? Insight from a lab experiment

Qun Harris, Analise Mercieca, Emma Soane and Misa Tanaka.

The bonus regulations were introduced based on the consensus amongst financial regulators that compensation practices were a contributing factor to the 2008-9 financial crisis. But little is known about how they affect behaviour in practice. So we conducted a lab experiment to examine how different bonus structures affect individuals’ risk and effort choices. We find that restrictions on bonuses, such as a bonus cap, can incentivise people to take less risk. But their risk-mitigating effects weaken or disappear once bonus payment is made conditional on hitting a high performance target. We also find some evidence that bonus cap discourages effort to search for better projects.

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Does competition help or hinder bank stability in the UK?

Sebastian de-Ramon, Bill Francis and Michael Straughan.

There is a debate in the regulatory and academic community about whether competition is good or bad for bank stability, particularly following the financial crisis (see Chapter 6 of the Independent Commission on Banking final report). The debate tends to be seen as a head-to-head argument between two camps: those that see competition as bad for stability (competition-fragility) versus those that see competition as good (competition-stability). In new research, we look at how competition affects the stability of banks in the UK. We find that competition affects less stable firms differently than more stable firms and that focussing on what happens to the average firm may not be sufficient.

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Reflections on the Bank’s History

David Kynaston

Last May, the Bank organised an economic history workshop at the St Clere Estate, home of former governor Montagu Norman. In this guest post, one of the speakers David Kynaston, visiting Professor at Kingston University, reflects on more than three centuries of Bank history…

It was a huge honour to be asked by Mervyn King to write a history of the Bank. The eventual book, Till Time’s Last Sand, was published last autumn. It covers 1694 to 2013 and is based heavily on the Bank’s own archive. Fitting more than 300 years of history into a single volume was a difficult task, and condensing that into a short blog post is harder still. Here I will try to bring out a handful of key lessons from my research into the Bank’s history that might be useful for the policymakers, economists and other interested observers of today – and their successors…

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