Small banks tend to have more specialised business models, likely focusing on commercial and retail banking activities, and show limited interconnectedness to other financial institutions. Hence, they are likely to show less intense cyclical patterns compared to large banks. This post investigates whether large and small banks in the UK and US differ in the cyclical patterns of capital positions and credit provision.
Luke Heath Milsom, Vladimír Pažitka, Isabelle Roland and Dariusz Wójcik
Exports of financial services decline with geographical distance at a rate comparable to that for international trade in goods (eg, Portes and Rey (2005)). This is surprising since there are no transportation costs involved. The consensus is that distance is a proxy for information frictions. We show how cross-border syndication can help overcome information barriers to trade in financial services. We zoom in on the equity underwriting industry where international syndicates reduce information asymmetry between issuers and investors located in different countries.
John Hillier, Tom Perkins, Ryan Li, Hannah Bloomfield, Josie Lau, Stefan Claus, Paul Harrington, Shane Latchman and David Humphry
In 2022 a sequence of storms (Dudley, Eunice and Franklin) inflicted a variety of hazards on the UK and across Northwest Europe, resulting in £2.5–4.2 billion in insured losses. They dramatically illustrate the potential risk of a ‘perfect storm’ involving correlated hazards that co-occur and combine to exacerbate the total impact. Recent scientific research reinforces the evidence that extreme winds and inland flooding systematically co-occur. By better modelling how this relationship might raise insurers’ capital risk we can more firmly argue that insurers’ model assumptions should account for key dependencies between perils. This will ensure that insurers continue to accurately assess and manage risks in line with their risk appetite, and that capital for solvency purposes remains appropriate.
Imagine you were tasked with thinking about how financial conditions have changed over a policy tightening cycle. Different economists would come to very different conclusions, and none would necessarily be wrong. Why? Because measuring financial conditions is challenging – for a variety of reasons. A financial conditions index (FCI) is a common solution, and its advantage lies in the disadvantage of the alternative: it is simpler than making a judgement across a range of individual variables. In this post, I propose one method to create a UK FCI. I find that financial conditions have tightened significantly over the past two years, coming from a period of accommodative conditions following Covid.
How concerned should policymakers be as UK business insolvencies have soared to 60-year highs? This phenomenon has been extensively covered in the media; with media outlets attributing the record-breaking numbers to a ‘perfect storm’ of energy prices, supply-chain disruptions and the cost of living squeeze. Insolvencies are a popular measure of economic distress because they have implications for both the financial system and the real economy. For the financial system, an insolvency generally means creditors will incur losses. Insolvent firms will have to cease trading and lay off workers, which affects the real economy. In this blog post, I assess the evolution of corporate insolvencies over time, including the post-Covid surge to understand what these record numbers mean for the UK economy.
In macroeconomic models, economic agents are often assumed to perfectly observe the current state, but in reality they have to infer current conditions (nowcast). Because of information costs, this is not always easy. Information costs are not observable in the data but they can be proxied. A good proxy is disagreement on a near-term forecast because significant disagreement indicates that it is difficult to observe current economic conditions – ie higher information frictions. If the ability to nowcast varies over time, this may affect agents’ ability to respond to various shocks, including monetary policy shocks. My recent paper shows that when disagreement is higher, contractionary monetary policy brings down inflation, at the cost of a greater fall in economic activity.
5.2 million properties in England are at risk of flooding. To ensure the availability and affordability of flood insurance to households in flood-prone areas, the UK Government introduced an innovative reinsurance scheme, Flood Re, in April 2016. It provides insurers with an option to pass the flood-risk element of their policies on to the reinsurer at a lower fixed price according to property council tax band. In a recently published Staff Working Paper, we employ a granular data set of all property transactions and flood events in England. We estimate the effect of Flood Re on property values. We also explore if Flood Re effects are heterogeneous across different subpopulations in England.
After the 2007–08 Global Financial Crisis (GFC), several jurisdictions introduced remuneration regulations for banks with the aim of discouraging excessive risk-taking and short-termism. One such regulation is the bonus cap rule which was first introduced in the European Union (EU) and the United Kingdom (UK) in 2014. This post examines whether the bonus cap mitigates excessive risk-taking and short-termism, both in theory and in practice. It also discusses unintended consequences highlighted by the literature.
During recessions, and indeed pandemics, housing prices usually fall. Yet between March 2020 and December 2021 (‘the pandemic’), housing prices grew in the UK, reaching at the time their highest growth rate in a decade. During this pandemic, many more people could work from home, which potentially influenced their housing choices. In a recent Financial Stability paper, we analyse how changes in peoples’ preferences might have played into house price growth. We find that about half the growth in housing prices was linked to shifts in preferences. This was mostly due to an increased premium paid for houses over flats, with changes in location preferences only contributing marginally. But other interventions and macroeconomic factors also affected housing price growth.
In 1936, John Maynard Keynes coined the famous term ‘Animal Spirits’ to illustrate how people take decisions based on urges, overlooking the benefits and drawbacks of their actions. To what extent are prices of Environmental, Social and Governance (ESG) assets driven by the sentiment of market participants, as opposed to economic fundamentals? To answer this question, I make use of Natural Language Processing (NLP) tools and an original corpus of tweets to capture market sentiment around climate change. Estimating a factor model, I find that sentiment is associated with immediate returns of climate change related stock indices. These results are stronger for days with the most extreme returns. Market sentiment might be particularly useful in explaining large movements in ESG asset prices.
