Climate and capital: some outstanding issues

Marco Bardoscia, Benjamin Guin and Misa Tanaka

There is a lively debate about whether and how capital regulations for banks and insurers should be adjusted in response to climate change. The Bank of England will host a conference later this year to discuss the points in favour of and against adjustments to the regulatory capital framework to take account of climate-related financial risks. The call for papers asks for research on appropriate capital tools to address these risks, eg whether risks point to microprudential tools which are firm specific or rather macroprudential system-wide ones. Moreover, it asks for research on an appropriate time horizon over which the risks should be considered and how scenarios and forward-looking data should be used. This post will review the existing literature and identify some key gaps.

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Does regulation bite only the less profitable? Evidence from the too big to fail reforms

Tirupam Goel, Ulf Lewrick and Aakriti Mathur

Reforms following the 2008 financial crisis have led to significant increases in banks’ capital requirements. A large literature since then has focused on understanding how banks respond to these changes. Our new paper shows that pre-reform profitability is a vital, but often overlooked, driver of banks’ responses. Profitability determines the opportunity cost of shrinking assets, and underpins the ability to generate capital. We develop a stylised model which predicts that a more profitable bank would choose to shrink by less (or grow by more) compared to a less profitable bank in response to higher capital requirements. Combining textual analysis of banks’ annual reports with the assessment of a key too big to fail (TBTF) reform, we show that this prediction holds in practice.

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Decomposing changes in the functioning of the sterling repo market from 2014 to 2018

Rupal Patel

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.

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