Kristin Forbes, Christian Friedrich and Dennis Reinhardt
Recent episodes of financial stress, including the ‘dash for cash’ at the onset of the Covid-19 (Covid) pandemic, pressure in the UK’s liability-driven investment funds in 2022, and the collapse of Silicon Valley Bank in 2023, were stark reminders of the vulnerability of financial institutions to shocks that disrupt liquidity and access to funding. This post explores how the funding choices of banking systems and corporates affected their resilience during the early stages of Covid and whether subsequent policy actions were effective at mitigating financial stress. The results suggest that policy responses targeting specific structural vulnerabilities were successful at reducing financial stress.
Kristina Bluwstein, Sudipto Karmakar and David Aikman
Inflation reached almost 9% in July 2022, its highest reading since the early 1990s. A large proportion of the working age population will never have experienced such price increases, or the prospect of higher interest rates to bring inflation back under control. In recent years, many commentators have been concerned about risks to financial stability from the prolonged period of low rates, including the possibility of financial institutions searching for yield by taking on riskier debt structures. But what about the opposite case? What financial stability risks do high inflation and increasing interest rates pose?
In less than two decades, the system of market-based finance (MBF) – which involves mainly non-bank financial institutions (NBFIs) providing credit to the economy through bonds rather than loans – has both mitigated and amplified the economic effects of financial crises. It mitigated effects after the global financial crisis (GFC), when it substituted for banks in providing credit. But it amplified effects at the outbreak of the Covid pandemic, when NBFIs propagated a dash for cash (DFC), and more recently when pension fund gilt sales exacerbated increases in yields. This post outlines five different aspects of MBF that contribute to such amplification and summarises some policy proposals – suggested and debated internationally by regulators, academics and market participants – to make MBF more resilient.
Open-ended funds (OEFs) offer daily redemptions to investors, often while holding illiquid assets that take longer to sell. There is evidence that this mismatch creates an incentive for investors to redeem ahead of others, which could lead to large redemptions from OEFs and asset price falls. Some research has suggested that ‘swing pricing’ can help to moderate these redemptions, but until now, no-one has considered the impact of its use on the wider economy. In a recent paper, we carry out a financial stability cost-benefit analysis of more widespread and consistent usage of swing pricing by OEFs, finding that enhanced swing pricing could reduce amplification of shocks to corporate bond prices, providing benefits to the financial system and economy.
Alina Barnett, Sinem Hacioglu Hoke and Simon Lloyd
Since 2007, macroprudential policymakers have grappled with a broad set of vulnerabilities. While regulators cannot be sure what risks the next decade will feature, they can be sure that the set of issues will continuously evolve. In this post, we explore threetimely challenges that financial stability policymakers are likely to face in the coming years, including risks associated with: non-bank financial intermediation, cryptoassets and decentralised finance (DeFi), and climate change. These challenges have been noted by many, and are already stimulating development of macroprudential frameworks. But while some of this development can build on well-grounded principles for financial stability policy, other aspects are likely to come up against threetimeless challenges, requiring novel and innovative thinking to overcome.
Stephen Millard, Margarita Rubio and Alexandra Varadi
The 2008 global financial crisis showed the need for effective macroprudential policy. But what tools should macroprudential policy makers use and how effective are they? We examined these questions in in a recent staff working paper. We introduced different macroprudential tools into a dynamic stochastic general equilibrium (DSGE) model of the UK economy and compared their impact on the economy and household welfare, as well as their interaction with each other and with monetary policy. We found that capital requirements reduce the effects of financial shocks. Instead, a limit on how much of borrowers’ income is spent on mortgage interest payments reduces the volatility of lending, output and inflation resulting from housing market shocks.
Central banks don’t just care about what is expected to happen. They also care about what could happen if things turn out worse than expected. In line with this, an emerging literature has developed models for measuring and predicting overall levels of macroeconomic risk. This body of work has focused on estimating the level of ‘tail risk‘ in a country by monitoring a range of domestic developments. But this misses a key part of the picture. In a recent Staff Working Paper, we show that monitoring developments abroad is as important as monitoring developments at home when assessing the vulnerability of the economy to a severe downturn.
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).
Today’s financial system is global: credit and several financial asset classes show booms and busts across countries, sometimes with severe repercussions to the global economy. Yet it is debated to what extent common dynamics rather than domestic cycles lie behind financial fluctuations and whether the impact of global drivers is growing. In a recent Staff Working Paper, we observe various global financial cycles going as far back as the 19th century. We find that a volatile global equity price cycle is nowadays the main driver of stock prices across advanced economies. Global cycles in credit and house prices have become larger and longer over the last 30 years, having gained relevance in economies that are more financially open and developed.