Macroprudential Policy and Financial Stability
Friday, Jan. 4, 2019 10:15 AM - 12:15 PM
- Chair: Stacey Schreft, U.S. Office of Financial Research
The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment
AbstractWe exploit an exogenous reduction in bank supervision to demonstrate a causal effect of supervisory resources on financial institutions' willingness to take risk. The additional risk took the form of more risky loans, faster asset growth, and a greater reliance on low quality capital. This response to less supervision boosted banks' odds of failure. Lastly, we identify channels by which the reduction in supervisory capacity led to more costly failures relative to unaffected areas. None of these patterns are present in depository institutions subject to a different supervisor but otherwise similar to the banks in our sample.
Bail-ins and Bail-outs: Incentives, Connectivity, and Systemic Stability
AbstractWe develop a theoretical framework to address the question of how a regulator can incentive banks to contribute to a voluntary bail-in. At the heart of the issue lies the credibility of the regulator's threat to not bail out the financial system without the bail-in contributions of banks. We show that credible bail-in strategies exist if and only if the network hazard does not exceed a certain threshold. Incentives to join a bail-in consortium are stronger in networks where banks are more exposed to contagion, such as in sparsely connected networks, than in densely connected networks where banks know that a large part of the benefits from their bail-in contributions accrue to other banks. Our results highlight the fundamental role played by the network structure in deciding whether a rescue can be financed from sources within the banking network or whether it has to be financed by taxpayer money.
- G2 - Financial Institutions and Services