Macroprudential Policy and Financial Stability
Friday, Jan. 3, 2020 2:30 PM - 4:30 PM (PDT)
- Chair: Luc Laeven, European Central Bank and CEPR
In Macroprudential Policies We Trust
AbstractMacroprudential policies have been implemented based on their ability to control financial disequilibria and the considerable evidence that financial disequilibria in credit markets play an important role in shaping the economic cycle. We evaluate these policies by considering both the short term and long term effects of credit on growth and show that there is an optimal level of financial disequilibrium that maximizes long term growth and volatility. Specifically, we find that when credit to GDP is situated in the third quarter of the distribution of these variables, growth is at its maxima, expansions are longer and recessions are tamed. We also consider the role of macro prudential policy, house price developments and productivity growth in driving these results.
Understanding the Effects of United States Bank Stress Tests
AbstractThe stress testing program for the capital of major US banks is a major innovation of the post-financial crisis era. In contrast to point-in-time Basel 3 requirements, capital required by the stress tests is forward-looking in that the tests assess bank capital adequacy assuming shareholder payouts in a very weak economy, and are designed to assure that banks will have enough capital to continue to carry out their critical role to provide credit. Thus capital requirements can vary each year, be less pro-cyclical, and lead to changes in how banks manage their shareholder payouts. Many US banks subject to the stress tests say that the results of the test are their binding capital requirement. This paper looks at a number of dimensions of the effects of these tests. We utilize the existing research literature and interviews with a number of participants—bankers, consultants, analysts, supervisors--in the stress testing process.
We summarize the research as indicating that US banks subject to the stress tests reduce lending and increase loan rates but also that many businesses are able to get credit from smaller banks not subject to stress tests or other lenders. The reduction in small business loans is more likely in markets where stress-tested banks do not have a branch. In addition, our interviews revealed that participants uniformly believed that stress tests have led to significant improvements in bank risk management and have better integrated risk assessment into decisions on earnings distributions. In addition, capital requirements under the stress tests are less procyclical although we can’t determine whether they will work to support the availability of bank credit in the next downturn until that happens.
Taking Regulation Seriously: Fire Sales under Solvency and Liquidity Constraints
AbstractWhich types of financial shocks and regulatory requirements can combine to produce fire sales? We build a model to analyse how capital and liquidity requirements can affect banks’ liquidation strategies and as a result the probability and cost of fire sales. We find that banks constrained by the leverage ratio prefer to first sell assets that are liquid and held in small amounts, while banks constrained by the risk-weighted capital ratio and liquidity coverage ratio need to trade off assets' liquidity with their regulatory weights. We calibrate the model to the UK banking system, and find that banks' optimal liquidation strategies translate into moderate fire-sale losses even for extremely large solvency shocks. By contrast, severe funding shocks can generate significant losses. Thus focussing exclusively on solvency risk may lead to a significantly underestimation of fire sales risk. Moreover, when studying combined funding and solvency shocks, we find complementarities between the two shocks' effects that cannot be reproduced by focussing on either shock in isolation. These results highlight the importance of accounting for liquidity stress when analysing risks from fire sales.
- G2 - Financial Institutions and Services