Financial Intermediation and Crises
Paper Session
Saturday, Jan. 6, 2024 2:30 PM - 4:30 PM (CST)
- Chair: Carola Frydman, Northwestern University
Nonbank Fragility in Credit Markets: Evidence from a Two-Layer Asset Demand System
Abstract
We develop a two-layer asset pricing framework to analyze fragility in the corporate bond market. Households allocate wealth to institutions, which allocate funds to specific assets. The framework generates tractable joint dynamics of flows and asset values, featuring amplification and contagion, by combining a flow-performance relationship for fund flows with a logit model of institutional asset demand. The framework can be estimated using micro-data on bond prices, investors holdings, and fund flows, allowing for rich parameter heterogeneity across assets and institutions. We use the estimated model to quantify the equilibrium effects of unconventional monetary and liquidity policies on bond prices.Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?
Abstract
We analyze U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financialstability. The U.S. banking system’s market value of assets is $2.2 trillion lower than suggested by their
book value of assets accounting for loan portfolios held to maturity. Marked-to-market bank assets have
declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline
of 20%. Most of these asset declines were not hedged by banks with use of interest rate derivatives. We
illustrate in a simple model that uninsured leverage (i.e., Uninsured Debt/Assets) is the key to understanding
whether these losses would lead to some banks in the U.S. becoming insolvent-- unlike insured depositors,
uninsured depositors stand to lose a part of their deposits if the bank fails, potentially giving them incentives
to run. We show that a bank’s survival depends on the market beliefs about the share of uninsured depositors
who will withdraw money following a decline in the market value of bank assets. If interest rate increases
are small such that the bank’s decline in asset values is relatively small, there is no risk of a run equilibrium.
However, for sufficiently high increases in interest rates, we have multiple equilibria in which uninsured
depositor run making banks insolvent (i.e., a “bad” run equilibrium) becomes a possibility. Banks with
smaller initial capitalization and higher uninsured leverage have a smaller range of beliefs supporting a
“good” no run equilibrium, increasing their fragility to uninsured depositor runs. A case study of the
recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized
losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower
capitalization than SVB. On the other hand, SVB had a disproportional share of uninsured funding: only 1
percent of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide
incentives for an SVB uninsured depositor run. We compute similar incentives for the sample of all U.S.
banks. Even if only half of uninsured depositors decide to withdraw, almost 190 banks with assets of $300
billion are at a potential risk of impairment, meaning that the mark-to-market value of their remaining assets
after these withdrawals will be insufficient to repay all insured deposits. If uninsured deposit withdrawals
cause even small fire sales, substantially more banks are at risk. Regions with lower household incomes
and large shares of minorities are more exposed to the bank risk. We also show that decline in banks’ asset
values eroded the ability of banks to withstand adverse credit events – focusing on commercial real estate
loans. Overall, these calculations suggest that recent declines in bank asset values very significantly
increased the fragility of the US banking system to uninsured depositor runs.
Discussant(s)
Chenzi Xu
,
Stanford University
Tyler Muir
,
University of California-Los Angeles
Itay Goldstein
,
University of Pennsylvania
JEL Classifications
- G2 - Financial Institutions and Services