Capital Regulation with Two Banking Sectors: Cyclicality and Implementation

We present a capital regulation policy in a model in which banks can choose to be unregulated, by operating in the shadow banking sector, when the cost of being regulated (restriction on portfolio risk) exceeds the benefit (cheaper funding/insurance). We show that the welfare maximizing capital requirement policy can be procyclical: lower requirement during booms and higher requirement during recessions. Our policy specifies the level of capital requirement as a function of the observed relative size of the unregulated and regulated banking sectors. This specification achieves the optimal aggregate risk exposure by obtaining the right mix of the two sectors.     

International Propagation of the Credit Crisis: Lessons for Bank Regulation*

The authors use a large sample of non‐U.S. banks to examine the origins and spread of the 2007–2009 crisis. Using both stock market and structural variables, they test whether the effects of the crisis on individual banks are better explained by crisis models or by the VaR‐type analysis of the Basel system. The latter emphasizes risk weightings for individual assets while ignoring linkages that could leave banks exposed to systemic shocks. Consistent with crisis models, the authors find that a small set of pre‐crisis measures of a bank's international linkages, leverage, and the fragility of its liability structure does a good job of discriminating between banks that suffered a large impact and those that did not. (Indeed, these measures explain almost 50% of the differences among banks' stock returns during the crisis period, and almost 40% of the changes in the variability of those returns.) The authors also provide evidence of both a direct linkage among banks' stock returns and an indirect linkage that could reflect either linkages in the real economy or common demands by investors for liquidity. The authors run a “horse race” that demonstrates that simple measures of book leverage were better predictors of bank performance than the Basel capital ratios. They find that banks with lower Basel risk weightings prior to the crisis proved, on average, to be more exposed to the crisis. The authors' explanation is that banks with lower Basel risk measures tended to operate with higher leverage and more aggressive funding strategies, which in turn exposed them to greater crisis risk (even as they conformed to the letter of the Basel system in terms of asset risk measures). Finally, the authors find no evidence that substandard governance was a separate contributing factor to crisis exposure. Banks with substantial international business that were exposed to systemic shocks had high governance scores.     

An Alternative View on Regulatory Distortions in a Competitive Financial Services Industry

We present an alternative view on regulatory distortions in the banking industry. We use the duopoly model developed by Boot, Dezelan, and Milbourn (BDM, 2000), where a bank with low monitoring costs faces a bank with high monitoring costs. We show that when the initial level of the capital requirement is low, an increase of the minimum ratio between capital and total assets causes a higher decrease in profits at the bad bank than at the good bank. This finding contrasts with BDM's theorem 1, which predicts that a regulation imposing an identical increase in production costs on both banks will cause a greater loss in profits at the good bank than at the bad bank. We also look at the impact of an increase in the minimum ratio between capital and total assets on the profits of a representative bank in three other competitive environments identified in BDM. We find that the decrease in the representative bank's profit caused by an increase in the capital requirement is larger when the bank faces competition from an unregulated firm than when it faces a regulated competitor or no competitor at all. This result is consistent with BDM's theorem 2.     

Assessing Systemic Risk Exposure from Banks and GSEs Under Alternative Approaches to Capital Regulation

A key function of capital regulation is to mitigate the potential for systemic financial risk by maintaining public confidence in the ability of regulated market participants to honor their financial obligations in times of market stress. While it is well known that the portfolios of banks and non-banks, especially those intermediaries specializing in mortgage securitization or in specialized mortgage lending, differ in important respects, debate over alternative capital regulations has yet to recognize the implications of these differences, despite the increasing importance of non-bank intermediaries in risk-sharing markets. This paper uses a simple two-date discrete state space exchange economy with opportunities for moral hazard on the part of financial intermediaries to investigate the design of capital regulations to control systemic risk. Holding constant asset risks, we show that intermediaries that issue contingent liabilities may exhibit low or no risk of insolvency while holding significantly less capital than deposit-taking institutions because banks primarily issue claims that promise fixed payments in all states of nature. We also show that, rather than raising capital requirements, the control of systemic risk may involve lowering capital requirements and extending guarantees to liability-holders, without a necessary increase in expected subsidy payments, if such requirements account for shareholder incentives. Specifically, we analyze an example of regulatory policy in which lower capital requirements and an ex post penalty schedule reduce systemic risk by increasing the volume of tradable securities exchanged and by offering a credible mechanism by which intermediaries can signal the true riskiness of their portfolios to liability-holders.     

Systemic risk contributions: A credit portfolio approach

We put forward a framework for measuring systemic risk and attributing it to individual banks. Systemic risk is coherently measured as the expected loss to depositors and investors when a systemic event occurs. The risk contributions are calculated so as to ensure a full risk allocation among institutions. Applying our methodology to a panel of 54–86 of the world’s major commercial banks for a 13-year time span with monthly frequency not only allows us to closely match the list of G-SIBs; we can also use individual risk contributions to compute bank-specific surcharges: systemic capital charges as well as countercyclical buffers. We therefore address both dimensions of systemic risk – cross-sectional and time-series – in a single integrated approach. As the analysis of risk drivers confirms, the main focus of macroprudential supervision should be on a solid capital base throughout the financial cycle and de-correlation of banks’ asset values.     

Does Macro‐Prudential Regulation Leak? Evidence from a UK Policy Experiment

The regulation of bank capital as a means of smoothing the credit cycle is a central element of forthcoming macro‐prudential regimes internationally. For such regulation to be effective in controlling the aggregate supply of credit it must be the case that: (i) changes in capital requirements affect loan supply by regulated banks, and (ii) unregulated substitute sources of credit are unable to offset changes in credit supply by affected banks. This paper examines micro evidence—lacking to date—on both questions, using a unique data set. In the UK, regulators have imposed time‐varying, bank‐specific minimum capital requirements since Basel I. It is found that regulated banks (UK‐owned banks and resident foreign subsidiaries) reduce lending in response to tighter capital requirements. But unregulated banks (resident foreign branches) increase lending in response to tighter capital requirements on a relevant reference group of regulated banks. This “leakage” is substantial, amounting to about one‐third of the initial impulse from the regulatory change.     

Systemic risk in an interconnected banking system with endogenous asset markets

We analyze the emergence of systemic risk in a network model of interconnected bank balance sheets. The model incorporates multiple sources of systemic risk, including size of financial institutions, direct exposure from interbank lendings, and asset fire sales. We suggest a new macroprudential risk management approach building on a system wide value at risk (SVaR). Under the SVaR metric, the contribution of individual banks to systemic risk is well defined and can be approximated by a Shapley value-type measure. We show that, in a SVaR regime, a fair systemic risk charge which is proportional to a bank's individual contribution to systemic risk diverges from the optimal macroprudential capitalization of the banks from a planner's perspective. The results have implications for the design of macroprudential capital surcharges.     

Designing a Countercyclical Insurance Program for Systemic Risk

This article proposes a framework for measuring and managing systemic risk. Current solvency regulations have been criticized for their focus on individual firms rather than the system as a whole. We show how an insurance program can be designed to deal with systemic risk through a risk charge on participating institutions. The risk charge is based on the generalized co‐conditional tail expectation, a conditional risk measure adapted from conditional value‐at‐risk. Current regulations have been criticized on the grounds that their capital requirements are procyclical. They require extra capital in periods of extreme stress thus exacerbating a crisis. We show how to construct a countercyclical risk charge and illustrate the approach using a numerical example.     

Capital regulation,heterogeneous monitoring costs,and aggregate loan quality

This paper develops a banking-sector framework with heterogeneous loan monitoring costs. Banks are exposed to the moral hazard behavior of borrowers and endogenously choose whether to monitor their loans to eliminate this exposure. After analyzing an unregulated banking system, we examine several cases in which regulatory capital requirements bind the notional loan supplies of various subsets of banks. To gauge the impact of capital requirements, we define loan ‘quality’ in terms of either the ratio of monitored to total loans or the ratio of monitoring banks to total bank population. Under the assumption of a specific cross-sectional distribution of banks, our simulations show that the imposition of binding capital requirements on a previously unregulated banking system unambiguously increases the market loan rate and reduces aggregate lending, but has an ambiguous effect on loan ‘quality’. Nevertheless, once capital requirements are in place, the simulations indicate that regulators can contribute to higher overall loan ‘quality’ by toughening capital requirements.     

政策连续性与商业银行系统性风险

本文基于2007年第一季度至2019年第四季度中国A股32家上市银行非平衡面板数据,从“冲击”和“传染”两个维度考察了政策连续性对银行系统性风险的影响。实证结果表明,政策连续性程度的提高通过降低银行个体风险和减弱银行个体与系统的关联性进而显著降低了银行系统性风险。进一步分析发现,政策连续性降低了银行被动风险承担水平而非主动风险承担意愿,减弱了银行间接关联程度而非直接关联程度。异质性分析表明,经济下行和货币宽松时期,政策连续性对系统性风险的降低效应更大,并且本身破产风险越高、信息透明度越低的银行,其系统性风险受政策连续性的影响越大。区分不同类型的政策发现,货币政策、财政政策、汇率与资本项目政策的连续性上升均能显著降低银行系统性风险,其中货币政策连续性对银行系统性风险的影响力度最大。     

宏观审慎与货币政策双支柱框架研究——基于系统性风险视角

本轮国际金融危机之后,建立“宏观审慎政策专门盯住金融稳定目标,货币政策主要关注经济稳定目标”的双支柱成为国际社会的普遍共识。本文基于系统性风险视角,深入剖析系统性风险的累积和实现机制,从时间和空间两个维度梳理宏观审慎政策实现金融稳定的有效性,以及货币政策对系统性风险造成的潜在溢出性。目前从系统性风险的时间维度探讨双支柱政策的研究已较为丰富,可以总结为宏观审慎政策的“逆周期调节”机制和货币政策的“资本缺口”机制。从系统性风险的空间维度探讨双支柱政策的研究,也即对双支柱政策如何作用和改变金融机构内部关联网络的研究正成为研究热点。本文从政策工具和影响机制上对空间维度双支柱政策进行了系统梳理。基于以上分析,本文对双支柱政策的制定提出如下建议:时间维度宏观审慎政策要关注并消除货币政策对时间维度系统性风险的溢出性,同时要加强空间维度宏观审慎政策工具的创新力度。     

Delayed Expected Loss Recognition and the Risk Profile of Banks

This paper investigates the extent to which delayed expected loan loss recognition (DELR) is associated with greater vulnerability of banks to three distinct dimensions of risk: (1) stock market liquidity risk, (2) downside tail risk of individual banks, and (3) codependence of downside tail risk among banks. We hypothesize that DELR increases vulnerability to downside risk by creating expected loss overhangs that threaten future capital adequacy and by degrading bank transparency, which increases financing frictions and opportunities for risk‐shifting. We find that DELR is associated with higher correlations between bank‐level illiquidity and both aggregate banking sector illiquidity and market returns (i.e., higher liquidity risks) during recessions, suggesting that high DELR banks as a group may simultaneously face elevated financing frictions and enhanced opportunities for risk‐shifting behavior in crisis periods. With respect to downside risk, we find that during recessions DELR is associated with significantly higher risk of individual banks suffering severe drops in their equity values, where this association is magnified for banks with low capital levels. Consistent with increased systemic risk, we find that DELR is associated with significantly higher codependence between downside risk of individual banks and downside risk of the banking sector. We theorize that downside risk vulnerability at the individual bank level can translate into systemic risk by virtue of DELR creating a common source of risk vulnerability across high DELR banks simultaneously, which leads to risk codependence among banks and systemic effects from banks acting as part of a herd.     

资本市场系统风险评估模型及其实证应用

本文在提出更全面和更具操作性的系统风险定义基础上,借鉴综合评价法及神经网络等方法,构建了一套适用于系统风险状态评估的模型体系。进而运用此模型对我国资本市场2001年第一季度至2009年第一季度的系统风险状态进行了实证研究,并在综合分析基础上指出我国资本市场建设若能得到持续、稳步推进,则2009年市场将有望维持在较低的系统风险状态。     

Multilayer financial networks and systemic importance: Evidence from China

In this paper, we develop a multilayer network structure and reveal the relationship between network structure and systemic risk. Unlike many previous studies, our model considers both liability and cross-holding of shares between financial institutions simultaneously. We propose a new systemic risk measurement by exploring the dynamic mechanism of financial contagion in the multilayer network. We display the network structure of Chinese financial institutions, including connectivity and diversity, and identify the systemic importance of them. We demonstrate that the multilayer network plays a non-linear role in financial risk spreading. Using the panel regression model and several experiment evidences, we show that the systemic risk can be explained more effectively by the linkage diversity more than the connectivity at both the institutional level and the system level. Our results highlight the importance of considering contagion mechanisms that go beyond a simple single-layer network structure.     

微观层面系统性金融风险指标的比较与适用性分析——基于中国金融系统的研究

准确测度金融机构对整体系统性金融风险的边际贡献是加强宏观审慎监管的基本前提。本文对常用的系统性金融风险指标进行了比较分析,并以“能否涵盖规模、高杠杆率和互联紧密性三方面信息”、“排序结果是否与银保监会认定的系统重要性银行名单相吻合”、“是否具有宏观经济活动预测力”三方面对上述指标在我国金融体系的适用性进行了综合评价。结果显示,SRISK更适于作为我国微观层面系统性金融风险的测度。同时,本文发现,“LRMES约等于1-exp(-18*MES)”的经验关系不具有普适性,不适用于我国金融体系。     

Market response to dividend change announcements: unregulated versus regulated US firms

This paper attempts to determine whether there is a significant difference in how the stock market responds to dividend change announcements of regulated (both utilities and financials) versus unregulated firms and, if so, which factors cause this difference. An analysis of dividend change announcements of US firms over the period 1962–2016 shows that the market response is larger for unregulated than for regulated firms, but this difference is statistically significant only for dividend increases (not for dividend decreases). Further, cross-sectional analysis indicates that, for dividend increases, the difference between regulated and unregulated firms increases with diffused ownership and informational asymmetry. When both these factors are controlled for, the difference between regulated and unregulated firms becomes statistically insignificant. Thus, the evidence suggests that the significant difference in market response to dividend increases of regulated versus unregulated firms can be explained by differences in diffused ownership and informational asymmetry. There seems to be no intrinsic difference between regulated and unregulated firms in the market response to dividend decreases.     

Measuring systemic risk: A risk management approach

This paper proposes a new method to measure and monitor the risk in a banking system. Standard tools that regulators require banks to use for their internal risk management are applied at the level of the banking system to measure the risk of a regulator’s portfolio. Using a sample of international banks from 1988 until 2002, I estimate the dynamics and correlations between bank asset portfolios. To obtain measures for the risk of a regulator’s portfolio, I model the individual liabilities that the regulator has to each bank as contingent claims on the bank’s assets. The portfolio aspect of the regulator’s liability is explicitly considered and the methodology allows a comparison of sub-samples from different countries. Correlations, bank asset volatility, and bank capitalization increase for North American and somewhat for European banks, while Japanese banks face deteriorating capital levels. In the sample period, the North American banking system gains stability while the Japanese banking sector becomes more fragile. The expected future liability of the regulator varies substantially over time and is especially high during the Asian crisis starting in 1997. Further analysis shows that the Japanese banks contribute most to the volatility of the regulator’s liability at that time. Larger and more profitable banks have lower systemic risk and additional equity capital reduces systemic risk only for banks that are constrained by regulatory capital requirements.     

Credit information sharing in the nexus between charter value and systemic risk in Asian banking

In this paper, we assess whether the link between charter value and systemic risk in banking is affected by credit information sharing at the country level. Using a sample of Asian listed banks, we document that banks with higher charter value exhibit lower systemic risk because these banks hold more capital. Nevertheless, we find that the self-disciplining role of charter value in banking is more pronounced for countries with lower depth of credit information sharing. Specifically, our findings also reveal that higher charter value alleviates systemic risk and increases capitalization, particularly in countries with lower quality of private credit bureaus. These findings suggest that higher charter value can be detrimental for financial stability due to an increase in bank systemic risk, particularly when private credit bureaus are of better quality. In order to overcome bank systemic risk, this paper advocates the importance of strengthening bank competition to limit charter value, in addition to promoting the development of private credit bureaus.     

The multi-layer network nature of systemic risk and its implications for the costs of financial crises

The inability to see and quantify systemic financial risk comes at an immense social cost. Systemic risk in the financial system arises to a large extent as a consequence of the interconnectedness of its institutions, which are linked through networks of different types of financial contracts, such as credit, derivatives, foreign exchange, and securities. The interplay of the various exposure networks can be represented as layers in a financial multi-layer network. In this work we quantify the daily contributions to systemic risk from four layers of the Mexican banking system from 2007 to 2013. We show that focusing on a single layer underestimates the total systemic risk by up to 90%. By assigning systemic risk levels to individual banks we study the systemic risk profile of the Mexican banking system on all market layers. This profile can be used to quantify systemic risk on a national level in terms of nation-wide expected systemic losses. We show that market-based systemic risk indicators systematically underestimate expected systemic losses. We find that expected systemic losses are up to a factor of four higher now than before the financial crisis of 2007–2008. We find that systemic risk contributions of individual transactions can be up to a factor of one thousand higher than the corresponding credit risk, which creates huge risks for the public. We find an intriguing non-linear effect whereby the sum of systemic risk of all layers underestimates the total risk. The method presented here is the first objective data-driven quantification of systemic risk on national scales that reveal its true levels.     

Research on China's financial systemic risk contagion under jump and heavy-tailed risk

To accurately measure the dynamic characteristics of systemic risk contagion under the impact of extreme financial events, we construct a research framework that analyzes the contagion dynamics of systemic risk under extreme risk impact from the perspectives of both time and space. Based on the macro-jump CCA method, this paper extracts the heterogeneous volatility sequence of financial industries considering the thick tail of the distribution of financial assets returns. Then, the dynamic variation of systemic risk in the financial sectors is characterized from the time dimension. The volatility spillover network method is used to examine the spillover contagion of systemic risk among financial system sectors from the spatial dimension. Empirical studies have found that when considering the risk contagion level, the capital market service sector plays a risk‑leading role, followed by the currency service sector and the insurance sector. The measurement indicators that consider the jump risk and the tail risk have good early warning effects on extreme financial events. Seen from the spatial direction of risk spillover, the real estate sector exhibits the most obvious risk spillover effect on other sectors and can be regarded as the source of systemic risk, which suggests differentiated regulation.