On dividend restrictions and the collapse of the interbank market

Until recently, financial services regulation remained largely segmented along national lines. The integration of financial markets, however, calls for a systematic and coherent approach to regulation. This paper studies the effect of market based regulation on the proper functioning of the interbank market. Specifically, we argue that restrictions on the payout of dividends by banks can reduce their expected default on (interbank) loans, stimulate trade in this market and improve the welfare of consumers.     

The Organizational Structure of Banking Supervision

Does it matter whether banking supervision is undertaken in‐house in the Central Bank or in a separate specialised supervisory institution? After all, bank supervisors and the Central Bank must continue to work closely together wherever the supervisors are located. Nevertheless there has been a recent trend towards hiving off bank supervision to a separate agency, as in the UK. The main driving forces are the rise of the universal bank, increased conglomeration, and concerns with conflicts of interest. Such separation, however, raises questions whether systemic stability might suffer. The ethos and culture of the separate supervisor might come to focus more on conduct of business, consumer protection, issues. Potentially systemic financial crises would have to be handled by a committee. These are qualitative issues, and developed countries, with differing historical, legal and institutional backgrounds, will come to differing conclusions. But in less developed countries, more weight needs to be placed on ensuring the quality of the supervisory staff, i.e. their professional skills, independence from external pressures, and adequate funding. This tells strongly towards retaining banking supervision under the wing of the Central Bank in such emerging countries. (J.E.L.: E5, F3, G2).     

What Weight Should be Given to Asset Prices in the Measurement of Inflation?

Besides the theoretical (Alchian/Klein, 1973) case for including asset prices in measures of inflation, there is also a practical case, that some asset prices, notably housing, are closely associated with the main trends in inflation, and via 'bubbles and busts' with output disturbances. Attempts to use the pure Alchian/Klein methodology in practice give excessive weight to unstable asset prices, but there are more appropriate weighting schemes, derived either from econometrically measured relationships or from final expenditures. Either way, the statistical treatment of housing is crucial, and is being discussed in Eurostat.     

News effects in a high-frequency model of the sterling-dollar exchange rate

This paper uses an extremely high frequency data set on the dollar-sterllng exchange rate to investigate the impact of news events on the very short-term movements in exchange rates. The data set is a continuous record of the quoted price for the exchange rate on the Reuters screen. As such it records some 130,000 observations over an 8-week period. The paper investigates the time-series properties of the data using orthodox regression models, and then by making allowance for a time-varying conditional variance. The conclusions vary significantly in moving to this more sophisticated model. The exercises are repeated now incorporating news announcement effects, letting these affect the level of the exchange rate and then the conditional variance process. Again it is found that the conclusions are radically altered in moving to the increasingly sophisticated model.     

The Skill Profile of Central Bankers and Supervisors

Using a new database covering some 91 supervisory agencies, this paper examines how important various skilled experts are in the supervisory process and the relative usage of different kinds of such experts. We seek to explore what kind of perspective supervisors in different institutional settings may adopt: a macro-oriented perspective or a more micro-approach? The answer to this question is relevant, as there is evidence that many financial crises have been macro-induced.It is found that central banks employ more economists and fewer lawyers in their supervisory/financial stability wing than non-centralbank supervisory agencies. This result would indicate that an institutional setting with direct or indirect central bank involvement is more likely to produce a macro-approach. Next, there are significant economies of scale in financial supervision, though this can be measured by several alternative variables (e.g., the relative scale of bank intermediation). Finally, there do not appear to be major economies of scope. A more complex financial system with a well-developed stock market would need both more supervisors as well as more skilled ones.     

The optimal monetary instrument for prudential purposes

The purpose of this paper is to assess the choice between adopting a monetary base or an interest rate setting instrument to maintain financial stability. Our results suggest that the interest rate instrument is preferable, since during times of a panic or financial crisis the Central Bank automatically satisfies the increased demand for money. Thus, it prevents sharp losses in asset values and enhanced asset volatility.     

A model to analyse financial fragility

Summary. This paper sets out a tractable model which illuminates problems relating to individual bank behaviour, to possible contagious inter-relationships between banks, and to the appropriate design of prudential requirements and incentives to limit ‘excessive’ risk-taking. Our model is rich enough to include heterogeneous agents, endogenous default, and multiple commodity, and credit and deposit markets. Yet, it is simple enough to be effectively computable and can therefore be used as a practical framework to analyse financial fragility. Financial fragility in our model emerges naturally as an equilibrium phenomenon. Among other results, a non-trivial quantity theory of money is derived, liquidity and default premia co-determine interest rates, and both regulatory and monetary policies have non-neutral effects. The model also indicates how monetary policy may affect financial fragility, thus highlighting the trade-off between financial stability and economic efficiency.Received: 6 November 2003, Revised: 6 October 2004 JEL Classification Numbers: D52, E4, E5, G11, G21.C.A.E. Goodhart, P. Sunirand, D.P. Tsomocos: We are grateful to T.F. Bewley, S. Bhattacharya, F. Hahn, C. Mayer, H.S. Shin and seminar participants at the Bank of Austria, Bank of England, Bank of Norway, Bank for International Settlements, Brown University, the 7th Annual Macroeconomic Conference, Crete, EcoMod-IIOA International Conference, Brussels, the 2nd Oxford Finance Summer Symposium and Nuffield, Oxford, the Hong Kong Institute for Monetary Research, Purdue University, the University of Birmingham, the VI SAET Conference, Rhodes, Yale University, and especially an anonymous referee and H.M. Polemarchakis for helpful comments. The views expressed are those of the authors and do not necessarily reflect those of the Bank of England. Correspondence to: D.P. Tsomocos