Research Exchange: April 2023

Selected Outside Research

How Do Interest Rates (and Depositors) Affect Measures of Bank Value?

This article reviews how interest rate risk affects bank valuations, highlighting key factors that are important for understanding recent market developments, including the failure of SVB. The discussion provides a simple illustration demonstrating how bank value and profitability can increase or decrease as interest rate risk increases, and highlights how this risk is further influenced by depositor price sensitivity and whether they choose to withdraw deposits. In particular, fixed-rate asset values fall as rates rise, but “this decline is offset—and in some plausible scenarios more than offset—by the increasing value of deposit funding when deposits are not rate-sensitive.” Read More ⇨

Bank Fragility and Reclassification of Securities into HTM

Under held-to-maturity (HTM) accounting rules, banks avoid using current market prices to value securities on their balance sheets. However, they must have both the intent and the ability to hold securities to maturity when using HTM accounting. This paper examines the factors associated with U.S. banks’ decisions to reclassify a large volume of securities from their available-for-sale portfolio as HTM between 2021 and 2022. The analysis indicates that more vulnerable banks—those with lower capital ratios, higher share of run-prone uninsured depositors and more exposed to interest rate risks—were more likely to reclassify their securities as HTM. These findings “cast some doubt upon whether auditors and supervisors were sufficiently assured that the reclassifying banks had the ability to hold these securities until their maturity” and suggest that regulators should properly assess “the reasonableness of banks’ claims that they have the ability to hold these securities until they mature.” Read More ⇨

Social Media as a Bank Run Catalyst

Motivated by the apparent role of social media in fueling the recent depositor run on Silicon Valley Bank (SVB), this study investigates the relationship between exposure to social media and run risk, using Twitter data. The analysis finds that exposure to social media predicts bank stock market losses in the period during which a bank is exposed to run risk, controlling for other relevant factors such as mark-to-market losses and uninsured deposits. In particular, the intensity of Twitter conversation about a bank predicts stock market losses. These effects are stronger for banks with heightened run risk factors and when tweets are authored by members of the Twitter startup community and contain keywords related to contagion. These results “are consistent with depositors using Twitter to communicate in real time during the bank run.” Read More ⇨

Do Banks Hedge Using Interest Rate Swaps?

The extent to which banks use interest rate swaps to hedge the interest rate risk of their assets is investigated in this paper, using regulatory data on individual swap positions for the largest 250 U.S. banks. The analysis indicates that while the average bank has a large notional amount of swaps, amounting to $434 billion which is more than 10 times assets, its swap positions largely offset each other, so that the average bank has essentially no net interest rate risk from swaps. Moreover, although there is variation across banks, at the aggregate, banking-system level, swap exposures are mostly offsetting. Read More ⇨

Deposit Betas: Up, Up and Away?

This article explores the responsiveness of bank deposit interest rates to the recent, rapid rise in wholesale market interest rates as measured by a “deposit beta”, which quantifies the responsiveness of deposit rates to the federal funds rate. In addition, the article examines how the amount and composition of deposits has been changing. The analysis demonstrates a “rise in deposit betas to levels not seen since prior to the global financial crisis” along with a decline in overall deposit balances, a shift of balances into more rate-sensitive time deposits and an increase in banks’ non-deposit borrowing such as funding from Federal Home Loan Banks. Read More ⇨

U.S. Banks’ Exposures to Climate Transition Risks

This paper investigates U.S. banks’ exposures to climate transition risks, specifically the impact of policies and scenarios promoting the transition to a low-carbon economy on bank safety and soundness. The analysis relies on a range of projections from previously published studies of alternative carbon tax policies’ effects on output and profits by industry sector. These industry-level estimates are combined with loan-level data from the Federal Reserve’s Y-14 data collection to estimate banks’ exposures to the various transition policies. The results demonstrate that “while banks’ exposures are meaningful, they are manageable”. The effects are larger under stress scenarios in which loans to industries potentially most affected by transition policies lose their entire value, but banks’ exposure to these industries appears to be declining.  Read More ⇨

Climate Stress Testing

This paper explores the design of stress tests for assessing and managing financial sector risks related to climate change. The discussion highlights the need for modelers to consider a variety of dynamic transition risk scenarios, feedback loops between climate change and the economy and “compound risk” scenarios in which climate risks co-occur with other risks. It also describes how stress testing can incorporate existing evidence on the effects of various climate-related risks on credit and market outcomes. The advantages and disadvantages of market-based climate stress tests using publicly available data are also discussed. Finally, the paper highlights key dimensions along which more research is needed. These include identifying and incorporating banks’ strategic responses to climate risks and assessing the adequacy of climate risk pricing in financial markets. Read More ⇨

How Climate Change Shapes Bank Lending: Evidence from Portfolio Reallocation

This study analyzes changes in the composition of bank loan portfolios since 2012 in response to climate risk, using supervisory, loan-level data from the largest U.S. banks. The analysis finds that beginning around 2015, banks significantly reduced lending to counties that were more exposed to climate risk, with flood risk and wildfire risk being used as proxies for climate risk. The largest effects were observed for HELOC and CRE lending and lending to borrowers with high credit risk. Read More ⇨

California Wildfires, Property Damage and Mortgage Repayment

This paper contributes to the literature on credit risk arising from exposure to natural disasters by evaluating the impact of wildfires on mortgage repayment, using a novel database of fire damage inspections geographically merged to properties with mortgages. The analysis finds that 90-day delinquencies were 4 percentage points higher and prepayments were 16 percentage points higher for properties that were damaged by wildfires compared to properties 1 to 2 miles outside of the wildfire, which suggests higher risks to mortgage markets than found in previous studies. However, no significant changes in delinquency or prepayment are observed for undamaged properties inside a wildfire boundary. Results further suggest that prepayments reflect insurance claim payments rather than sales or refinances and that underinsurance may force borrowers to prepay instead of rebuild. Read More ⇨

Fintech Lending with Low-Tech Pricing

Using a comprehensive dataset of personal loans from fintech companies, this study evaluates the claim that fintech lending can improve upon traditional credit scoring and pricing models by exploiting big data and machine learning methodologies. The analysis indicates continued, heavy reliance by fintech lenders on conventional credit scores for loan pricing, including 45 percent higher interest rates for nonprime borrowers, while other known default predictors are often neglected. Moreover, “within each segment (prime/nonprime) loan rates are not very responsive to default risk resulting in realized loan-level returns decreasing with risk.” Read More ⇨

Enhancing Monitoring of NBFI Exposure: The Case of Open-End Funds

Nonbank financial institutions (NBFIs) have grown steadily over the last two decades into important providers of financial intermediation services, interacting with banking institutions in many markets. Banks have developed significant direct exposures stemming from counterparty relationships with NBFIs and may also be exposed to NBFIs indirectly via common asset holdings. This article examines the latter, indirect form of exposure and suggests ways to identify and quantify the corresponding vulnerabilities. The discussion highlights the heterogeneity of indirect exposures across bank holding companies driven by differences in business models. One important takeaway is that “monitoring of direct exposures may not be sufficient, as risks from indirect channels of exposure can be significant during periods of stress” Read More ⇨

The Importance of Financial Literacy: Opening a New Field

Two decades of research on financial literacy are reviewed and assessed in this paper, based on the concept of financial knowledge as a form of investment in human capital. In addition, the paper examines recent data on differences in financial knowledge and literacy across the population in the United States and highlights similarities to other countries. Conclusions are drawn about the effects and consequences of financial illiteracy and on what can be done to fill financial literacy gaps. Read More ⇨

Anatomy of the Repo Rate Spikes in September 2019

Despite the large volume of funding transactions conducted in repurchase agreement (repo) markets in the U.S., repo rates can be quite volatile. This paper explores the potential causes of the dramatic spike in repo rates in mid-September 2019 using intraday timing data from the repo market. The analysis suggests that a lack of information transmission across repo segments and internal frictions within banks most likely exacerbated the spike. In particular, the findings demonstrate how the segmented structure of the market can contribute to its fragility. Read More ⇨

Chart of the Month

Reserve Banks Citing a Tightening of Bank Credit in the Beige Book

The April 2023 edition of the Beige Book mentions standards and terms more often than the previous editions. Likewise, deposit inflows and outflows were major points of concern in this edition. These references to tightened standards and terms reflect heightened concern regarding the banking sector throughout all 12 Federal Reserve districts due to the crisis events of the past few weeks. Three of the districts mention the SVB event specifically.

Featured BPI Research

Improving The Government’s Lender of Last Resort Function: Lessons From SVB and Signature Bank

The post discusses how the government can improve its lender of last resort function, using the recent failures of  SVB and Signature Bank as case studies. The post argues that by reforming this function, it can become a more viable option to mitigate the potential for bank runs. It argues that an effective reform approach would encourage banks to pre-pledge loans or other economic-growth-enhancing assets as collateral and require bank examiners to recognize this reality when they assess a bank’s liquidity position. This requires a more flexible lending policy that considers a wider range of factors, such as the quality of the bank’s assets and the specific market conditions. By instituting such reforms, the government could better support financial stability while also minimizing the risks associated with moral hazard. Read More ⇨

Seasonal Credit and Committed Liquidity Facilities

The post discusses how the failure of Silicon Valley Bank (SVB) has prompted misguided calls for banks to hold an even larger share of their assets in high-quality liquid assets (HQLA), which would reduce lending and economic growth. The post examines an alternative approach that could improve the liquidity position of banks without imposing such substantial societal costs—to allow committed liquidity facilities (CLFs) provided by the Fed to count as HQLA. Like discount window loans, the CLFs would be collateralized by banks’ loans to businesses and households (as well as other assets) and would be available for a fee. Banks would be allowed to anticipate drawing on their CLFs to meet cash outflows, easing liquidity constraints and enabling them to make more loans, which could, in turn, be used to collateralize their CLF. The post also explains how the positive consequences for bank credit and employment when the Fed introduced seasonal credit in 1973 illustrates how CLFs can help support the economy. Read More ⇨

The CFPB’s Deeply Flawed Proposal on Credit Card Late Fees: Part 1

This research note is the first in a series addressing the Consumer Financial Protection Bureau’s proposal on credit card late fees. It highlights major conceptual shortcomings in the Bureau’s consideration of the deterrence role of late fees and, relatedly, the Bureau’s failure to consider the risk-based pricing aspect of late fees. Aside applying an excessively narrow definition of deterrence in considering the role of late fees, the Bureau fails to give serious consideration to various potential incentive effects of late fees for consumers who are prone to inattention, mistakes or well-documented behavioral biases such as overoptimism (about ability to meet debt obligations). In addition, the Bureau ignores the risk pricing aspect— the fact that missing a payment date indicates increased likelihood of default, and banks must price this increased risk. The Bureau compounds these errors by asserting, without evidence or explanation, that while the proposal may weaken deterrence, it “creates additional incentives for issuers to emphasize reminders, automatic payment, and other mechanisms that maintain similar or better payment behavior.” Read More ⇨

Misunderstandings About Credit Card Late Fees

This note briefly reviews why the proposal from the Consumer Financial Protection Bureau to limit late fees, by limiting banks’ ability to offset costs and by eliminating or reducing deterrence, will have deleterious effects on the market’s ability to serve consumers across the credit risk spectrum. With deterrence weakened under the proposed reduction in late fees, payment delinquencies and credit losses will increase, prompting issuers to manage credit risk by tightening card credit limits or availability and increasing interest rates or other fees. Increased frequency of late payment will rebound to the ultimate harm of consumers through reduced credit scores. These effects will be borne by all consumers with credit cards, including by those who pay on time (not just by those who violate the terms of card agreements), but will be most pronounced for higher-risk consumers for whom cards may become less readily available. Read More ⇨

The Mysterious Footnote 7: To Whom and on What Terms is the Fed Lending $173 Billion?

Although the Federal Reserve has at times been accused of excessive secrecy about its lending, up until recently it has been exceptionally transparent. All the terms and conditions of all its regular and emergency lending programs have been published prior to or coincident with any lending. The Fed has only kept secret the identities of the borrowers, but that secrecy is critical for being an effective lender of last resort. However, the Fed has now diverged from this established practice, opening and operating a new, large lending program about which it has provided little information. This category appears in the Fed statistical reports as “other credit extensions” and is described as loans that were extended to depository institutions established by the Federal Deposit Insurance Corporation and that are secured by collateral, and the FDIC provides repayment guarantees. This post questions to whom and on what terms this money was lent, as well as why this information is not publicly disclosed. The author argues that this lack of specificity is concerning and raises questions about the purpose and terms of the lending. Read More ⇨

Conferences & Symposiums

The 16th NY Fed / NYU Stern Conference on Financial Intermediation: Announcement and Call for Papers
Federal Reserve Bank of New York
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5/14/2023 – 5/17/2023
2023 Financial Markets Conference
Federal Reserve Bank of Atlanta
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5/18/2023 – 5/19/2023
2nd Annual International Roles of the U.S. Dollar Conference: Announcement and Call for Papers
Federal Reserve Bank of New York
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6/14/2023 – 6/15/2023
Conference on Networks in Modern Financial and Payment Systems: Announcement and Call for Papers
The Bank of Canada
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Governance and Culture Reform Conference
Federal Reserve Bank of New York
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6/21/2023 – 6/23/2023
Policy Summit 2023: Communities Thriving in a Changing Economy
Federal Reserve Bank of Cleveland
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6/21/2023 – 6/23/2023
Economics of Financial Technology Conference: Announcement and Call for Papers
The University of Edinburgh
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7/5/2023 – 7/7/2023
The 2023 Annual Meeting of the Central Bank Research Association: Announcement and Call for Papers
Federal Reserve Bank of New York and Columbia University School of International and Public Affairs
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The 8th Annual Cambridge Conference on Alternative Finance: Announcement and Call for Papers
University of Cambridge Center for Alternative Finance
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7/10/2023 – 7/28/2023
National Bureau of Economic Research Summer Institute 2023
Cambridge, MA and Virtual
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7/12/2023 – 7/13/2023
The Fifth Biennial Conference on Auto Lending
Federal Reserve Bank of Philadelphia
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Yale Program on Financial Stability Conference
Yale University, New Haven, CT
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8/31/2023 – 9/1/2023
Inflation: Drivers and Dynamics Conference
Federal Reserve Bank of Cleveland and European Central Bank
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9/28/2023 – 9/29/2023
22nd Annual Bank Research Conference: Announcement and Call for Papers
Federal Deposit Insurance Corporation Center for Financial Research
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10/4/2023 – 10/5/2023
Community Banking Research Conference: Announcement and Call for Papers
Federal Reserve Bank of St. Louis
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10/19/2023 – 10/20/2023
New Perspectives on Consumer Behavior in Credit and Payments: Announcement and Call for Papers
Federal Reserve Bank of Philadelphia
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10/19/2023 – 10/20/2023
Federal Reserve Stress Testing Research Conference
Federal Reserve Bank of Boston and Virtual
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11/16/2023 – 11/17/2023
2023 Financial Stability Conference
Federal Reserve Bank of Cleveland and Office of Financial Research
Cleveland, OH and Virtual
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11/16/2023 – 11/17/2023
2023 Asia Economic Policy Conference: Announcement and Call for Papers
Federal Reserve Bank of San Francisco
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The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.