Selected Outside Research
Banks’ Balance Sheet Costs, Monetary Policy and the ON RRP
This paper investigates the drivers of the recent and persistent increase in investment of money market funds (MMFs) at the Federal Reserve’s overnight reverse repo agreement (ON RRP) facility, reaching $2.4 trillion as of September 2022. The rise in balances at the ON RRP, which are a liability of the Federal Reserve, has important implications for the Federal Reserve’s effort to normalize its balance sheet following its rapid balance sheet expansion in response to COVID-19. The analysis demonstrates that expiration of the temporary change to banks’ supplementary leverage ratio capital requirement, the so-called SLR relief of 2020-2021, which excluded U.S. Treasury securities and reserves from the SLR calculation, affected MMFs’ use of the ON RRP by affecting banks’ balance sheet costs. After the SLR relief period ended, banks had less flexibility to expand their holdings of Treasury securities and reserves without affecting the SLR requirement. The resulting increase in banks’ balance sheet costs incentivized them to push deposits toward MMFs and to reduce their overnight borrowing from MMFs, leading to an increase in MMF investment at the ON RRP. In addition, the study finds that monetary policy tightening and Treasury bill scarcity also have contributed to the recent increase in ON RRP usage. Read More ⇨
GSIB Status and Corporate Lending
This study examines the effects of the higher capital requirements and closer supervision applied to Global Systemically Important Banks on the supply of GSIB credit to businesses and the consequences for borrowers. The analysis finds that when banks are designated GSIBs they reduce lending on average by 5.9% and reduce lending to risky firms by 7.2%. Moreover, this reduced access to credit leads to lower asset, sales and investment growth, especially among high-risk borrowers, and reduced R&D expenditures among all GSIB-dependent firms. In addition, the study finds that supervision-induced effects are larger than those attributed to GSIB-specific capital surcharges. Thus, while closer supervision reduces banks’ risk-taking, it “has potentially unintended implications for firms’ ability to finance innovation, which seems to crucially depend on bank credit.” Read More ⇨
Bank Funding Risk, Reference Rates and Credit Supply
Corporate credit lines are drawn more heavily when funding markets are more stressed and banks’ funding costs are rising. Until 2022, this effect was moderated by linking the interest paid on credit lines to credit-sensitive reference rates such as LIBOR. However, banking has since made a transition to “risk-free” benchmark reference rates such as the secured overnight financing rate (SOFR), which typically falls during stress periods, encouraging firms to draw more heavily on credit lines. Thus, transitioning to risk-free reference rates may reduce ex-ante incentives for providing credit lines. This paper provides a theoretical and empirical investigation of how the choice of a loan reference rate affects the supply of revolving credit lines. The study finds that the transition from LIBOR to SOFR will lead to much heavier drawdowns when bank credit spreads rise sharply. However, the adverse impact on the provision of credit lines is attenuated to the extent that draws on lines offered by a bank are expected to be left on deposit at the same bank, thus reducing the bank’s funding costs, as happened at some of the largest banks during the COVID-19 shock. Read More ⇨
Keeping Up in the Digital Era: How Mobile Technology Is Reshaping the Banking Sector
This paper examines the effect of mobile banking technology adoption on competition in retail banking markets from 2010 through 2019. Data for the analysis are drawn from multiple sources, including hand-collected data on the timing of the introduction of mobile banking apps by individual banks and data on county-level mobile infrastructure improvements from the FCC. The study demonstrates that “mobile banking acts as a de facto negative technological shock” for small community banks, which are relatively slow to implement mobile technologies and lose deposits to larger, better-digitized banks following mobile infrastructure improvements. These dynamics also are associated with a significantly higher likelihood of branch closure by small community banks and negatively affect their small business lending. Lending by fintech firms and larger banks does not compensate for the entire reduction in small business lending. Finally, the study shows that the local economy benefits less from digitalization and mobile services in areas where small community banks had an important presence before their introduction. Read More ⇨
Leverage and Stablecoin Pegs
The fundamental properties of stablecoins as a form of private money are explored in this paper. The paper demonstrates “how stablecoins can maintain a constant price even though they face run risk and pay no interest” because stablecoin holders are indirectly compensated for run risk via the ability to lend the coins to levered traders. In turn, levered traders are willing to pay a premium to borrow stablecoins when speculative demand is strong. Thus, “the stablecoin can support a $1 peg even with higher levels of run risk.” Read More ⇨
The Dynamics and Demographics of U.S. Household Crypto-Asset Use
U.S. households’ involvement in crypto-assets, which has risen sharply during and since the COVID-19 pandemic, is investigated in this report. The analysis is based on a sample of nearly 5 million active checking account customers, of whom over 600,000 have conducted transfers to crypto accounts. The analysis focuses on the dynamics of crypto engagement, the demographics of crypto asset transactors, and their risk exposure. Crypto holdings for most individuals are relatively small; the analysis finds that “median flows equal less than one week’s worth of take-home pay—but almost 15 percent of users have net transfers of over one month’s worth of pay to crypto accounts.” In addition, the analysis suggests that the median investor appears to have experienced substantially negative returns, with lower-income individuals faring worse. The report also finds that crypto-asset engagement has been “broader and deeper for men, Asian individuals, and younger individuals with higher incomes.” Read More ⇨
Improving the Availability of Small Mortgage Loans
Unavailability of mortgage financing for low-cost properties has been a barrier to homeownership for people with low and moderate incomes. On Oct. 4, 2022, the U.S. Department of Housing and Urban Development released a request for information on barriers to small mortgage loans in the Federal Housing Administration (FHA) program with the aim of finding ways to expand affordable homeownership in underserved markets with low housing prices. This study from the Urban Institute responds to that request. It provides an analysis of the characteristics of small mortgage loans using new property records data and data from a demonstration program launched in 2019 by a leading community development financial institution. The study finds that loan applications under $100,000 have had an elevated likelihood of denial, with property condition playing a larger role in denials than for higher-priced homes. The study also highlights how the fixed costs associated with a mortgage transaction are a major factor limiting first-time homebuyer access to affordable homes. The study concludes that “FHA can facilitate marginally more access to these properties for owner occupancy, especially with respect to purchase-construction lending and property condition requirements. But effectively serving this market segment will require cross-agency and cross-industry cooperation and the will to design a path for small-dollar, entry-level mortgages.” Read More ⇨
Climate Risks in the U.S. Banking Sector: Evidence from Operational Losses and Extreme Storms
While banks’ exposure to credit losses tied to climate risk have received substantial attention in research studies, relatively little consideration has been given to climate-related operational losses. Using supervisory data from large U.S. bank holding companies, this paper examines how extreme weather events affect banks’ operational losses. The analysis finds that operational losses rise during episodes of extreme storms, including losses due to external fraud, faulty business practices, damage to physical assets and business disruption. The study further shows that banking organizations with past exposure to extreme storms reduce operational losses from future exposure to storms. Overall, the “findings provide new evidence regarding U.S. banking organizations’ exposure to climate risks with implications for risk management practices and supervisory policy.” Read More ⇨
Chart of the Month
The chart above shows a rapid increase in overnight RRP balances to over $2 trillion following the expiration of the temporary SLR relief in March 2021. As a result of the usual year-end pressures, ON RRP balances reached a new record above $2.5 trillion on Dec. 30, 2022.
Featured BPI Research
Quantifying the Costs and Benefits of Quantitative Easing
This new National Bureau of Economic Research Working Paper, co-authored by BPI Chief Economist Bill Nelson, conducts a systematic analysis of the costs and benefits of large-scale securities purchases, as exemplified by the Federal Reserve’s QE4 program as a concrete example. This program was initiated at the onset of the pandemic in March 2020 and continued for two years, leading to a doubling of the Fed’s securities holdings to about $8.5 trillion as of March 2022. While QE4 was initially aimed at mitigating strains in markets for Treasuries and agency mortgage-backed securities, it was subsequently broadened with the aim of supporting market functioning and providing monetary stimulus. However, QE4 did not have any notable benefits in reducing term premiums, and since the securities purchases were financed by expanding the Fed’s short-term liabilities, the program amplified the interest rate risk associated with the publicly held debt of the consolidated federal government. Simulation analysis presented in this paper indicates that QE4 is projected to reduce the Federal Reserve’s remittances to the U.S. Treasury by about $760 billion over the next 10 years. Read More ⇨
