Selected Outside Research
Designing Market Shock Scenarios
Effective stress testing of financial firms requires developing market shock scenarios that plausibly capture systemic risks without placing undue operational costs on the firms. This paper presents a structured two-component approach that first identifies key risk factors and estimates econometric models to characterize the interrelationships among these risk factors to ensure internal consistency. The second component simulates and selects scenarios most likely to induce tail losses. This framework involves refining thousands of possible scenarios into a focused, high-impact set. Unlike existing methods, this approach improves risk capture while reducing scenario redundancy, enhancing regulatory oversight and internal risk management. An application to interest rate risk illustrates its ability to generate extreme but plausible shocks, aligning with real-world financial stress conditions.
Designing Market Shock Scenarios
Of Last Resort: Evaluating the Treasury-Equity Model of Federal Reserve Emergency Lending
The Federal Reserve’s emergency lending framework has increasingly relied on the Treasury-Equity Model, blending Treasury Department fiscal backing with the Fed’s liquidity provision. Conceived during the Global Financial Crisis to alleviate legal uncertainties, it was the primary model for the Fed’s interventions during COVID-19 and was again implemented during the banking turmoil of March-May 2023. This paper reviews and critiques the Fed’s reliance on this approach, in particular assessing whether Treasury involvement strengthens or weakens the Fed’s ability to respond to crises. The paper argues that, rather than enhancing the Fed’s ability to provide liquidity, Treasury participation has frequently introduced political constraints and operational inefficiencies, diluting the effectiveness of emergency interventions. Thus, it is asserted that the Fed should only accept Treasury equity when it genuinely expands risk capacity, rather than as a default bureaucratic mechanism. Otherwise, the Fed risks entrenching a flawed precedent that weakens its autonomy. Moreover, the legal risk that was the original impetus for the Model arguably has been alleviated by post-GFC legislative changes – particularly through Dodd-Frank – rendering the legal justification obsolete. Thus, a recalibrated approach is advised to ensure the Fed’s crisis response remains agile, independent and effective.
Of Last Resort: Evaluating the Treasury-Equity Model of Federal Reserve Emergency Lending
Modernizing Access to Credit for Younger Entrepreneurs: From FICO to Cash Flow
Small business lending in the U.S. has long depended heavily on FICO scores, thereby disadvantaging younger entrepreneurs with limited credit history. This study investigates whether integrating cash flow data from business bank statements into underwriting models is informative about ability to repay and thus may improve small business credit access without increasing risk. The analysis, using data from two fintech lenders and one platform entity, demonstrates that younger applicants – especially those with low FICO scores – experience significantly higher approval rates under cash flow underwriting, with no corresponding increase in default risk. These findings suggest that cash flow data can expand the availability of financing for entrepreneurs relative to reliance on credit scores alone.
Modernizing Access to Credit for Younger Entrepreneurs: From FICO to Cash Flow
Assessing FHFA’s Pilot Program on Automated Title Decisioning: Promoting Competition and Reducing Housing Prices
Housing affordability in the U.S. is increasingly constrained by high closing costs, with title insurance serving as a significant but largely unstudied barrier. The Federal Housing Finance Agency (FHFA) has conducted a pilot program that introduces automated title decisioning in place of traditional title insurance for low-risk refinancing transactions. The program is aimed at reducing costs and increasing competition. This study provides a detailed assessment of the pilot program. The study estimates that scaling up the program could generate annualized consumer savings of $96 million, with projected lifetime benefits between $1.38 and $2.19 billion. These savings include direct cost reductions for participating consumers along with the price reductions due to enhanced competitive pressure within what is presently a highly concentrated industry. Low-income, rural and minority homeowners, who face systemic hurdles to refinancings, are particularly likely to benefit from these reduced costs. The study also provides preliminary evidence that automated title decisioning maintains comparable loss rates to traditional title insurance. The overall takeaway is that scaled implementation of automated title decisioning could have a significant positive effect on homeownership.
Impact of the Volcker Rule on the Trading Revenue of Largest U.S. Trading Firms During the COVID-19 Crisis Period
This study examines newly assembled data on trading activity and associated profits and losses of the 21 largest U.S. trading firms during the COVID-19 stress period to assess the effectiveness of regulatory reforms implemented after the Global Financial Crisis (GFC). In particular, the analysis considers the effects of the Dodd-Frank Act’s Volcker Rule and its restrictions on proprietary trading. The analysis finds that despite extreme market volatility, trading profits remained strong and, in fact, increased, driven primarily by volume-based fees, bid-ask spreads and commissions rather than speculative positioning. By comparing actual and hypothetical profits and losses, the analysis confirms that the firms avoided excessive gains/losses associated with directional bets. These results suggest that the Volcker Rule effectively constrained proprietary trading without impairing market-making profitability and thus suggest that financial regulations can enhance systemic stability while maintaining liquidity in crisis periods.
Buy Now, Pay Later: Market Impact and Policy Considerations
The emergence of Buy Now, Pay Later has transformed consumer purchasing behavior, offering short-term, interest-free installment plans that have rapidly gained popularity. Typically, BNPL programs allow consumers to divide purchases into four equal payments, each interest-free and due two weeks apart. This article reviews the distinguishing characteristics of BNPL products, the markets growth and performance, the benefits of BNPL to consumers and merchants and policy issues that arise in relation to consumer protection and financial stability. Between 2019 and 2021, the number of BNPL transactions associated with the top five U.S. lenders ballooned from 16.8 to 180 million, with the total dollar value increasing from $2 to $24.2 billion. Merchants, despite incurring higher fees for BNPL transactions, experience benefits such as increased sales and higher average transaction sizes. Potential policy concerns include inconsistent disclosures, data privacy issues and the risk of consumers accruing debt beyond their repayment capacity. The article emphasizes the need for policymakers and industry participants to work together to maintain responsible lending practices that safeguard consumers and promote financial stability.
Buy Now, Pay Later: Market Impact and Policy Considerations
When Banks Hold Back: Credit and Liquidity Provision
This paper examines banks’ tendency to systematically underutilize central bank liquidity facilities, even when borrowing conditions are favorable and stigma is absent. The study argues that this reluctance stems from a structural misalignment: banks don’t heed the central bank’s call for more credit to finance investment because they simply ignore the collective gains from stronger activity in their atomistic decisions. Thus, a lender-of-last-resort (LOLR) framework that offers liquidity on non-concessionary terms prevents fire sales but does not resolve the intermediation shortfall. In contrast, credit easing (CE) – offering long-term, attractively priced loans – and quantitative easing (QE) – injecting reserves directly – both significantly boost lending activity. In support of this view, the paper presents an empirical analysis using Euro-area bank and loan-level data confirming that conventional liquidity injections fail to stimulate credit whereas CE and QE lead to measurable increases in economic activity. These results suggest that banks are not indifferent to liquidity sources, and that by designing liquidity policies to align banks’ incentives with broader economic objectives, central banks can promote efficient credit allocation while enhancing financial stability.
When Banks Hold Back: Credit and Liquidity Provision
Interchange Fees and Consumer Benefits in the Electronic Payments System
Interchange fees, paid by merchants to banks for processing debit and credit card transactions via interbank payment networks, are a major source of revenue for credit card issuers. This paper estimates a time-series model examining the relationship between new card issuance and growth in revenue fee income and assesses the implications for policy proposals to cap interchange fee income. Using quarterly data from 2012 to 2024 at the bank holding company level, the analysis indicates that interchange fee income is an important driver of new card issuance, controlling for other relevant factors. For instance, “a one-percent increase in aggregate interchange income associated with a 0.94 percent increase in new account growth.” The findings suggest that “policies that reduce interchange fee income, such as fee caps or routing mandates, may result in fewer new credit cards being issued, particularly affecting lower-income and less creditworthy individuals.”
Interchange Fees and Consumer Benefits in the Electronic Payments System
Central Bank Intervention and Bank Liquidity: Evidence from the Paycheck Protection Program
During the COVID-19 crisis, the Paycheck Protection Program (PPP) created an exogenous increase in liquidity demand in the banking sector. This study examines the role of the Federal Reserve’s discount window in meeting that demand and facilitating banks’ PPP lending activity. Using loan-level transaction data, the study identifies a causal link between discount window borrowing and increased PPP loan origination, particularly among large banks and prior to the rollout of the Federal Reserve’s PPP Lending Facility (PPPLF) as a longer-term funding source. The study estimates that discount window access nearly doubled large-bank lending, with the effect diminishing following the introduction of the PPPLF. Even after the PPPLF rollout, banks continued to use the discount window, underscoring its relevance in stabilizing short-term credit supply.
Central Bank Intervention and Bank Liquidity: Evidence from the Paycheck Protection Program
Chart of the Month
In recent years, banks have continued to lose market share of commercial debt (loans, bonds and other commercial borrowing) to nonbanks, a trend that began with the rise of the high-yield corporate bond market in the late 1980s. Banks’ share now hovers near an all-time low of 20 percent.
Featured BPI Research
Silvergate Bank: A Discount Window Success Story
During the second quarter of 2022, Silvergate Bank, a $16 billion institution with significant crypto industry exposure, faced a depositor run following FTX’s collapse, losing nearly 70 percent of its deposits ($8.1 billion). In comparison to Silicon Valley Bank and Signature Bank, which both subsequently both failed in March 2023 under similar liquidity constraints and pressures, Silvergate was better positioned to effectively utilize the Federal Reserve’s discount window to access emergency liquidity. Silvergate Bank borrowed $4.5 billion from the San Francisco Fed and an additional $4.3 billion from the Federal Home Loan Bank of San Francisco to meet the depositor run. The bank fully repaid its discount window loan by Dec. 15, 2022. The bank was strategically prepared for this borrowing—it had conducted a test loan on Nov. 15, 2022, as FTX was collapsing, and had set aside sufficient collateral for further borrowing. Despite stabilizing temporarily, Silvergate announced its self-liquidation on March 8, 2023. The bank repaid all its depositors; there was no loss to the FDIC. Silvergate Bank’s experience in contrast to that of Silicon Valley and Signature highlights the critical importance of operational readiness and proactive engagement with the discount window for banks to effectively manage liquidity crises and maintain financial stability.
Silvergate Bank: A Discount Window Success Story
What a Recent Bloomberg Editorial Missed About Bank Capital: The Importance of Assessing Risk
This blog post critiques a Bloomberg editorial (“Fed’s Bank Stress Tests Are Facing a Stress Test,” Jan. 17) for presenting a distorted view of bank capital adequacy. While the editorial claims declining capital strength, this assessment is based on looking only at leverage ratios, which fail to account for the declining levels of risk on banks’ balance sheets as indicated by rising risk-based capital levels. The post demonstrates the limitation of assessments based on leverage ratios and argues for the continued use of risk-based requirements to better align capital adequacy with the realities of asset risk. The risk-based approach fosters a more robust and resilient regulatory landscape that reflects the evolving nature of banking risk.
What a Recent Bloomberg Editorial Missed About Bank Capital: The Importance of Assessing Risk
