Research Exchange: July 2022

Selected Outside Research

The Global Dash for Cash in March 2020

The economic disruptions associated with the COVID-19 pandemic prompted a “global dash for cash” with investors rapidly selling securities. This selling pressure occurred across advanced sovereign bond markets and led to various central bank actions. This post describes how these disruptions occurred disproportionately in the U.S. Treasury market and offers explanations for why selling pressures “were more pronounced and broad-based in this market than in other sovereign bond markets.”  The post argues that the relatively greater decline in Treasury market functioning was tied to the dollar’s dominant status as an investment and funding currency and to the large presence of levered entities in the Treasury market in early 2020. In addition, the post discusses the implications of recent changes in the Treasury market, including the Federal Reserve’s introduction of new liquidity facilities, for future market functioning under stress.  Finally, the post discusses some beneficial reforms under consideration, including expansion of central clearing, registration of active trading firms engaged in purchasing and selling of securities as dealers with the SEC, enhanced oversight of trading platforms, and improvements in data reporting (although one possible change not discussed is reforming the supplementary leverage ratio requirement). Read More ⇨

Assessing Market Conditions ahead of Quantitative Tightening

To combat inflation, the Federal Open Market Committee has been increasing the federal funds rate and reducing the Federal Reserve’s nearly $9 trillion balance sheet.  This quantitative tightening—the reduction in the Federal Reserve’s balance sheet—will transfer a significant amount of Treasury and agency mortgage-backed securities to investors. The FOMC’s plan for the current QT episode is for a faster and larger reduction in asset holdings relative to the previous 2017 QT episode. This note assesses whether this episode of QT might play out differently by evaluating market conditions ahead of QT along three dimensions: the state of the U.S. Treasury market, monetary policy uncertainty, and the balance sheet positions of potential investor types.  The analysis suggests that, due to the relatively unsettled state of market conditions today, the current QT episode “has the potential to be more disruptive compared with the benign start to the 2017 runoff.” Read More ⇨

Intermediary Balance Sheets and the Treasury Yield Curve

Regime change in the U.S. Treasury market post-global financial crisis, whereby dealers switched from a net short to a net long position in the Treasury market, is documented in this study. The analysis demonstrates that “Treasury yields moved from net short curve pre-GFC to net long curve post-GFC, consistent with the shift in the dealers’ net position,” attributable to increased bond supply and tightening leverage constraints. This regime change “in turn helps explain negative swap spreads and the co-movement between swap spreads, dealer positions, yield curve slope, and covered-interest-parity violations, and implies changing effects for a wide range of monetary policy and regulatory policy interventions.” Read More ⇨

Bank Diversification and Lending Resiliency

In this study, changes in bank regulation are treated as exogenous shocks to identify causal effects of two major types of asset diversification: geographic expansion and undertaking more non-lending activities. The analysis demonstrates, over of a sample period of 1997-2017, that increased geographic diversification is associated with higher and more resilient credit supply, including increased small business lending, and with more stable bank earnings.  In addition, the paper examines five categories of banks’ non-lending activities: insurance activities; securities broker-dealer and investment banking; securitization; non-deposit trust subsidiaries; and trading activity. The analysis finds that insurance activity supports lending and its resilience over the business cycle, while little effect is observed for other segments (except for trading activity being tied to reduced lending during the global financial crisis). Overall, the paper strongly supports the view that asset diversification promotes increased and more stable lending and enables banks to better absorb negative shocks. Read More ⇨

Stress Tests and Capital Requirement Disclosures: Do They Impact Bank’s Lending and Risk-Taking Decisions?

The impact that European stress tests and subsequent disclosure of the test results had on banks’ lending, risk-taking, and ensuing profitability is examined in this paper. The analysis relies on unique confidential databases containing (i) stress test information for the 2016 and 2018 EU exercises covering a total of 93 and 87 banks, respectively; and (ii) quarterly supervisory information on approximately 1,000 banks (stress-tested and non-stress-tested.)  The study finds that “banks participating in the stress tests reallocate credit away from riskier borrowers and towards safer ones in the household sector” (based on banks’ internal risk ratings). This effect is strongest for the set of banks for which there had been no prior disclosure of either stress test results or Pillar 2 capital requirements, consistent with the view that disclosure promotes market discipline. Read More ⇨

Evolution of Debt Financing Toward Less Regulated Financial Intermediaries

Nonbank financial institutions have been playing an increasingly important role in the provision of business loans over the recent decade, by increasing their participation in syndicated loans to large businesses and as direct lenders to small and mid-sized businesses. The composition of holders of market debt also has changed, with mutual funds and other less regulated entities gaining more material market shares. This paper provides a selective review of papers on this growth of nonbank lending, focusing on the 2000s in the United States. It provides evidence on the extent of nonbank participation in the direct and syndicated loan markets and corporate bond markets and describes how banks and nonbanks helped provide liquidity to the nonfinancial sector during the COVID-19 pandemic shock. In addition, the paper discusses the distortions associated with the differing degrees of regulatory oversight for banks versus nonbanks, and it examines the financial stability implications of this “transformed landscape of credit markets.” Read More ⇨

Credit and the Family: The Economic Consequences of Closing the Credit Gap of U.S. Couples

Section 150 of the Truth in Lending Act (which imposes ability-to-pay requirements in the U.S. consumer credit card market) originally required credit card issuers to evaluate co-applicants’ individual incomes. The statute was reversed in November 2013 to allow credit card issuers to consider household income, facilitating access to credit for secondary earners and stay-at-home spouses. This research brief summarizes findings from an analysis of the impact of this statutory change on gaps between spouses in credit access and consumption. The analysis finds that secondary earners’ credit access increased by more than $1,000 over the two-year period after the reversal, amounting to 40 percent of secondary earners’ average monthly consumption in the year prior to the reversal. Secondary earners’ consumption level and share of household consumption also increased significantly. Delinquency rates were not measurably affected, suggesting that household financial standing did not worsen. Read More ⇨

Young Borrowers’ Usage of Cosigned Credit Cards and Long Run Outcomes

This study explores, using credit bureau data, the use of cosigned credit cards by parents to help their children establish and build credit. The analysis indicates that establishing an initial credit record with a cosigned credit card is associated with a higher credit score compared to entering with an individual credit card or another type of credit.  Moreover, this gap in credit score persists as borrowers age, and borrowers with cosigned credit cards are more likely to have a mortgage by age 30. Thus, parental cosigning may be a contributing factor to correlation between parental and child wealth since credit market experience plays a significant role in wealth accumulation. Read More ⇨

Lessons Learned from Mortgage Borrower Policies and Outcomes during the COVID-19 Pandemic 

This paper examines how key policy responses to the COVID-19 pandemic affected outcomes in the U.S. mortgage market. These included a national forbearance mandate, a foreclosure moratorium, expanded unemployment insurance benefits, and economic impact payments to most households. In addition, the Federal Reserve’s large-scale asset purchase program (including purchases of mortgage-backed securities), intended to improve market functioning and lower long-term interest rates, helped promote mortgage refinancing. The analysis finds that these policies were largely successful in relieving financial distress and allowing homeowners to stay in their homes. This success in part is attributed to rising housing prices and home equity, before and during the pandemic—conditions that might not hold in future downturns. Forbearance was especially beneficial to Black and Hispanic mortgage borrowers, who were disproportionately affected by disruptions to income during the pandemic; however, they were less likely than white or Asian borrowers to refinance. Read More ⇨

Climate-Related Financial Stability Risks for the United States: Methods and Applications

This paper reviews the current literature on climate-related financial stability risks for the United States, describes the major methodologies adopted in studying the financial stability implications of climate change, and identifies areas for future research concerning such risks. The discussion characterizes financial system vulnerabilities, provides an assessment of those vulnerabilities (high/medium/low) as identified by the current literature, and evaluates the uncertainty surrounding these assessments based on interpretation of the findings and coverage of existing literature. One key takeaway is that modeling and assessing climate-related financial stability risks present several challenges. These include (1) accounting for uncertainty, (2) adapting to long time horizons, (3) embedding heterogeneity, (4) incorporating technological change, and (5) modeling damage functions to measure the economic impacts of climate change. Read More ⇨

The Determinants of Bank Liquid Asset Holdings

In contrast to non-financial firms, there is little evidence on the factors influencing bank liquid asset holdings. This paper addresses this gap in the literature by examining the determinants and the evolution of U.S. bank liquid asset holdings from 1984 to 2020.  The analysis finds strong support for an investment motive for holding liquid assets, whereby banks hold fewer liquid assets when their lending opportunities are better.  In addition, the study finds that large banks hold much more liquid assets after the global financial crisis and this change cannot be explained using models of liquid asset holdings estimated using pre-crisis data.  Rather, evidence is consistent with the view that the increase in liquid assets of large banks is tied to post-crisis regulatory changes. Read More ⇨

Chart of the Month

Deposits vs Retail Money Market Funds
Monthly Seasonally Adjusted Change

The chart shows the monthly changes in bank deposits and in retail money market fund deposits, seasonally adjusted ($ billions.)  The rapid expansion of bank deposits during 2021 and into early 2022 began to reverse in April 2022.  Money market fund deposits, which had seen little change through April 2022, began to rise in May 2022. 

Featured BPI Research

Our Search for an Urban Banking Market Made Less Competitive by a Banking Merger

 This research note takes a close look at urban banking markets that are classified as “concentrated” under the Herfindahl-Hirschmann measure of market concentration employed by the Federal Reserve System and the U.S. Department of Justice. The primary objective is to assess the role of mergers in causing a market either to become concentrated in the first instance or materially more concentrated if it was already highly concentrated pre-merger. The analysis demonstrates that assessments of banking market competition by the Federal Reserve are approached conservatively. The note highlights three important dimensions where conservatism is applied: the delineation of geographic banking markets; the extent to which competition from nonbank financial firms is considered; and how bluntly deposits at local branches are measured for quantifying market shares. Overall, the analysis demonstrates that existing merger policy has been successful at preserving competition in urban banking markets. Read More ⇨

The FDIC’s Proposed Increase in Deposit Insurance Assessments May Be Based on Incorrect Projections

This research replicates the FDIC’s projections of the ratio of reserves to insured deposits and explore the implications of modifying two of the FDIC’s assumptions. First, in place of the FDIC’s assumption that interest earnings on banks’ overnight lending will be zero over the forecast horizon, the note assumes that starting in 2022Q3, they will sum to 2½ percent, which roughly aligns with current overnight and term rates and with the Federal Open Market Committee’s outlook for the overnight rate over the longer term. Second, in place of the FDIC’s assumption that deposits will grow at 3½ or 4 percent, the note assumes that the level of deposits will remain unchanged in the medium term, which is in line with the fact that deposits are currently contracting and that the factors that have boosted deposits over the past few years have all reversed. Under these modified assumptions that better reflect recent developments, projections indicate that the DIF reserve ratio is on track to reach 1.35 percent by the middle of next year, more than 5 years before the statutory deadline and between 4 and 9 years earlier than the FDIC projected. As a result, the FDIC proposal to double the base assessment rate from 2 basis points to 4 basis points is not supported by the rationale the FDIC provides. Read More ⇨

Conferences & Symposiums


8/3/2022 – 8/4/2022
Sixth Annual Fintech Conference
Federal Reserve Bank of Philadelphia
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9/6/2022 – 9/7/2022
2022 TCH + BPI Annual Conference
The Pierre, New York City
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Climate Implications for Financial Stability Conference
Office of Financial Research (Virtual)
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9/14/2022 – 9/16/2022
FDIC 21st Annual Bank Research Conference: Announcement and Call for Papers
New York City
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9/28/2022 – 9/29/2022
Community Banking in the 21st Century Research and Policy Conference 2022
Federal Reserve Bank of St. Louis
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9/29/2022 – 9/30/2022
Inflation: Drivers and Dynamics Conference 2022
Federal Reserve Bank of St. Louis
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Financial Stability Considerations for Monetary Policy
Federal Reserve Bank of New York
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10/6/2022 – 10/7/2022
Conference on Real-Time Data Analysis: Applications in Macroeconomics and Finance
Federal Reserve Bank of St. Louis
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10/6/2022 – 10/7/2022
2022 Federal Reserve Stress Testing Research Conference
Federal Reserve Bank of Boston
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10/19/2022 – 10/20/2022
MIT Golub Center for Financial Research 9th Annual Conference (co-sponsored by Barclays)
Cambridge, MA
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Johns Hopkins Carey Finance Conference 2022
Johns Hopkins Carey Business School, Johns Hopkins University, Baltimore, MD
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10/26/2022 – 10/27/2022
The Fourth Workshop on Payments, Lending, and Innovations in Consumer Finance
Federal Reserve Bank of Philadelphia
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11/7/2022 – 11/8/2022
The Implications of Financial Technology for Banking: Announcement and Call for Papers
Office of the Comptroller of the Currency
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11/17/2022 – 11/18/2022
Global Research Forum on International Macroeconomics and Finance
Federal Reserve Bank of New York
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11/17/2022 – 11/18/2022
2022 Financial Stability Conference: Announcement and Call for Papers
Federal Reserve Bank of Cleveland and Office of Financial Research
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12/15/2022 – 12/16/2022
CFPB Research Conference 2022: Announcement and Call for Papers
Consumer Financial Protection Bureau
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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.