Selected Outside Research
Debt-to-Income as a Measure of Ability to Repay
A commonly used measure to evaluate mortgage applicants’ ability to repay their mortgage is their debt payment-to-income ratio, which is often criticized on the grounds that its predictive ability is weak. This paper tests whether the DTI ratio, properly measured, is an effective predictor, while at the same time highlighting one important source of measurement error that impedes its effectiveness. The analysis relies on a mortgage database that contains both the information used to underwrite each mortgage, including a potentially mismeasured debt-to-income ratio that incorporates projected property tax payments, and a corrected DTI ratio based on updated and verified tax payment information. The study finds that loans originated based on understated DTIs are significantly more likely to become seriously delinquent than those with accurate or overstated DTIs, “consistent with the ability of DTI to explain variations in mortgage performance.”
Debt-to-income as a measure of ability to repay
Is Maturity-Transformation Risk Priced into Bank Deposit Rates?
This paper uses data on the term structure of bank CD rates to examine the relationship between maturity-transformation risk and the rates banks offer customers. The analysis finds that banks price maturity risk in the interest rates offered to depositors, as reflected in lower deposit rates on accounts requiring more maturity transformation. Specifically, “maturity-transformation risk is priced into the CD rates that banks offer their customers”. This finding is consistent with the view that “households value the unique liquidity/convenience services that bank deposit accounts provide and are willing to accept lower interest rates in order to gain access to them.” Moreover, the findings support the view that “household demand for the special characteristics of bank deposits could provide an alternative non-market-power based explanation for the existence of deposit spreads.”
Is Maturity-Transformation Risk Priced into Bank Deposit Rates?
How the Source of Financing Discrimination Affects Housing Opportunities for FHA Buyers
Using proprietary data on real estate listings, this study documents that 42 percent of for-sale listings of homes eligible for Federal Housing Administration mortgage financing state that FHA offers are not acceptable for the seller, and it then explores what may be driving this outcome. The analysis finds that real estate agents are the primary contributor to this outcome, as they account for over 40 percent of the variation in whether FHA offers are accepted, whereas location and time account for only about 10 percent of the variation. Agents with previous FHA experience, regardless of the side of the transaction they are on, are more likely to include FHA offers in subsequent listings. Thus, the analysis suggests that “agents play a crucial role in market access for FHA borrowers” and that less experienced agents may be hesitant to tie the transactions to a program that they view as complex and “difficult to navigate.”
How the Source of Financing Discrimination Affects Housing Opportunities for FHA Buyers
Toss a Stablecoin to Your Banker – Stablecoins’ Impact on Banks’ Balance Sheets and Prudential Ratios
Stablecoins are cryptocurrencies that aim to maintain a stable value relative to a specified asset or pool of assets. This paper examines how bank balance sheets, liquidity and capital ratios are affected when banks issue stablecoins themselves or acquire stablecoin deposits. One key takeaway is that banks that issue stablecoins must back them with central bank reserves or with reserves invested in low-risk assets, which makes them a less effective funding source relative to traditional retail deposits. The analysis also highlights that the effect of bank-issued stablecoins on the bank’s liquidity coverage ratio depends on whether the holders are identifiable – unknown holders weaken the LCR. Another important takeaway is that stablecoin deposits can also weaken a bank’s LCR by effectively converting stable retail deposits into more volatile wholesale deposits, even if these funds are reinvested in high-quality liquid assets.
Balance-Sheet Netting in U.S. Treasury Markets and Central Clearing
Most U.S. GSIBs have primary dealer subsidiaries that participate in primary issuance of Treasury securities and also intermediate repurchase transactions in secondary markets. The “footprint” of these GSIB subsidiaries in the U.S. Treasury and repo markets is large and their willingness and ability to participate in these markets are considered vital for overall Treasury market functioning. However, the GSIB subsidiaries are subject to regulatory leverage requirements (the supplementary leverage ratio) that increase the cost of these intermediation activities to the extent that the rules do not permit them to net offsetting transactions. Central clearing is an alternative to dealer intermediation, but currently its role is limited. In 2023, the SEC adopted new rules with the aim of expanding the role of central clearing in the Treasury market, to go into effect in late 2025 and mid-2026. This paper explores the potential for expanded central clearing to mitigate the constraining effects of the SLR on Treasury market intermediation. The analysis finds that, while intermediaries increase their balance sheet netting when their regulatory balance sheet costs are higher, “sizeable quantities of bilaterally cleared activity would not be nettable even if centrally cleared.” Moreover, a significant portion of activity is already nettable outside of central clearing because of how dealers are structuring their trades. Therefore, the study concludes that expanded central clearing would have limited scope for mitigating dealers’ balance sheet costs associated with the SLR.
The Fed – Balance-Sheet Netting in U.S. Treasury Markets and Central Clearing (federalreserve.gov)
One Month Longer, One Month Later? Prepayments in the Auto Loan Market
This paper documents and characterizes a long-run trend of increasing auto loan maturities and the factors propelling this trend, and it explores borrower prepayment behavior with auto loans. The analysis finds that over the past 50 years, auto loan maturities on average have risen from 30 to over 70 months, in part reflecting improved vehicle durability. Additional analysis focusing on the majority of auto loans originated over the past 16 years indicates that longer-maturity new car loans have significantly higher interest rates, with a steeper yield curve than comparable Treasury securities. In addition, the analysis finds that most auto loans, including those bearing zero interest, are prepaid, often resulting in borrowers paying more interest than if they were to choose a loan of shorter maturity. The study concludes that factors such as liquidity constraints, uncertainty about future income and monthly payment targeting likely account for only a portion of the trend and that further study is needed.
Small-Dollar Loans in the U.S.: Evidence from Credit Bureau Data
This note provides an overview of the market for small-dollar consumer loans in the U.S. as reflected in credit bureau data. Among the key takeaways are that nearly one-third of loan balances are secured, half are fixed-rate and almost 70 percent of small-dollar loan balances belong to subprime borrowers. Finance companies hold nearly 60 percent of balances, or $835 million, while banks currently hold 22 percent of total balances or $319 million. Fintech lender-issued small-dollar loan balances currently stand at $181 million or 13 percent of the market. The bank share has increased markedly since 2019.
The Fed – Small-Dollar Loans in the U.S.: Evidence from Credit Bureau Data (federalreserve.gov)
The Effect of Primary Dealer Constraints on Intermediation in the Treasury Market
Primary dealers, a select group of market-making financial firms that are typically affiliated with large banking organizations, participate directly in the primary market for Treasury debt issuance and also resell the Treasuries to investors in the secondary markets. This paper studies the extent to which the Treasury securities market can be affected by regulatory constraints on bank-affiliated primary dealers, a task that can be challenging because of data limitations and the confounding effects of broader market conditions. The analysis uses “confidential microdata on dealers’ risk limits, positions, turnover, and profits” and applies two alternative strategies. First, a difference-in-differences strategy is used to assess the impact of the supplementary leverage ratio (SLR), a regulatory constraint that targets the banking organization’s overall balance sheet composition. Second, the impact of internal risk-holding constraints at the trading-desk level is analyzed by examining dealers’ responses to idiosyncratic shocks. The findings support the view that primary dealers reduce their Treasury holdings when they are subject to these constraints.
An Empirical Analysis of the Cost of Borrowing
This study examines the comparative cost of borrowing using bank loans versus corporate bond issuance for U.S. firms and related issues. The analysis finds significant, within-firm heterogeneity in borrowing costs even after controlling for observable characteristics such as loan size and maturity, and it finds that obtaining a bank loan is generally cheaper than issuing a corporate bond, with an average cost difference of 132 basis points. Moreover, the analysis finds that fluctuations in borrowing costs have persistent negative effects on key firm-level outcomes, such as investment and leverage decisions, with these effects varying across industry sectors.
An Empirical Analysis of the Cost of Borrowing- Working Papers – St. Louis Fed (stlouisfed.org)
Preventing Foreclosures: What Has Been Done? What Is to Come?
Loss mitigation strategies for distressed residential mortgage loans have evolved significantly over the past 15 years, yielding significant improvement in outcomes. This study documents the “paradigm shifts” in loss mitigation brought about by the 2008 financial crisis and the further refinements implemented during the COVID-19 pandemic, and reviews empirical evidence demonstrating a significant reduction in foreclosure rates resulting from these interventions. The paper proposes potential enhancements to existing programs, including further improvements in streamlined mitigation processes, integration of mortgage reserve accounts and pragmatic customer outreach. The discussion also emphasizes the need for ongoing innovation of loss mitigation tools to better support borrowers facing financial hardships, particularly underserved populations, to further reduce default rates and enhance homeownership stability.
Preventing Foreclosures (urban.org)
Does Media Sentiment Influence Bank Supervision?
This paper examines the relationship between Federal Reserve supervisory ratings of bank risk management and views about the bank (“sentiment”) expressed in media reports. The analysis, which employs a robust, difference-in-differences strategy to isolate effects of media sentiment from risk fundamentals, finds a significant impact of media sentiment on supervisory ratings. Specifically, more negative articles are associated with weaker ratings. The analysis also finds that “the length of the bank exam and the experience of the examiner in charge also impact the identified effect: longer exam duration and more extensive supervisor experience reduce the impact of media sentiment on the risk management ratings.”
Chart of the Month
This chart illustrates a hypothetical combination of five Category IV banks: Citizens Financial Group, Inc., Fifth Third Bancorp, First Citizens Bancshares, Inc., Keycorp and Regions Financial Corporation. This hypothetical merged entity demonstrates the dramatic expansion needed to replicate the scale and geographic diversification of the largest U.S. banks. The combined entity would have a geographic deposit market coverage of 77.1 percent, rivaling those of the largest GSIBs including JPMorgan (76.5 percent), Wells Fargo (69.1 percent) and Bank of America (72.3 percent). This hypothetical scenario is meant to emphasize the possibility of providing benefits through enhanced competition due to the economies of scale, lowered funding costs and improved funding stability that would be realized via regional bank mergers.
Featured BPI Research
Empty Promises: Revisiting the Reasons to Fix the Supplementary Leverage Ratio
This post argues that the supplementary leverage ratio requirement should be reformed as it has become a binding constraint on banks, contrary to its initial function of acting as a backstop to inadequate risk-based capital requirements. This has led to unintended consequences, such as disincentivizing banks from functioning as dealers in low-risk asset markets, such as for U.S. Treasury securities. The article suggests several fixes, including reducing the eSLR buffer and excluding certain low-risk assets from the SLR calculation, to restore the leverage ratio to its intended purpose and improve market liquidity and intermediation.
Empty Promises: Revisiting the Reasons to Fix the Supplementary Leverage Ratio
Reassessing the OFR’s Commercial Real Estate Concerns: A Closer Look at Bank Resilience and Risk Factors
This post critiques the OFR’s concerns about banks’ exposure to commercial real estate (CRE) risks, arguing that these risks are overstated. It is noted that smaller banks have strong capital buffers, adequate loan loss allowances and diversified CRE portfolios. To provide further evidence, it should also be acknowledged that unrealized losses on securities are often temporary and that lower interest rates could mitigate these losses in a recession – most banks have the goal to hold these securities to maturity, allowing for the evasion of realized losses. In conclusion, smaller banks, especially those with high CRE concentrations, are more resilient than the OFR brief suggests, emphasizing their robust capital positions and improved risk management practices.
Regional Bank Mergers Would Increase Competition Without Increasing Systemic Risk
The article argues that mergers of regional banks in the U.S. would enhance competition and stability without increasing systemic risk. It criticizes the OCC and FDIC’s regulatory proposals that would impose arbitrary total asset thresholds on merged entities, hindering the ability of regional banks to scale up and compete nationally. It argues that by achieving greater geographic diversification of deposits through mergers while maintaining a low systemic risk profile, regional banks can reduce funding costs and enhance funding stability through mergers. While mergers of large regional banks would not create new global systemically important banks (GSIBs), they will still promote competition. Thus, a balanced regulatory approach towards M&A is recommended for the progression of the industry.
Regional Bank Mergers Would Increase Competition Without Increasing Systemic Risk
Should Banks, Thrifts and Credit Unions be Forced to Make Interest-Free Loans to the U.S. Government?
This article examines recurring proposals to require banks, thrifts and credit unions to hold zero-interest deposits at central banks, effectively providing interest-free loans to the government. This idea is criticized as an inequitable tax on these depository institutions, that provides no efficient benefits to monetary policy but would complicate its implementation. Indeed, academic experts such as Milton Friedman have supported central banks paying interest on reserve balances to improve monetary policy efficiency. The proposals would arbitrarily single out banks, thrifts and credit unions, while other counterparties, like government-sponsored enterprises and foreign central banks, continue to receive interest on their loans to the Fed. In sum, the post calls for maintaining fair and effective monetary practices without imposing undue financial strains on banks that could weaken financial stability by arbitrarily requiring banks to make interest free loans to the government.
Should Banks, Thrifts, and Credit Unions be Forced to Make Interest-Free Loans to the US Government?
Conferences & Symposiums
8/9/2024
Yale Program on Financial Stability Annual Research Conference: Announcement and Call for Papers
Yale University
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9/19/2024 – 9/20/2024
23d Annual Bank Research Conference: Announcement and Call for Papers
FDIC Center for Financial Research
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9/26/2024
10th Annual U.S. Treasury Market Conference
Federal Reserve Bank of New York
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10/1/2024 – 10/2/2024
Conference on Technology-Enabled Disruption
Federal Reserve Bank of Atlanta
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10/2/2024 – 10/3/2024
Community Banking Research Conference
Federal Reserve Bank of St. Louis
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10/9/2024 – 10/10/2024
Chicago Payments Symposium
Federal Reserve Bank of Chicago
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10/10/2024 – 10/11/2024
Federal Reserve Stress Testing Research Conference: Announcement and Call for Papers
Federal Reserve Bank of Boston
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10/11/2024
Community Bankers Symposium
Federal Reserve Bank of Chicago
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10/18/2024 – 10/19/2024
The 10th Anniversary Wharton Conference on Liquidity and Financial Fragility: Announcement and Call for Papers
Philadelphia
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10/22/2024 – 10/23/2024
8th Annual Fintech Conference
Federal Reserve Bank of Philadelphia
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10/24/2024 – 10/25/2024
Workshop on Changing Demographics and Housing Demand
Federal Reserve Bank of Philadelphia
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10/24/2024 – 10/25/2024
Inflation: Drivers and Dynamics
Federal Reserve Bank of Cleveland
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10/24/2024 – 10/25/2024
MIT GCFP 11th Annual Conference – Consumer Finance
Cambridge, MA
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11/15/2024 – 11/16/2024
5th CEAR-RSI Household Finance Workshop
Montreal, Canada
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11/19/2024
FX Market Structure Conference
Federal Reserve Bank of New York
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11/21/2024 – 11/22/2024
Conference on Financial Stability: Announcement and Call for Papers
Federal Reserve Bank of Cleveland and Office of Financial Research
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11/22/2024
Pacific Basin Research Conference
Federal Reserve Bank of San Francisco
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11/25/2024 – 11/26/2024
III CEMLA-Dallas Fed-IBEFA Workshop on Financial Stability: Announcement and Call for Papers
Mexico City
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12/5/2024 – 12/6/2024
The Evolving Structure of the Financial Services Industry: Announcement and Call for Papers
Federal Reserve Bank of Atlanta and Georgia State University
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