Research Exchange: March 2023

Hiring: Senior Economist

The Bank Policy Institute is hiring a senior economist. BPI is a nonpartisan public policy, research and advocacy group, representing the nation’s leading banks. The senior economist would work in the Research group with several other experienced PhD economists and research analysts. The senior economist conducts and presents economic research on bank regulation and its consequences. The research varies from papers intended for publication in peer-reviewed journals to quick-response blog posts on breaking developments. Candidates should have a PhD in economics or a related field, eight or more years’ experience conducting empirical research on banking or related issues, and strong writing and communication skills. Apply here >>

Selected Outside Research

Do Financial Consumers Discipline Bad Lenders? The Role of Disclosure Awareness

The role of disclosure awareness in enhancing market discipline regarding consumer financial protection is examined in this paper. The study investigates whether U.S. mortgage borrowers penalize lenders that engage in predatory lending practices, identifying these lenders using enforcement actions issued by the Consumer Financial Protection Bureau and state regulators. The study finds a significant drop in loan applications and a significant reduction in interest rates following enforcement actions, but only when the actions receive extensive media coverage. The analysis additionally indicates that “the sanctioned lenders penalized by borrowers subsequently improve their service quality, as reflected in fewer consumer complaints.” Read More ⇨

Reserve Demand, Interest Rate Control and Quantitative Tightening

This study develops a framework for understanding banks’ demand for central bank reserves and demonstrates its application to Federal Reserve policymaking. The framework highlights the spread between market rates and the interest rate on reserves, banks’ liquidity needs (implying that reserves generate a convenience yield) and bank balance sheet costs as key drivers of reserve demand. In addition, the study describes how central banks control equilibrium short rates via interest on reserves, reserve supply and lending/borrowing facilities. The framework is used to estimate reserve demand for the US from 2009M1-2022M10, and the estimated reserve demand function is then used to (a) guide the setting of interest on reserves, and (b) assess how much quantitative tightening is feasible. Read More ⇨

How Do Banks Respond to Nonbank Competition in the Conforming Residential Mortgage Market? The Role of the Balance Sheet

How banks have responded to increasing non-bank competition in the conforming residential mortgage market since 2012 is examined in this study. The analysis finds that banks increasingly used their balance sheet financing capability, substantially increasing the proportion of originated, conforming loans retained on their balance sheet. Specifically, banks have retained increasing proportions of adjustable-rate mortgages and fixed-rate mortgages with medium-to-high credit scores and low-to-medium combined loan-to-value ratio (CLTV), which are conforming mortgages for which the GSE guarantee fees may be high relative to these loans’ credit risk. In addition, the analysis shows that banks charge lower interest rates on mortgages retained on their balance sheets relative to those sold to the GSEs. Read More ⇨

Nonbank Financial Institutions and Banks’ Fire-Sale Vulnerabilities

In addition to banks’ direct risk exposures to nonbank financial institutions associated with lending activity, they may also face indirect risk exposures via a type of contagion effect tied to the distressed sale of assets by nonbanks. When certain nonbanks experience distress, they may be forced to sell assets at fire-sale prices, which could depress prices and impair the net worth of banks that hold similar assets. This paper analyzes the linkages between banks’ and nonbanks’ asset holdings and documents “significant, and rising, exposures by U.S. banks to potential asset fire sales from nonbanks”. The analysis also demonstrates how initial fire sales by nonbanks in a particular asset segment can propagate through other asset segments, thereby spilling over into banks that may not have exposure to the segment where the shock originated. Read More ⇨

Securities Portfolio Management in the Banking Sector

This paper develops a method to measure banks’ securities purchasing and selling activity using publicly available data from regulatory filings and analyzes banks’ securities management practices based on this data. The study first documents several stylized facts about banks’ security sales, including that the banking sector tends to be a net purchaser of securities in most quarters, and that banks tend to sell safe securities. In addition, regression analysis is conducted to isolate and quantify the impact of balance sheet movements on bank selling activity. One key finding is that “deposit shocks have the greatest explanatory power among balance sheet changes that are exogenous from the bank perspective”. The analysis also finds that “banks only sell securities to meet deposit withdrawals when cash holdings are low” and that “only well-capitalized banks sell their risky securities in these cases”. Read More ⇨

Shocks to Transition Risk

This paper develops and implements a method to identify shocks to climate transition risk, which identifies shocks as “instances where significant new information about the economic relevance of climate change increases the valuation of green firms over brown firms”. The method is then applied illustratively to explore the effects of shocks to transition risk in the United States. The analysis demonstrates that these shocks are associated with events that increase the likelihood of an orderly transition, they specifically affect parts of the economy related to fossil fuels and energy, and they may have financial instability implications. Read More ⇨

Not Cashing In on Cashing Out: An Analysis of Low Cash-Out Refinance Rates

Using anonymized data on mortgage refinancing behavior, this paper investigates the extent to which mortgage borrowers with high-interest debt and available home equity utilize the opportunity to pay down that debt by taking cash out when refinancing their mortgage. The results indicate that most such borrowers do not take advantage of their cash-out opportunities, even among those who have already chosen to refinance their mortgage. The findings suggest a potential role for “nudges” encouraging such borrowers to take advantage of cash-out opportunities. Read More ⇨

Tornado Cash and Blockchain Privacy: A Primer for Economists and Policymakers

Contrary to popular belief, permissionless blockchains are completely transparent, with all confirmed transactions publicly observable and stored as part of the blockchain’s history. Users’ identities are protected only through the use of pseudonymous addresses. This setup enables public blockchains to operate without any intermediaries, allowing all participants to verify the integrity of transactions and the current state of the ledger. However, this raises privacy concerns if someone were to obtain information linking an address to a user’s identity. To preserve privacy, many users rely on so-called crypto asset mixers such as Tornado Cash. Users deposit the same amount of a specific crypto asset into a mixer address, with the mixer acting as a pool; they later may withdraw their funds using a new address, concealing the link between the deposit and withdrawal addresses. This article explores crypto asset mixers, examining their types, how they work and their associated risks and opportunities. Additionally, it suggests an approach, based on voluntary disclosure that would allow financial market regulators to combat money laundering and illicit activities while allowing honest users to interact with privacy-enhancing protocols. Read More ⇨

Chart of the Month

The failure of Silicon Valley Bank and Signature Bank led to a significant increase in borrowing from the Federal Reserve’s lending facilities. The banks’ borrowing from the Fed’s discount window and Bank Term Funding Program amounted to $354 billion in the week that ended in March 22. The borrowing declined by $12 billion in the subsequent week, indicating a degree of stabilization in deposit outflows.

Featured BPI Research

Capital Requirements, Nonbank Finance and Financial Fragility

This blog post evaluates some of the results in a recent paper by Begenau and Landvoigt (2022), which examines the impact of bank capital requirements on migration of credit intermediation activity to nonbanks. While this paper provides valuable insights, it also has some limitations that need to be acknowledged for readers to fully understand its implications for bank capital requirements. While quantitative general equilibrium models, like the one used in the paper, are useful in assessing the qualitative impact of policy changes on economic agents, they do not account for many important factors, making it challenging to rely on their quantitative findings. The blogpost highlights two main limitations of the analysis, such that the model does not capture effectively: (i) the size and impact of the shadow banking sector during economic recessions, and (ii) the stylized format of banks’ balance sheets, including the absence of consideration for the significant amount of safe assets that banks hold in their balance sheets, as well as the long-term debt that can be converted to equity upon bank failure. By accounting for these factors, the model’s quantitative findings could be adjusted, providing a more accurate optimal capital requirement for U.S. banks. Read More ⇨

The “Branch Destruction” Fiction | Part I

The post critiques a research paper co-authored by a group of Federal Reserve Board economists that was presented at the OCC’s Symposium on Bank Mergers, held on Feb. 10. This research paper analyzes detailed data on banking market structure, deposit growth and deposit account interest rates in the U.S. from 1980 to 2014. The period covered in this paper saw a significant amount of bank consolidation as well as a significant increase in the number of bank branches. The study obscures these facts by shifting the focus to neighborhood-level comparisons, arguing that mergers cause “branch destruction” and therefore the traditional, market concentration approach to assessing competitive effects needs reconsideration. However, more accurately described, the paper finds that the number of bank branches (on average) grew more slowly in local markets where merging banks had closely overlapped networks compared to those with no overlap. So, for example, if a merged bank ended up with two branches on the same or a nearby block, it would be likely to close one of them. The post concludes that the paper presents a well-developed analysis of how the effects of bank mergers can vary depending on the degree of spatial overlap of the merging banks’ branch networks, but the statistical results do not, in fact, support the paper’s narrative that the current approach to competitive analysis of bank mergers is flawed. Read More ⇨

The “Branch Destruction” Fiction | Part 2

This is the second post in a series addressing the factual basis of a belief held by some opponents of bank mergers: that bank mergers drive branch closings that harm consumers. For instance, two prominent federal government officials (Consumer Financial Protection Bureau Director Rohit Chopra and Federal Trade Commission Chair Lina Khan) have articulated this view. In characterizing bank mergers as a source of widespread branch closures, they cite a research paper authored by Hoai-Luu Q. Nguyen, a professor at the UC Berkeley Haas School of Business. However, in drawing such an inference, they are misreading that paper. The referenced study finds only that merger-related closings most frequently occur where the merging banks’ branch networks closely overlap. Moreover, the Nguyen study is limited to just 13 large-bank mergers that took place between 2003 and 2007, a period during which the total number of bank branches in the U.S. increased more than 20 percent. Neither that study, nor the paper by Federal Reserve Board staff economists reviewed in the previous, Part 1 blog post, nor any other statistically rigorous study that the author of the post is aware of, indicate that bank mergers lead to broad-based and systematic branch closings. Read More ⇨

The Fed’s Discount Window Lending

As has been widely reported, Federal Reserve lending increased sharply over the week leading up to Wednesday, March 15. That increase should not be surprising, as this situation is exactly the scenario for which its lending programs were designed. The lending took three forms: regular discount window lending (“primary credit”), lending to the bridge banks the FDIC created for SVB and Signature and lending through the Fed’s new Bank Term Funding Program. For those interested in the specifics, this blog post provides an explanation of the various programs and how they work. Read More ⇨

Conferences & Symposiums

BPI-Columbia Bank Regulation Conference Explores Business Cycle, Buffers

The seventh annual Conference on Bank Regulation of the Bank Policy Institute and Columbia University School of International and Public Affairs took place on March 1, 2023. Each year, the conference brings together academics, banking agency economists and market participants to discuss the latest research on banking and bank regulation. The keynote this year was delivered by Randal Quarles, and this year’s theme was bank regulation and the business cycle. The conference covered capital dynamics and regulations, countercyclical capital buffers, evidence on temporary regulatory actions and what can be expected for bank regulation. One broad takeaway was that releasable buffers like the countercyclical capital buffer are effective in supporting in reducing procyclicality, but judgmental buffers like the capital conservation buffer are not.  Another recurrent message was that post-GFC bank regulations have been performing well but can always use improvements and updates. Read More ⇨

4/11/2023 – 4/12/2023
Investing in Rural America 2023
Federal Reserve Bank of Richmond
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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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Office of Financial Research Rising Scholars Conference: Announcement and Call for Papers
Washington, D.C.
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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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Yale Program on Financial Stability Conference: Announcement and Call for Papers
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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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.