Research Exchange: May 2023

Selected Outside Research

Bank Relationships and the Geography of PPP Lending

This paper examines how bank relationships affected the timing and geographic distribution of Paycheck Protection Program lending. The analysis finds that half of banks’ PPP loans went to borrowers within 2 miles of a branch, mostly driven by relationship lending, and that firms near less active lenders were more reliant on fintechs and internet lenders. The latter borrowers tended to experience delays receiving credit. A structural model estimated to fit the observed relationship between branch distance, bank PPP activity and origination timing indicates that banks served relationship borrowers 5 to 9 days before other borrowers. Read More ⇨

Why Are Bank Holdings of Liquid Assets So High?

Since the Global Financial Crisis, aggregate bank liquid asset holdings (reserves plus liquid securities) have grown from 13 percent to 33 percent of total assets as of 2020. This paper demonstrates that, consistent with economic incentives, bank holdings of liquid assets are inversely related to availability of profitable lending opportunities. The analysis indicates that bank liquid asset holdings have increased since the GFC partly due to weak lending opportunities, but that regulatory changes have also played a role. Read More ⇨

Getting up from the Floor

Since the Great Financial Crisis, a growing number of central banks have adopted abundant reserves systems (“floors”) to set the interest rate, in place of the pre-GFC scarce reserve systems (“corridors”). This article examines that shift, assesses its implications and argues that there are at least three good reasons for returning to scarce reserve systems. First, “the costs of floor systems take considerable time to appear, are likely to grow and tend to be less visible.” Second, “there is a risk of grossly overestimating the implementation difficulties of corridor systems, in particular the instability of the demand for reserves.” Third, a corridor system provides more leeway for the central bank to adjust the composition of its liabilities. Read More ⇨

Does IT Help? Information Technology in Banking and Entrepreneurship 

This study presents new evidence that information technology plays an important role in banks’ provision of credit supply to entrepreneurial firms. The analysis demonstrates that job creation by young firms is stronger in U.S. counties more exposed to IT-intensive banks. In addition, the analysis finds that banks’ IT makes the supply of entrepreneurial credit supply more responsive to changes in house prices, and that it “reduces the importance of geographical distance between borrowers and lenders.” Overall, the evidence presented is “consistent with banks’ IT adoption facilitating entrepreneurship by improving banks’ use of hard information, in particular collateral.”  Read More ⇨

Are There Too Many Ways to Clear and Settle Secured Financing Transactions?

This blog post describes the four main ways that secured financing trades involving U.S. Treasury securities are cleared and settled. It also highlights some concerns discussed in a recent recently released consultative paper on these processes from the Federal Reserve Bank of New York. The FRBNY consultative paper identified various risk and resiliency issues for the purpose of generating discussion about whether current practices have room for improvement, and this blog post focuses on two of these issues: (i) the fragmented nature of clearing and settlement of SFTs and (ii) the bespoke and opaque nature of clearing and settlement for non-centrally cleared bilateral SFTs. Read More ⇨

How Private Equity Fuels Nonbank Lending

Using administrative data from the Shared National Credit register combined with information from Pitchbook on buyout deals, this study explores the rise of private equity in driving increased nonbank participation in the U.S. syndicated loan market. The analysis indicates that “PE-backed loans are associated with lower active bank monitoring, lower loan share retained by the lead arranger, and more loan sales to non-bank financial intermediaries.” Moreover, consistent with economic logic, the analysis finds that lead banks having a larger share of committed funds engage in more active monitoring of the borrower. However, this relationship is less pronounced for PE-backed loans, consistent with a role of PE sponsors in mitigating credit risk, such as by providing valuable operational guidance to their portfolio companies. Overall, “the findings suggest that PE sponsors’ actions substitute for bank monitoring in containing credit risk as well as mitigate moral hazard and asymmetric information problems in loan sales.” Read More ⇨

A Positive Neutral Rate for the Countercyclical Capital Buffer: State of Play in the Banking Union

Drawing on experience from the coronavirus pandemic in Europe, this article assesses the potential role of a countercyclical capital buffer—positive during normal times and releasable during downturns—in enhancing the effectiveness of macroprudential policy. The article highlights evidence from the pandemic period which suggests that banks may be reluctant to utilize their ordinary capital buffers when losses materialize, and that that the role of releasable macroprudential capital buffers needs to be enhanced. In addition, it highlights evidence from the pandemic period showing that capital relief can effectively prevent reductions in lending, cushioning the effects of adverse systemic shocks. Whereas authorities had mostly relied on ad hoc capital relief measures, the article argues that explicitly releasable buffers such as the CCyB reduce concerns about buffer usability and therefore can effectively provide the requisite capital relief. The article also provides a cross-country overview of recent progress on the application countercyclical capital buffers and offers some observations on their potential future application in the European banking union. Read More ⇨

The Reinstatement of the AOCI Filter under the Tailoring Rules and Banks’ Motivations for Designating Securities as Held to Maturity

This article provides evidence that banks classify securities as held to maturity (HTM) rather than available for sale (AFS) when HTM classification provides preferred financial accounting and regulatory capital treatments, rather than based on fundamental economic factors. The analysis focuses on the effects of changing regulatory treatment of accumulated other comprehensive income (AOCI), the largest and most variable component of banks’ AFS portfolio. From 1995 through 2013, AOCI securities were exempted from the trading book capital requirements of all U.S. banks. This “AOCI filter” was phased out from 2014 to 2018 under the initial U.S. implementation of Basel III for banks subject to the “advanced approaches.” It was then reinstated for five of the “advanced approaches” banks at the end of 2019 under the Federal Reserve’s tailoring rules. The analysis finds that banks shifted securities between AFS and HTM in response to these changes in ways consistent with mitigating regulatory capital volatility. For instance, banks for which the AOCI filter was reinstated responded by transferring securities to AFS, and also increased the risk of their AFS securities, did not hedge this risk and increasingly financed these securities with uninsured deposits. The findings purportedly “provide support for recent calls to eliminate the HTM category and AOCI filter.” Read More ⇨

Partial Effects of Fed Tightening on U.S. Banks’ Capital

The depositor run that led to the failure of Silicon Valley Bank in March 2023 was triggered by unbooked losses on securities holdings, which were in turn tied to the rapid increase in market interest rates associated with the Fed’s 2022 inflation-fighting measures. This paper addresses the question of how broadly such losses affect the banking system overall. The study finds, as of 2022 Q4, there were $482 billion of unbooked, after-tax securities losses and $362 billion of unbooked, after-tax, interest-rate-related loan losses. Together, these losses amount to 40 percent of common equity tier 1 capital and are distributed fairly evenly across bank size classes. The study also finds that if these losses were fully reflected in bank balance sheets, roughly half of banks (representing around half of all bank assets) would not meet their minimum regulatory capital requirements. However, there may be some unmeasured effects on bank capital ratios that could offset these losses. Read More ⇨

Chart of the Month

Bank Deposit Trends Over Time

The chart above depicts the time series for domestic deposits over time alongside the long-run trend. Following the recent bank failure events including the failure of SVB, deposits have started to decrease, but remain well above the long-run trend.

Featured BPI Research

How Did Regulatory Tailoring Affect SVB’s Capital Requirements?

The Fed’s SVB report asserts that Silicon Valley Bank Financial Group would have experienced a decline in regulatory capital had it been subject to stress tests earlier. Therefore, the report speculates that had the bank been subject to stress tests it may have been prompted to raise capital sooner or to moderate its exposure to risk. This post demonstrates otherwise. First, as noted in the Fed’s report, SVB’s capital ratio would have declined by 1.7 percentage points in 2022 if the firm had been an advanced approaches bank. However, even after the decline, SVB’s common equity tier 1 capital ratio, at 10.4 percent, would be above its regulatory requirement. Moreover, if the firm had been required to include unrealized losses on available-for-sale (AFS) securities in the calculation of its regulatory capital, it could have increased the proportion of securities classified as held-to-maturity, which would have reduced volatility in its regulatory capital ratio when it became an advanced approaches bank. Second, the post shows that SVB’s stress capital buffer would have been at or close to the 2.5 percent floor, regardless of whether the stress test scenarios involved increasing or declining interest rates. Read More ⇨

The CFPB’s Deeply Flawed Proposal on Credit Card Late Fees – Part 2

This note is the second in a series critiquing the CFPB’s proposed changes to credit card late fees. The note disputes the Bureau’s assertion that available evidence from published studies on the deterrent or incentive effects of late fees lacks relevance to assessing the appropriate safe harbor late fee limit. It also finds fault with the Bureau’s new, in-house analysis which purports to show little marginal deterrence effect for late fees at the current safe harbor levels. The post describes why the published studies are more relevant and more robust than alleged in the Bureau’s review, which is not only one-sided but also incomplete, and how the Bureau’s new analysis exhibits multiple serious shortcomings. In short, the note demonstrates that the CFPB falls short of its statutory obligation to consider all factors and important costs and benefits of the proposed regulation by, cherry-picking and downplaying evidence from published research studies and overstating the relevance of its new analysis. Read More ⇨

A Failure of (Self-) Examination:  A Thorough Review of SVB’s Exam Reports Yields Conclusions Very Different From Those in the Fed’s Self-Assessment

On April 28, 2023, the Federal Reserve Board released a review of its supervision and regulation of Silicon Valley Bank, together with certain examination materials that shed further light on its supervisory activities for SVB in recent years. Based on that report, Vice Chair for Supervision Michael Barr has concluded that supervisors did not fully appreciate SVB’s vulnerabilities, did not take sufficient steps to ensure that SVB fixed those problems quickly enough and that statutorily mandated tailoring of regulation and a “shift in supervisory policy” that occurred in 2018-19 impeded effective supervision of SVB. In an earlier blog post the authors described a range of relevant issues that were either placed out of the scope of the report or were within the scope of the report but ignored. In this blog post, the authors turn to assessing what materials and information the Fed did provide.  Specifically, the authors review here both the examination materials and the supervisory facts and timeline provided by the Federal Reserve and provide an assessment of mistakes and weaknesses in supervision that those materials expose. Read More ⇨

The Importance of Regional Banks for Small Business Lending and Economic Growth

Analysis provided in this blog post demonstrates that regional banks are vital to economic growth, serving as the source of nearly one-third of small business bank lending. They exhibit high rates of small business loan originations per capita in the Northeast, South, West and certain regions of the Midwest. Additionally, in 2020, regional banks played a crucial role in disbursing Paycheck Protection Program (PPP) loans to small businesses, accounting for approximately 25 percent of all PPP loans in dollar amounts. Regional banks thereby drive business and economic growth in this country. Any requirement that they hold more capital and liquidity considering the failure of SVB therefore would come not only with some benefits but also with considerable costs, and a need to balance the two. Recent testimonies by Federal Reserve Vice Chair for Supervision Michael Barr, FDIC Chair Martin Gruenberg and Acting Comptroller of the Currency Michael Hsu overlook the potential costs associated with heightened regulations on these banks, including the adverse effects on the availability and cost of loans. However, when such costs are duly considered by other policymakers, alternative policies may appear substantially preferable. For instance, one alternative could involve the Federal Reserve fulfilling its traditional role of providing liquidity to solvent banks experiencing a run. Another alternative could involve the FDIC modernizing and enhancing its processes for resolving failed banks. Read More ⇨

Why is the FRTB Expected Shortfall Calculation Designed as It Is?

This post discusses the rationale behind the design of the Expected Shortfall (ES) calculation in the Fundamental Review of the Trading Book (FRTB) framework. The article explains that ES is considered a more comprehensive risk measure than Value at Risk (VaR) as it captures tail risk and provides a more accurate assessment of potential losses. The design of the ES calculation in FRTB aims to address shortcomings of VaR and align with international regulatory standards. It incorporates a stressed period and the use of historical data to capture extreme events. The article highlights that the ES calculation, while more complex, offers improved risk measurement and promotes financial stability. Read More ⇨

Conferences & Symposiums

6/14/2023 – 6/15/2023
Conference on Networks in Modern Financial and Payment Systems
The Bank of Canada

Governance and Culture Reform Conference
Federal Reserve Bank of New York

6/21/2023 – 6/23/2023
Policy Summit 2023: Communities Thriving in a Changing Economy
Federal Reserve Bank of Cleveland

6/21/2023 – 6/23/2023
Economics of Financial Technology Conference
The University of Edinburgh

7/5/2023 – 7/7/2023
The 2023 Annual Meeting of the Central Bank Research Association
Federal Reserve Bank of New York and Columbia University School of International and Public Affairs

The 8th Annual Cambridge Conference on Alternative Finance
University of Cambridge Center for Alternative Finance

7/10/2023 – 7/28/2023
National Bureau of Economic Research Summer Institute 2023
Cambridge, MA and Virtual
More Information

Yale Program on Financial Stability Conference
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
More Information

9/28/2023 – 9/29/2023
22nd Annual Bank Research Conference
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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10/19/2023 – 10/20/2023
Federal Reserve Stress Testing Research Conference
Federal Reserve Bank of Boston and Virtual
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11/16/2023 – 11/17/2023
2023 Financial Stability Conference
Federal Reserve Bank of Cleveland and Office of Financial Research
Cleveland, OH and Virtual
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11/16/2023 – 11/17/2023
2023 Asia Economic Policy Conference: Announcement and Call for Papers
Federal Reserve Bank of San Francisco
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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.