Research Exchange: October 2022

Selected Outside Research

Buy Now Pay (Pain?) Later

BNPL is a credit product that enables consumers to defer payments interest-free into a small number of (typically four) installments. Using banking data for 10.6 million U.S. consumers, this study explores the impact of BNPL usage on consumer credit performance and finds that new BNPL users experience rapid increases in overdraft charges and credit card interest and fees, as compared to non-users. In addition, evidence is presented of a causal link whereby BNPL promotes excessive spending with adverse implications for financial health.  The study concludes that “regulators should take seriously the concern that BNPL plausibly has negative welfare implications.” Read More ⇨

Measuring the Ampleness of Reserves

This article provides estimates of the slope of the reserve demand curve and how it has varied between 2010 and 2022, during which time reserves grew from $1 trillion to $4 trillion. The analysis relies on a “method to estimate the time-varying interest rate sensitivity of the demand for reserves that accounts for the nonlinear nature of reserve demand and allows for structural shifts over time.” The analysis indicates that there is not a constant relationship between the level of reserves and the slope of the reserve demand curve, and that the demand curve has shifted, with vertical upward shifts being particularly important since 2015. A key takeaway is that “the level of the federal funds-IORB spread may not be a reliable summary statistic for the sensitivity of interest rates to reserve shocks, and that estimates of the price sensitivity in the demand for reserves provide additional useful information.” Read More ⇨

Capital Regulation, Market-Making, and Liquidity

The 2011 European Banking Authority capital exercise that mandated certain banks to increase regulatory capital. Using a proprietary, transaction-level dataset in Germany, this study examines how this increase in bank capital requirements affected the liquidity of corporate bonds.  The analysis indicates that banks affected by the higher capital requirement reduce their inventory holdings, pre-arrange more trades, and have smaller average trade sizes. Although non-bank-affiliated dealers increase their market-making activity, they are unable to fully compensate for the reduced market-making activity by affected banks, and  aggregate liquidity declines. The strongest such relationships are observed for banks with a higher capital shortfall, for non-investment grade bonds, and for bonds where the affected banks were the dominant market-maker. Read More ⇨

Considerations Regarding the Use of the Discount Window to Support Economic Activity through a Funding for Lending Program

The Federal Reserve discount window typically is used to provide overnight funds to banks facing short-term liquidity pressures, and to relieve upward pressures on the federal funds rate in support of the monetary policy target. This paper discusses how the discount window and the Federal Reserve’s ability to provide loans to banks might additionally be used to promote bank lending in support of monetary policy objectives of maximum employment and stable prices through implementation of a “funding for lending program.”  The paper describes alternative ways a funding for lending program could be structured and reviews key considerations, costs, and benefits. One approach would be for the Federal Reserve to make ample low-cost funding available to banks; alternatively, the Federal Reserve would only provide low-cost funding conditional on the banks meeting certain lending targets.  Read More ⇨

Climate Change and Regulatory Capital: A Stylized Framework for Policy Assessment

A conceptual framework for assessing how the financial risks of climate change could interact with a regulatory capital regime is developed in this paper. The framework is applicable across differing country-specific regimes and incorporates core features of a regime such as expected and unexpected losses, regulatory ratios and risk-weighted assets, and minimum requirements and buffers. The framework highlights how assessing the potential implications of climate change for regulatory capital “requires clear views around both climate-related changes to the loss-generating process for banks and the specific objectives of the different components of the capital regime.” The paper concludes that, “while climate change could potentially impact the regulatory capital regime in several ways, an internally coherent approach requires a strong link between specific assumptions and beliefs about how these financial risks may manifest as bank losses and what objectives regulators are pursuing.” In addition, the paper identifies potential research opportunities to better understand these issues and inform policy development. Read More ⇨

How Much Does Racial Bias Affect Mortgage Lending / Evidence from Human and Algorithmic Credit Decisions

Using new, confidential supervisory data collected under the Home Mortgage Disclosure Act, this paper estimates the extent to which racial and ethnic discrimination by mortgage lenders generate disparities in mortgage denial rates. The analysis finds that observable applicant risk factors explain all but 1 to 2 percentage points of the racial disparities in lender denials. Minority applicants tend to have significantly lower credit scores, higher leverage, and are about half as likely than white applicants to receive algorithmic approval from race-blind government automated underwriting systems. In addition, the analysis exploits the data on automated underwriting outcomes to show there are risk factors not directly observed that explain at least some of the residual 1-2 percentage point denial rate gaps. Overall, the analysis indicates that “differential treatment has played a limited role in generating denial disparities in recent years.” Read More ⇨

Did High Leverage Render Small Businesses Vulnerable to the COVID-19 Shock?

This paper explores, using supervisory data, how the COVID-19 pandemic affected bank lending to small and mid-sized nonfinancial enterprises.  The analysis indicates that SMEs with higher leverage faced tighter constraints. Specifically, SMEs with higher pre-COVID leverage obtained a smaller volume of new loans and had to pay a higher spread on them during the pandemic period. Moreover, these effects were concentrated in loans originated by banks with below-median capital buffers, consistent with an impact of the buffers on credit supply. Thus, “highly levered SMEs that relied on low-capital large banks for funding before the pandemic were not able to substitute to other sources of debt financing and thus experienced more of a reduction in total debt as well as a decline in investment and employment.” However, the Paycheck Protection Program (PPP) and other public sector interventions mitigated the adverse effects tied to bank credit constraints. Read More ⇨

The Financial Stability Implications of Digital Assets

This paper describes financial stability challenges associated with digital assets, applying the Federal Reserve’s framework for analyzing vulnerabilities—factors that may amplify financial shocks—in the traditional financial system.  The digital asset ecosystem addressed in the analysis includes “coins designed to maintain a stable value, crypto-assets without such a peg, centralized lenders and exchanges, and decentralized finance (DeFi) protocols, among other things.” The paper describes ways that “the digital asset ecosystem replicates many of the same types of market failures and vulnerabilities that arise in traditional finance—generally without regulatory safeguards—while also introducing new risks.”  The discussion also highlights how, due to limited interconnectedness with the traditional financial system, the digital asset ecosystem does not present significant risks to financial system.  In addition, the discussion “identifies emerging vulnerabilities that could present risks to financial stability in the presence of stronger interlinkages between digital and traditional financial institutions and in the event of future growth of the digital asset ecosystem.” Read More ⇨

Chart of the Month

The FDIC just released its latest national survey on findings on financial inclusion, the 2021 National Survey of Unbanked and Underbanked Households, which documents continuation of the long-term trend of improving financial inclusion in the U.S., broad-based across income and demographic groups. Approximately 1.2 million more households were banked in 2021 compared to 2019, and the estimated percentage of unbanked households in the U.S. has fallen to 4.5, the lowest national unbanked rate since the FDIC survey began in 2009. The data also show large drops in unbanked rates for lower-income and minority populations.

Featured BPI Research

The Role of Machine Learning and Alternative Data in Expanding Access to Credit: Fintechs’ Regulatory Advantage is to the Detriment of Consumers

The use of machine learning models, especially when applied in combination with alternative credit data, can improve credit decisions and facilitate broader access to credit. ML combined with creative use of alternative data sources has helped propel the expanding market share of fintech companies in consumer and small business lending. This post briefly reviews how ML models and alternative data can play a role in broadening household and small business access to credit and describes the cost and risk tradeoffs associated with their use. The discussion highlights the need for regulatory policies and practices to keep pace with the developments in credit modeling and to apply a consistent approach for banks and fintechs, to ensure equitable treatment of all borrowers under the consumer protection laws. Read More ⇨

U.K. Pension Fund Debacle Illustrates How Government-Created Moral Hazard Can Lead to Systemic Risk

With the encouragement of their regulator, many U.K. private pension funds invested in liability-driven investments–a fund that amplifies returns on low-risk, low-return U.K. government securities by employing leverage, largely through derivatives. The counterparties to derivatives contracts with the LDIs had required them to enter into margin agreements. According to the WSJ, at least one pension fund was worried by the risks posed by investments in LDIs, presumably including potential liquidity pressures on LDIs if yields on gilts rose sharply, triggering margin calls on the LDI and forced sales of assets to meet those calls. So, why was the pension regulator encouraging such investments? It appears that past interventions in the gilt market by the Bank of England convinced the pensions regulator that this risk was contained — that in effect there was a put to the Bank of England. This post warns that repeated Federal Reserve interventions in the Treasury market may have created an analogous moral hazard affecting U.S. financial markets.  Read More ⇨

Two Important Fed Programs that Should Be Mutually Reinforcing Are in Conflict. Why?

The Federal Reserve requires that banks be able to demonstrate that they can convert Treasuries and agency mortgage-backed securities that they hold for liquidity contingencies into cash, and it offers banks a new permanent standing repo facility (SRF) that functions to convert those same securities into cash. Banks could sign up for the SRF, making that facility more effective in accomplishing the Fed’s objectives, and making the banks even more reliably liquid. Banks, in turn, could point to that access as how they would monetize their portfolio of government securities in a liquidity stress event. Nevertheless, as far as it can be determined, the Fed is not allowing any banks in their internal liquidity stress tests to point to the SRF as the way that they would monetize their assets. The result is especially impactful for smaller regional banks, many of which do not have regular access to the repo market, which is costly to establish and not needed for their normal business, and so would be particularly helpful if they could point to the SRF as their access point.  The SRF has become essentially a facility exclusively for primary dealers, U.S. GSIBs, and U.S. branches of foreign banks. The post describes a potential solution.  Read More ⇨

“There You Go Again”: Setting the Record Straight on Large Bank’s Branch Presence in LMI and minority Neighborhoods

This post documents that the nation’s large banks are expanding their presence among underserved customers through both branches and digital banking. In fact, branch openings have been higher in minority and LMI communities than in non-minority or wealthier communities after adjusting for the distribution of population growth. In addition, the authors show, based on aggregate industry data, that the banking industry has not been forsaking lower-income and minority areas. While the number of bank branches per capita has had a modest decline in recent years, lower-income and minority areas have experienced less of a reduction in branches per capita compared to higher-income and non-minority areas. Moreover, the average distance to the nearest bank branch has been little changed across all neighborhood categories.    Read More ⇨

Conferences & Symposiums


Symposium on Inflation: Risks, implications and Policies
Federal Reserve Bank of New York
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The 16th FRBNY / NYU Stern Conference on Financial Intermediation: Announcement and Call for Papers
Federal Reserve Bank of New York
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11/07/2022 – 11/08/2022
The Implications of Financial Technology for Banking
Office of the Comptroller of the Currency
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The 2022 U.S. Treasury Markets Conference
Federal Reserve Bank of New York
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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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2022 Pacific Basin Research Conference
Federal Reserve Bank of San Francisco
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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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Symposium on Bank Mergers
Office of the Comptroller of the Currency
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3/30/2023 – 3/31/2023
Procyclicality Symposium: Announcement and Call for Papers
Federal Reserve Board
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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.