Research Exchange: September 2022

Selected Outside Research

Comment Letter to the U.S. Treasury Department Regarding the Risks of Stablecoins

This paper, which was written by Arthur Wilmarth and submitted as a public comment on a presidential executive order issued in March 2022 (No. 14067, “Ensuring Responsible Development of Digital Assets”) highlights serious risks arising from the use of stablecoins. It argues that stablecoins currently pose significant risks to U.S. financial markets and investors and may destabilize the U.S. financial system and economy if they become a widely accepted form of payment. It further argues that, to the extent that stablecoins are issued and distributed by commercial enterprises including Big Tech firms, the nation’s longstanding policy of separating banking and commerce would be seriously compromised. The paper also provides recommendations to address these concerns, including that Congress and federal agencies should designate stablecoins as deposits and require all issuers and distributors of stablecoins to be chartered as FDIC-insured banks.” Read More ⇨

Buy Now, Pay Later Credit: User Characteristics and Effects on Spending Patterns

The U.S. BNPL market is examined in this study using a large dataset of BNPL transactions. The study documents characteristics of users and their usage patterns. The analysis finds that BNPL access increases both total spending levels and the retail share in total spending, both for consumers with and those without inferred liquidity constraints. The findings are interpreted as consistent with a “liquidity flypaper effect” such that the additional retail liquidity associated with expanding supply of BNPL credit “sticks where it hits.” In other words, the BNPL use may be better explained by impulse spending as opposed to a standard, economic model of consumption choice in the face of a relaxed liquidity constraint.” Read More ⇨

Nonconforming Preferences: Jumbo Mortgage Lending and Large Bank Stress Tests

The jumbo-mortgage share of the mortgage originations of large banks subject to CCAR is higher than at other banks. This paper documents that the banks that participated in CCAR shifted towards jumbo loans only in the 2010s, after passage of the Dodd-Frank Act. The paper further explores these banks’ greater preference for jumbo loans by exploiting the fact that the advantages conferred by access to the Fannie Mae and Freddie Mac credit guarantees for conforming loans are reflected in bunching of the mortgage size distribution at the conforming loan limit. The amount of bunching reflects the cost of issuing a nonconforming loan relative to a conforming loan of a similar size. The analysis finds that bunching noticeably decreased for the CCAR banks after Dodd-Frank. This finding suggests that “financial regulation changed regulated banks’ preference for jumbo mortgages specifically rather than large loans more generally. Read More ⇨

How Can Safe Asset Markets Be Fragile?

Although Treasury prices typically increase during times of stress, the market for U.S. Treasury securities in March 2020 experienced an extreme stress event in which prices dropped precipitously (yields spiked) over a period of about two weeks. This article highlights two important elements of this stress event. First, “the dealer banks that provide Treasury market liquidity faced mounting challenges to their intermediation capacity.” Second, “the behavior of foreign investors and mutual funds, the main sellers of Treasury securities in March 2020, was very unusual,” in that their volume of sales in the first quarter of 2020 was unprecedentedly large. The article then develops a theoretical model consistent with these observed phenomena. The model demonstrates that “markets for safe assets can be fragile due to strategic interactions among investors who hold Treasury securities for their liquidity characteristics.” The fragility arises from investor fears about having to sell at potentially worse prices in the future, which may prompt them to sell preemptively, generating a self-fulfilling market run similar to how bank runs arose historically. Read More ⇨

Does Judicial Foreclosure Procedure Help Delinquent Subprime Mortgage Borrowers?

This study assesses the effect of judicial foreclosure on the ability of subprime mortgage borrowers to reinstate their delinquent loans outside foreclosure liquidation, focusing on the cumulative shares of various exit types up to five years after a mortgage first become 90 days past due. The findings suggest that “judicial states offer more opportunities for delinquent borrowers to reinstate their loans outside foreclosure liquidation, especially during a housing market downturn.” In addition, the study documents that most of the judicial foreclosure benefit shows up after the start of the foreclosure process, and that after 2009, loan modifications became the primary driver of reinstatement. Read More ⇨

How to Release Capital Requirements during a Pandemic? Evidence from Euro Area Banks

Using confidential supervisory and credit register data, this paper examines the impact of the capital relief package adopted to support euro area banks at the outbreak of the COVID-19 pandemic. The analysis finds that the capital relief measures supported banks’ capacity to supply credit to firms, but that “banks adjust their credit supply only if the capital relief is permanent or implemented through established processes that foresee long release periods.” In addition, the analysis indicates that “requirement releases are more effective for banks with a low capital headroom over requirements and do not trigger additional risk-taking.” Read More ⇨

Bank Deposit Flows to Money Market Funds and ON RRP Usage during Monetary Policy Tightening

This paper develops projections for the flow of bank deposits into money market funds that will result from the current monetary policy tightening, based on the historical experience from past cycles and the expected path of the federal funds rate for the current cycle.  The results indicate that the flows would be relatively small, amounting to about $600 billion through the end of 2024, or about 3 percent of current bank deposits. Of these potential inflows to MMFs, about $100 billion are projected to flow into the overnight reverse repo facility.  The analysis also suggests that MMF take-up at the ON RRP facility will be more substantially affected by other factors, including private demand for repo funding and the net supply of Treasury bills. Read More ⇨

Credit Card Profitability

This note examines trends in and drivers of credit card profitability using detailed data on the credit card portfolios of some of the largest credit card lenders. It documents that between 2014 and 2019, return on assets for card issuers exhibited a modestly declining trend. Following the start of the COVID-19 pandemic in March 2020, it declines sharply, and then rebounded sharply, reflecting banks’ provisioning for credit card losses that did not materialize. Decomposing credit card profitability into its main sources—the credit function, the transaction function, and miscellaneous fees, including late fees—the analysis indicates that, on average, about 80 percent of the credit card profitability derives from the credit function. The contribution of the transaction function is slightly negative, with rewards and other expenses on credit card transactions negating banks’ interchange revenues. Read More ⇨

The Fed Is Shrinking Its Balance Sheet: What Does That Mean? 

At the onset of the COVID-19 pandemic, the Fed sought to mitigate adverse economic effects by reducing its interest rate target to near zero and injecting reserves into the banking system by purchasing large quantities of U.S. Treasury bonds and mortgage-backed securities—a type of balance sheet expansion known as quantitative easing. The reverse process of shrinking the Fed’s balance sheet, referred to as quantitative tightening, was initiated this year in response to inflation running well above its long-run target. This article provides a primer on these policy tools. The article describes the Fed’s QE and QT activities and discusses what the Fed hopes to accomplish with QT. In addition, the article reviews economists’ views on using the central bank’s balance sheet as a policy tool, highlighting the debate over how QE and QT work and how effective they are, and knowledge gaps. Read More ⇨

How Do Banks Manage Liquidity: Evidence from the ECB’s Tiering Experiment

This paper exploits the introduction of the ECB’s two-tier system, which differentially reduced the cost of additional reserves holdings, to investigate how banks manage their liquidity among the various assets at their disposal. According to the new policy, excess reserves holdings below a certain threshold were eligible to a lower holding cost. The analysis indicates that treated banks increase reserve holdings by borrowing on the interbank market, decreasing lending to affiliates of the same group, and selling marketable securities, with the implication that “frictions in one market for liquidity can spill over to several markets.” In addition, the analysis indicates that banks prefer a stable portfolio composition of liquid assets over time—the introduction of tiering appears to have little effect on the composition of banks’ liquid portfolio, beyond the increase in reserves holdings. Read More ⇨

The Effect of Job Loss on Bank Account Ownership

The effect of job loss on households’ bank account ownership is examined in this paper. The analysis relies on data from the biennial FDIC survey on Household Use of Banking and Financial Services, linked to respondents’ work history in surrounding months constructed from the basic monthly Current Population Survey. The findings indicate that job loss results in a high likelihood of becoming unbanked and leads to increased use of nonbank products and services that might substitute for a bank account. For instance, “households that experienced a job loss in the months leading up to the FDIC survey are about 18 percentage points more likely to be unbanked than households that lost a job in the subsequent year. Read More ⇨

Chart of the Month

Selected Funding Sources for the Federal Reserve

The Fed is shrinking its balance sheet by up to $95 billion a month as it allows some securities to mature without replacement. As its assets shrink, its liabilities shrink too, including reserve balances and balances at the ON RRP facility. The Fed can’t let reserve balances shrink below the level banks demand for liquidity purposes and still conduct monetary policy using its ample reserve framework, a level the FRBNY guesses will be reached in mid-2025 when reserve balances are $2.3 trillion.  But FRBNY assumes ON RRP will shrink to zero before that level is reached.  If ON RRP stays elevated, the Fed will have to end QT sooner. 
For a summary of this issue and four BPI bank strategists’ (Abate (Barclays), Cabana (BAC), Cloherty (UBS), and Ho (JPM)) views, see here.  For a discussion of how Fed capital rules are pushing up the ON RRP facility, see here.  For a discussion of how bank examiners are obstructing monetary policy by artificially increasing banks’ demand for reserves, see here.

Featured BPI Research

Regulatory Risks May Discourage Small-Dollar Lending by Banks

 Many U.S. households, when faced with cash shortfalls, typically rely on payday loans or high-cost, nonbank credit products because these U.S. households lack financial resources needed to meet small, unexpected expenses. Fortunately, the banking industry has been stepping up to provide lower cost, small-dollar credit alternatives that allow financially vulnerable households to meet their short-term borrowing needs more sustainably. This post reviews the potential social benefits of bank-provided, small-dollar loans and the sources of regulatory uncertainty that may be impeding their availability. The discussion highlights how more supportive and coordinated treatment by the CFPB and the prudential banking agencies of these products would minimize the regulatory risks for banks that offer small-dollar products, thereby expanding the set of affordable borrowing options for households that struggle to pay small and unexpected expenses. Read More ⇨

Assessing the Decline in Bank Lending to Businesses

Much commentary has focused on a major shift of mortgage origination and servicing from the banking to the non-banking sector. But less attention has been paid to an equally significant trend: a shift in business lending to nonbanks. Here, private capital markets—private equity, hedge funds, loan mutual funds, finance companies and business development companies (BDCs)—have dramatically increased their market share. And since these lenders are generally not publicly traded companies, and therefore lack transparency into the size and scope of their operations, their role has been more difficult for the public and policymakers to observe. This post documents the decline in the bank share of business debt; explains how high capital requirements imposed by banking regulators have driven that decline; and identifies implications for financial stability (including potential future extraordinary Fed interventions in financial markets), given the increasing reliance by businesses on nonbank lenders to meet their funding needs. Read More ⇨

Missing Factors in the CFPB’s Analysis of Rising Credit Card Interest Rates

A recent blog post published by the Consumer Financial Protection Bureau (CFPB) examined average credit card interest rates for borrowers that qualify as revolvers: borrowers that carry balances over multiple months. The blog post concludes that lack of competition in the credit card market could be a key factor in explaining rising average credit card interest rates for revolving accounts and has enabled credit card banks to earn “outsized profits.” This post shows that the CFPB’s analysis failed to account for several important factors that better explain the increased profitability of credit card banks during 2021 and the rise in interest rates of revolving credit card accounts during the period referenced in the CFPB’s post. First, the authors show that profits of credit card banks declined from 2011 to 2019, consistent with more competition in the credit card market. Furthermore, the increase in bank profitability in 2021 cited by the CFPB was largely driven by the adoption of a new accounting standard, combined with the decline in bank allowances for credit losses since their COVID-19 pandemic-era peak. Read More ⇨

How the Overnight Reverse Repurchase Agreement Facility Could Derail the Fed’s Path to Getting Smaller

BPI hosted an open Zoom panel discussion on Sep. 9, 2022, on the overnight reverse repurchase agreement facility, reserve balances and the end of quantitative tightening. Discussion has been brewing among market participants and Fed watchers about whether the large and growing ON RRP facility will siphon reserves out of the banking system and force an early end to the Fed’s QT process since the possibility was discussed at a BPI symposium on money markets and the Fed’s balance sheet back in February.  Read More ⇨

Bank Examiner Preferences Are Obstructing Monetary Policy

As part of its monetary policy, the Federal Reserve is currently allowing its vast holdings of Treasury securities and agency MBS to mature without reinvestment, steadily reducing the size of its portfolio over time. When the Fed allows its securities to roll off, its liabilities shrink too, particularly reserve balances, which are the deposits of commercial banks and thrifts and credit unions at Federal Reserve banks. The Fed can get no smaller than the size necessary to create the amount of reserve balances demanded by banks and still conduct policy using its current framework. If it tried, interest rates would rise above the level the FOMC intends. The note also discusses that examiner preferences boost bank demand for reserves in two ways. As this note discusses, these examiner preferences run contrary to the intent of liquidity regulations and discount window policy, but the Fed’s multi-year effort to change them has been largely unsuccessful. To understand how we got to this point, the note reviews the history of this conflict between monetary policy and bank supervision. The unfortunate outcome is a Fed immensely larger than it used to or needs to be.   Read More ⇨

“Bank On” Transaction Accounts Helped Support Financial Inclusion during the Pandemic

Households without a bank account must rely on higher-cost and less convenient alternatives from nonbank financial service providers for financial products and services. These households, referred to as “unbanked,” are predominantly low-income, and their unbanked status is a barrier to full integration into the American economy. The banking industry has played a key role supporting this progress, especially through its support of the “Bank On” initiative. This national program, implemented through many local Bank On coalitions in collaboration with the Cities for Financial Empowerment (CFE) Fund, advances financial inclusion through expanded access to low-cost bank transaction accounts. Currently more than 200 banks, comprising 56 percent of national deposits, offer Bank On certified accounts. This post updates earlier research examining take-up and usage of Bank On certified accounts in relation to area characteristics, based on data collected from the subset of Bank On affiliated institutions that have agreed to contribute to the program’s “National Data Hub.” The analysis confirms the effectiveness of the Bank On program as an approach to increase financial inclusion.   Read More ⇨

Conferences & Symposiums


10/06/2022 – 10/07/2022
Conference on Real Time Data Analysis: Applications in Macroeconomics and Finance
Federal Reserve Bank of St. Louis
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10/06/2022 – 10/07/2022
2022 Federal Reserve Stress Testing Research Conference
Federal Reserve Bank of Boston
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10/06/2022 – 10/07/2022
Annual Financial Stability Conference
Federal Reserve Bank of Atlanta
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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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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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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.