Weekly Research Rundown – August 09, 2019

Weekly Research Rundown – August 09, 2019

The Effects of the Volcker Rule on Corporate Bond Trading: Evidence from the Underwriting Exemption

The Volcker Rule, part of the Dodd-Frank Act passed in response to the financial crisis, bars commercial banks from engaging in certain kinds of proprietary trading. This paper uses dealer-identified data to study the impact of the rule on covered firms’ corporate bond trading, finding no evidence that the rule reduces the riskiness of these trades as intended. Instead, the paper finds that the Volcker Rule has increased the cost of liquidity provided by covered firms and decreased those firms’ market share.

Read More: https://www.financialresearch.gov/working-papers/2019/08/06/the-effects-of-the-volcker-rule-on-corporate-bond-trading

CECL and the Credit Cycle

This paper studies the impact of the soon-to-be-implemented Current Expected Credit Loss (CECL) standard on bank lending over the economic cycle. By estimating historical loss allowances under CECL and modeling how the impact on accounting variables would have affected banks’ lending and capital distributions, the authors find that CECL would have dampened fluctuations in lending. In particular, they estimate that lending would have grown more slowly before the financial crisis and more quickly after.

Read More: https://www.federalreserve.gov/econres/feds/files/2019061pap.pdf

Central Banks and Reputation Risk

In response to the 2008 crisis, central banks have been granted a variety of new regulatory powers. This column tells the story of the Central Bank of Iceland’s 2012 enforcement action against the country’s largest exporter, Samherji, in which the Bank organized a police raid of the firm that led to a media backlash, a Supreme Court decision against the Bank, and criticism of the Bank’s decision by the parliament ombudsman. The author uses this story to illustrate the risks that widening authority poses to both central bank independence and effectiveness.

Read More: https://voxeu.org/article/central-banks-and-reputation-risk

Banking on Demography: Population Aging and Financial Integration

The populations of the world’s advanced economies are aging, threatening living standards as abundant savings find fewer investment opportunities. This paper uses county-level bank deposit data to study the ability of an integrated financial sector to mitigate the effects of this demographic trend. The authors find that local aging leads to an increase in deposits: these deposits are then used by banks to lend in places with younger populations, leading to increases in building permits, firm formation, and house prices.

Read More: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3430184

Real Effects of Financial Distress: The Role of Heterogeneity

The difference in how financially fragile firms and healthy firms respond to an economic downturn is a natural indication of a financial shock. This paper uses Portuguese loan-level data from the time of the sovereign debt crisis to study how a financial shock may be transmitted to the real sector. The authors find that highly leveraged firms and those with a larger share of short-term debt contracted more during the crisis.

Read More: https://www.bankofengland.co.uk/working-paper/2019/real-effects-of-financial-distress-the-role-of-heterogeneity

Leveraged Bank Loan versus High Yield Bond Mutual Funds

The markets for Bank Loan (BL) and High Yield Bond (HYB) mutual funds have grown significantly since the financial crisis. This paper characterizes and compares the universes of BL and HYB mutual funds over the period 2000 – 2018, documenting that BL mutual funds have underperformed HYB mutual funds in the post-crisis period, BL and HYB mutual funds’ respective market shares of leveraged loans and high yield corporate bonds outstanding have grown since the mid-2000s, and BF and HYB mutual funds hold roughly 60 percent of B, BB, and BBB-rated assets.

Read More: https://www.federalreserve.gov/econres/notes/feds-notes/universe-of-leveraged-bank-loan-and-high-yield-bond-us-mutual-funds-20190802.htm