To mitigate the risks of international trade for firms, banks offer trade finance products – specifically, letters of credit and documentary collections. This column exploits new data from the SWIFT Institute to establish key facts on the use of these instruments in world trade. Letters of credit (documentary collections) cover 12.5% (1.7%) of world trade, or $2.3 trillion ($310 billion).
Friederike Niepmann, Tim Schmidt-Eisenlohr, 11 June 2016
Dennis Bams, Magdalena Pisa, Christian C. P. Wolff, 02 May 2016
In the absence of full information about small businesses’ risk of loan default, banks are unable to accurately calculate counterparty risk. This column suggests that banks can use industry and linked-industry data to better establish counterparty risk, because distress from one industry is transmitted to supplier and customer industries. A reliable and easily available signal for such distress is any failure reported by S&P.
Roel Beetsma, Siert Vos, 23 February 2016
There is a broad consensus that banks and insurance companies may contribute to systemic risk in the financial system. For other financial market institutions, it is less clear-cut. This column examines the resilience of pension funds to severe shocks. While the evidence indicates that they are of low systematic importance, policy trends that apply to all financial players may undermine this. Specifically, risk-based solvency requirements carry the risk of homogenising the behaviour of all players, potentially amplifying shocks and destabilising markets.
Di Gong, Harry Huizinga, Luc Laeven, 18 February 2016
Prior to the Global Crisis, banks could easily use off-balance sheet structures to lower their effective capitalisation rates. This column examines another way that US banks circumvented capital regulations – by maintaining minority-owned, non-consolidated subsidiaries. Had these subsidiaries been consolidated, average reported equity-to-assets ratios would have been 3.5% lower. These findings suggest that some US banks were actively misrepresenting the riskiness of their assets prior to the crisis.
Clemens Bonner, 03 January 2016
Economists continue to debate whether preferential treatment in financial regulation increases banks’ demand for government bonds. This column looks at bank purchases of government bonds and other types of bonds when constrained by a capital or liquidity requirement. Financial regulation seems to be a main driver of banks’ demand. If regulators wish to break the vicious circle from weak banks to weak governments, revising financial regulation seems to be a good starting point.
Nikolaos I. Papanikolaou, Christian C. P. Wolff, 06 December 2015
In the years running up to the global crisis, the banking sector was marked by a high degree of leverage. Using US data, this column shows how, before the onset of the crisis, banks accumulated leverage both on and, especially, off their balance sheets. The latter activities saw an increase in maturity mismatch, raised the probability of bank runs, and increased both individual bank risk and systemic risk. These findings support the imposition of an explicit off-balance sheet leverage ratio in future regulatory frameworks.
Avinash Persaud, 20 November 2015
As the recent Financial Stability Board decision on loss-absorbing capital shows, repairing the financial system is still a work in progress. This column reviews the author’s new book on the matter, Reinventing Financial Regulation: A Blueprint for Overcoming Systemic Risks. It argues that financial institutions should be required to put up capital against the mismatch between each type of risk they hold and their natural capacity to hold that type of risk.
Jerry Tsai, Jessica Wachter, 11 June 2015
The high equity premium and high volatility in equity markets have long been a puzzle. This column discusses how rare, economy-wide disasters can account for this conundrum, as well as for patterns in prices, consumption, and interest rates during the Great Recession.
Fatih Guvenen, Fatih Karahan, Serdar Ozkan, Jae Song, 29 April 2015
Many policy design issues depend crucially on the nature of the idiosyncratic risks to labour income. The earning dynamics literature has typically relied on an implicit or explicit assumption that earnings shocks are log-normally distributed. This column challenges conventional knowledge by bringing in new evidence from a very large administrative dataset on US workers. It presents evidence suggesting income shocks exhibit substantial deviations from log-normality, and that shock persistence depends on income levels as well as the size and sign of the shock.
Jon Danielsson, 18 January 2015
The Swiss central bank last week abandoned its euro exchange rate ceiling. This column argues that the fallout from the decision demonstrates the inherent weaknesses of the regulator-approved standard risk models used in financial institutions. These models under-forecast risk before the announcement and over-forecast risk after the announcement, getting it wrong in all states of the world.
Christine L. Exley, 27 December 2014
Decisions involving charitable giving often occur under the shadow of risk. A common finding is that potential donors give less when there is greater risk that their donation will have less impact. While this behaviour could be fully rationalised by standard economic models, this column shows that an additional mechanism is relevant – the use of risk as an excuse not to give. In light of this finding, this column also discusses how charities may benefit from structuring their donation requests in particular ways.
Jussi Keppo, Josef Korte, 07 September 2014
Four years ago, the Volcker Rule was codified as part of the Dodd–Frank Act in an attempt to separate allegedly risky trading activities from commercial banking. This column presents new evidence finding that those banks most affected by the Volcker Rule have indeed reduced their trading books much more than others. However, there are no corresponding effects on risk-taking – if anything, affected banks take more risks and use their trading accounts less for hedging.
Zoltan Pozsar, 07 November 2013
Modern banks operate in a complex global financial ecosystem. This column argues that proper regulation requires an updating of our ideas about how they operate. Modern banks finance bond portfolios with uninsured money market instruments, and thus link cash portfolio managers and risk portfolio managers. Gone are the days when banks linked ultimate borrowers with ultimate savers via loans and deposits. The Flow of Funds should be updated to reflect the new realities.
Jon Danielsson, 06 March 2013
Is the fact that different banks have different risk models problematic? Contrary to the Basel Committee and the European Banking Authority, this column argues that heterogeneity is a good thing. It leads to countercyclicality, and thereby reduces instances of procyclical price movements. Both the Basel Committee and the European Banking Authority have indicated that they are troubled by heterogeneity and are seeking to rectify the problem. Their conclusion is plainly wrong.
Eugenio Cerutti, Stijn Claessens, Patrick McGuire, 17 December 2012
The current global crisis highlights how interconnected the financial world has become. This interconnectedness is a challenge for global systemic risks analysis. This column argues that much of the data needed for tracking systemic risk are not available and that, in fact, world decision makers are leading in the dark. Recent initiatives that aim to improve aggregate banking statistics and gather better institution-level data are welcome, but the complexity of the system means that we won’t have the data we need for some time yet.
Mathias Hoffmann, Bent E. Sørensen, 09 November 2012
How do members of existing monetary unions share risk? Drawing on a decade of research, this column argues that fiscal transfers in fact make a limited contribution to economic coherence. In the context of Europe’s current crisis, the evidence suggests that unfinished capital market integration must be completed if we wish to see adequate and effective risk sharing.
Lars Frisell, 07 November 2012
Measuring financial risk is difficult. But what lessons, if any, have we learnt from the current crisis? This column argues against a move to leverage ratios and instead proposes continuing to measure financial risk (despite the difficulties), but with higher capital charges for banks. Focusing on the basics can only bolster central banks’ ability to fulfil their duties – looking for imbalances, and promptly tackling them with informed decisions.
Ian Tonks, 08 January 2012
Ever since the fall of Lehman Brothers, it has been a popular view – and one increasingly held by officials – that banker bonuses are at least partly to blame. This column compares executive pay in banks with other companies and finds, contrary to the growing consensus, that the financial sector differs not so much in its reward for taking risks, but in its reward for expansion.
Jeffrey Frankel, Carlos A. Vegh , Guillermo Vuletin, 23 June 2011
With the ongoing financial turmoil in Europe, many emerging market countries are now deemed less risky than so-called “advanced” countries. This column examines why this is the case and finds that the cyclicality of a country’s fiscal policy – a sign of its riskiness – is inversely correlated with the quality of the country’s institutions.
Enrico Perotti, Mark Flannery, 09 February 2011
Contingent Convertible (CoCo) bonds have been suggested as a way to ensure that banks keep aside enough capital to help them through financial crises. This column proposes a market-triggered CoCo buffer to maintain risk incentives during periods of high leverage. It argues that this will also activate risk information discovery through the market prices of bank securities and increase activism by outside shareholders.