Financial Stability

The Impact Of Digitalization On Banking And Financial Stability

Carbo-Valverde discusses how FinTech firms are changing the banking landscape. He observes that while digitalization has been around for decades, its impact and speed of diffusion are unprecedented. FinTech firms are changing competiton in these markets. His conclusions are as follows. First, analyzing these markets will require models that are based on network externalities and multi-sided platforms with their underlying pricing strategies. Second, while digitalization will likely reduce marginal costs and increase productivity, lines between bank and non-bank providers will continue to blur creating privacy, regulatory, and law enforcement challenges. Third, the regulation of financial services need to shift from institution based to activity based to create a more level playing field for all providers and better manage risks.

Ending Too Big To Fail: What Is The Proper Role For Capital And Liquidity

In his testimony, Bob Chakravorti elaborated on the following areas:  first, the state of the economic literature on the costs and benefits of capital regulation; second, the enormous changes that we have seen post-crisis in the bank capital regulatory landscape and the ensuing changes to the quality and quantity of capital on banks’ balance sheets; and third, the reforms made in areas other than capital regulation that impact banks’ decisions on their financial intermediation activities. His ultimate conclusion is that given the recent and significant changes to the regulatory capital framework, as well as the relative uncertainty around the potential consequences – both intended and unintended – of these changes to banking activity and the economy, we should now evaluate and monitor the new capital framework to better understand the economic impacts before we consider further changes to it. 

The Societal Benefits Of Large Banks

Baumann, Chakravorti, and Shaaya identify and summarize the recent academic and industry literature on the benefits of large banks from the perspective of economies of scale and scope along with the benefits of a large, diverse set of products and services provided by a large bank. Second, they explore how large banks are able to leverage their broad customer bases to increase the pace and spread of innovations. Third, they discuss how risk diversification is a key benefit of large banks that augments their resiliency and stability. Finally, they examine the policy implications of our findings.

Safety-Net Benefits Conferred On Difficult-To-Fail-And-Unwind Banks In The US And EU Before And During The Great Recession

Carbo, Kane, and Rodrituez model and estimate ex ante safety-net benefits at a sample of large banks in US and Europe during 2003-2008. Our results suggest that difficult-to-fail and unwind (DFU) banks enjoyed substantially higher ex ante benefits than other institutions. Safety-net benefits prove significantly larger for DFU firms in Europe and bailout decisions less driven by asset size than in the US. We also find that a proxy for regulatory capture helps to explain bailout decisions in Europe. A policy implication of our findings is that authorities could better contain safety-net benefits if they refocused their information systems on measuring volatility as well as capital.

Regulatory Arbitrage In Cross-Border Banking Mergers Within The EU

Expanding the cross-country footprint of an organization's profit-making activities changes the geographic pattern of its exposure to loss in ways that are hard for regulators and supervisors to observe. Carbo, Kane, and Rodriguez test and confirm the hypothesis that differences in the size and character of safety-net benefits available to banks in individual EU countries help to account for cross-border merger activity. Our results suggest that central bankers need to develop statistical procedures for assessing the consequences of differences in supervisory strength and weakness in partner countries. We believe that the methods used here can help in this task.

Analysis Of Systemic Risk In Multilateral Net Settlement Systems

Chakravorti studies systemic risk in multilateral net settlement systems is investigated using a four-period model. The model focuses on the tradeoff between systemic risk and the cost of interbank transfers along with the importance of the overnight money markets that was a key factor in the most recent financial crisis. Banks optimize their reserve holdings at the central bank, the settlement medium, based on a future random liquidity shock and payment system parameters such as total asset and collateral requirements, and net debit caps. The model’s results are as follows. The model determines the maximum number of bank defaults that can be sustained without a stoppage in the clearance and settlement process. An interbank funds market increases the efficiency of the payment system. The payment system operator can reduce systemic risk by imposing asset and collateral requirements, and debit caps. The central bank can provide sufficient liquidity to prevent a systemic collapse but may face high costs.


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