Karam, Philippe, Ouarda Merrouche, Moez Souissi and Rima Turk (2014), “The Transmission of Liquidity Shocks: The Role of Internal Capital Markets and Bank Funding Strategies,” IMF Working Paper, 14, 207, (November).


Capital
Optimal Level of Capital? The authors analyze bank capital regulation. They find that: (i) there is generally an optimal level of capital requirements; (ii) when bank leverage is high the economy is more responsive to shocks; and (iii) making capital requirements countercyclical is moderately stabilizing when the level of capital requirements is sufficiently high, but destabilizing when the level of capital requirements is low. Therefore, regulators need to find a compromise between reducing the distortions associated with bank failure risk and constraining credit supply. The authors note that a compromise can be found at a capital ratio around 10.5%, which is above the Basel III levels, but below levels proposed by Admati and Hellwig.

Clerc, Laurent, Alexis Derviz, Caterina Mendicino, Stephane Moyen, Kalin Nikolov, Livio Stracca, Javier Suarez and Alexandros Vardoulakis (2014), “Capital Regulation in a Macroeconomic Model with Three Layers of Default,” Banque of France Working Paper, 533, (December).


Effect of Capital Requirements on Bank Business Models. The author examines whether capital requirements undermine liquidity creation by causing banks to reduce their deposits. The paper finds that a small rise in capital requirements can, in some cases, lead to a reduction in deposits, which can have high social costs. However, a more substantial rise in capital requirements reverses this effect and crowds in deposits.

Arping, Stefan (2014), “More Equity, Fewer Deposits? The Elusive Effect of Capital Requirements on Bank Debt,” University of Amsterdam Business School, (December).


Effects of Basel III on Capital, Credit, and International Competitiveness. The GAO measures the impact of Basel III capital requirements and the associated increased compliance costs on lending activity. The report finds that analysis of Q1 2014 data demonstrates that increased capital requirements and compliance costs will have a “modest” impact on lending activity, as most banks will not need to raise additional capital to meet the minimum requirements. Of the 10 officials the GAO interviewed from G-SIBs, three officials said that U.S. minimum capital ratios for Basel III “tend not to be the binding capital constraint,” and a majority of these bank officials said they expect the capital requirements to improve the resilience of the banking system. The report discussed issues of international competitiveness created by jurisdictional differences in the implementation of Basel III capital standards and noted that the competitive effect on internationally active banks is unclear at the present time.

Government Accountability Office (2014), “Bank Capital Reforms: Initial Effects of Basel III on Capital, Credit and International Competitiveness.” (November).


Leverage Ratio More Countercyclical than Other Capital Ratios. The authors investigate the behavior of the new Basel III leverage ratio and compare the new definition of the leverage ratio using the exposure measure as the denominator with alternative ratios (Tier 1/Total assets and capital-to-risk-weighted assets ratio). Using the financial statements of 109 international banks headquartered in 14 advanced economies for the period 1995-2012 the paper finds: (i) in normal times the leverage ratio based on the new exposure measure is significantly more countercyclical than other capital ratios; (ii) this result is driven by the inclusion of guarantees and other off-balance positions in the exposure measure; and (iii) all three capital ratios tend to be more pro-cyclical during the crisis period. Furthermore, the study shows that Tier 1 capital is weakly correlated with GDP and credit, namely banks do not accumulate capital in expansions and tend to smooth capital consumption in recessions.

Brei, Michael and Leonardo Gambacorta (2014), “The Leverage Ratio over the Cycle,” BIS Working Papers, 471, (November).


Risk
Survey Finds Sharpening Focus on Conduct Risk. In its second annual survey on how financial institutions manage their conduct risk, Thomson Reuters finds that although conduct risk continues to be a priority for regulators, 81% of financial institutions remain unclear about what it is and how to deal with it. The survey demonstrates that conduct risk has become one of the highest priorities for financial services firms. The changing regulatory environment has also been identified as the biggest challenge when implementing conduct risk management.

Cowan, Michael, Stacey English and Susannah Hammond (2015), “Conduct Risk Report 2014/2015,” Thomson Reuters.


Hedging Credit Risk of Corporate Loans. The authors examine different factors that influence how banks manage the credit risk of their loan portfolios. Some factors include: borrowers credit quality, capital and liquidity requirements, existence of a prior relationship and reputational concerns. The paper finds that banks with capital and liquidity constraints are more likely to use credit risk transfer instruments (CRT). Furthermore, banks are more likely to use CRT instruments for transactional borrowers, and keep loans on their balance sheet if they have an ongoing relationship with a borrower.

Beyhaghi, Mehdi, Nadia Massoud and Anthony Saunders (2014), “Why and How Do Banks Lay Off Credit Risk? The Choice between Retention, Loan Sales and Credit Default Swaps,” University of Texas at San Antonio Department of Finance, Melbourne Business School University of Melbourne, New York University Stern School of Business, (December).


Internal Risk Models Inconsistent. The authors investigate whether there are systemic differences in banks’ reported risk metrics under the internal-ratings based approach. Using a data set of syndicated loan participants and their Basel II risk metrics, the authors find significant variations in how banks rate borrowers, namely some banks report risk metrics above the median of the syndicate and others report risk metrics below the median for the same syndicated loan. These findings indicate that some banks hold less capital for a given credit by reporting lower credit risk. Furthermore, the banks reporting less credit risk tend to be the least well capitalized.

Plosser, Matthew and João Santos (2014), “Banks’ Incentives and the Quality of Internal Risk Models,” Federal Reserve Bank of New York Staff Reports, 704, (December).


How Financial Institutions Efficiently Liquidate Large Positions. The author explores how large financial institutions efficiently liquidate large blocks of shares while balancing the need to liquidate with the cost of illiquidity. He finds that the liquidation strategy for an investor able to hedge market risk is the same as the liquidation strategy of a less risk-averse investor without a hedge. Additionally, the liquidation strategy for an investor able to hedge market risk is the same as for an investor facing higher price impact effects but without the ability to hedge market risk.

Monin, Phillip (2014), “Hedging Market Risk in Optimal Liquidation,” Office of Financial Research Working Paper, 14, 08, (November).


Systemic Risk
Systemic Risk in the European Banking Sector. The authors find empirical evidence of bank size, asset and income structure, loss and liquidity coverage, profitability and several macroeconomic conditions as drivers of systemic risk. Furthermore, the paper provides evidence that existing microprudential liquidity, capital and leverage rules are less effective and propose that policymakers consider new measures such as asset diversification to mitigate systemic risk.

Kleinow, Jacob and Tobias Nell (2015), “Determinants of Systemically Important Banks: The Case of Europe,” Freiberg University, (January).


Is Corporate Risk-Taking Excessive? The author posits that in this increasingly competitive and complex global economy, firms must take risks to innovate and create value for shareowners. The author examines how law should control risk-taking without impeding broader economic progress and focuses on the extent to which corporate risk-taking should be regarded as excessive. Schwarcz concludes that firm level liability may be insufficient, and that managers should be subject to liability for engaging in excessive systemic risk-taking.

Schwarcz, Steven (2015), “Liability for Financial Failure: Corporate Risk-Taking and the Decline of Personal Blame,” Duke University, (January).


CoVaR and MES Not Reliable Measures of Systemic Risk. The authors use conditional value at risk (CoVaR) and marginal expected shortfall (MES) measures to determine individual financial institutions’ systemic risk. The authors construct hypothesis test statistics for CoVaR and MES that can be used to detect systemic risk at the institutional level, and apply it to daily stock returns data for over 3500 firms during 2006-07. Their tests identify almost 500 (1000) firms as systemically important supporting the conclusion that CoVaR and MES measures are incapable of reliably detecting a firm’s systemic risk potential.

Kupiec, Paul and Levent Guntay (2015), “Testing for Systemic Risk using Stock Returns,” American Enterprise Institute, Federal Deposit Insurance Corporation, (January).


Systemic Risk Theory Based on Uncertainty Aversion. The authors propose a new theory of systemic risk based on uncertainty aversion. The authors study an economy where uncertainty-averse investors hold a portfolio of risky assets. The authors write that these uncertainty-averse investors prefer to hold multiple uncertain assets in their portfolio. As a result, a shock to one asset class spreads to other asset classes creating contagion and uncertainty aversion becomes a source of systemic risk. Additionally, the paper finds that bank runs are associated with stock market crashes and flight to quality. Furthermore, the authors argue that increasing uncertainty makes the financial system more fragile and more prone to financial crises.

Dicks, David and Paolo Fulghieri (2014), “Uncertainty Aversion and Systemic Risk,” University of North Carolina Kenan-Flagler Business School, (November).


Macroprudential Regulation
The Interplay Between Microprudential and Macroprudential Regulation. The authors expose a fundamental tension between micro-prudential and macro-prudential regulation. The authors discuss how micro-prudential regulation aims to regulate risk taking at the individual level and that macro-prudential regulation seeks to contain systemic risk. They find that higher minimum capital requirements that reduce systemic risk and decrease the expected social cost of industry collapse may be preferable to ex-post lender-of-last-resort liquidity. Furthermore, the authors advise that rather than relying on market signals, regulators should generate their own data on aggregate risk which will allow them to intervene selectively.

Acharya, Viral and Anjan Thakor (2015), “The Dark Side of Liquidity Creation: Leverage and Systemic Risk,” European Corporate Governance Institute (ECGI) Finance Working Paper, 445, 2015, (January).


Tackling CCP Systemic Risk: Self-Funding Systemic Risk Charge for TBTF. The authors examine interactions of clearing members with a single central counterparty (CCP). The study finds that the clearing network tends to be dominated by a few clearing members with high total asset value, which raises systemic risk concerns because of the positive relation between bank size and systemic risk. This concentration may be reduced if clearing members are allowed to freely raise capital. Allowing banks to freely raise capital may induce an increase in the leverage ratio. A regulator then needs to control two systemic risk measures: (i) market concentration; and (ii) leverage ratios of individual members. To accomplish this, the authors propose a self-funding systemic risk charge ‒ a charge on size ‒ that would allow regulators to control market concentration without inducing clearing members to raise capital.

Capponi, Agostino, W. Allen Cheng and Sriram Rajan (2014), “Systemic Risk: The Dynamics under Central Clearing,” Columbia University, John Hopkins University, Office of Financial Research, (December).


Regulators’ Coordination Efforts in Implementing Dodd-Frank. The GAO finds that regulators coordinated on 34 of the 54 Dodd-Frank rulemakings it reviewed. For the Volcker Rule, interagency coordination led regulators to adopt a common rule and regulators voluntarily have continued coordination efforts during rule implementation. For swaps rulemakings, regulators coordinated domestically and internationally. However, such coordination did not always result in harmonized rules, and key differences among some rules have raised compliance and market efficiency concerns among market participants, industry associations, and foreign regulators.

Government Accountability Office (2014), “Dodd-Frank Regulations: Regulators’ Analytical and Coordination Efforts,” (December).


How Do Banks Respond to Changes in Regulatory Requirements. The author examines the constraints regulatory requirements impose on banks’ behavior and finds that if capital requirements are too low relative to the underlying credit risk in banks’ loan portfolios, increasing reserve requirements could lead to a higher number of bank failures. Additionally, higher capital regulatory requirements help reduce solvency problems but raise risk related to interconnectedness.

Chan-Lau, Jorge (2014), “Regulatory Requirements and Their Implications for Bank Solvency, Liquidity and Interconnectedness Risks: Insights from Agent-Based Model Simulations,” International Monetary Fund, (December).


Analyzing Macroprudential Policies that Prevent Systemic Instability. The authors develop a macroeconomic model which can be used to analyze macroprudential policies aimed at preventing systemic instability. They find that an episode of capital inflows and rapid credit expansion, triggered by low country interest rates, leads banks to decrease the rate of equity issuance, contributing to an increase in the probability of a crisis. The authors propose that policymakers use both countercyclical capital buffers and capital controls to lower the probability of financial crises.

Akinci, Ozge and Albert Queralto (2014), “Banks, Capital Flows and Financial Crises,” Board of Governors of the Federal Reserve System, International Finance Discussion Papers, 1121, (November).


Payments
How Should Retail Payment Systems Be Viewed by Regulators? The author focuses on the seven desirable benefits of the retail payment system: (i) finality and reversibility; (ii) universality (ability to use at point of sale and remotely); (iii) recordkeeping; (iv) liquidity (maximizing interest earning assets); (v) security and safety; (vi) financial inclusion and access; and (vii) fungibility and ease of use. While each retail payment system provides certain advantages, overall the analysis suggests that debit and credit cards represent the most desirable payment system for achieving the seven benefits set forth above.

Scott, Hal (2014), “The Importance of the Retail Payment System,” Harvard Law School, (December).


Structural Reform
Delinking Deposits and Lending Would Eliminate Financial Instability. The author argues for splitting the lending function from the safekeeping function in both traditional and shadow banking. In what the author calls a “Pure Reserve Banking regime”, safe banks would offer safekeeping and payment services, and nothing else. Loans would be a function solely of capital markets. The author notes that capital markets are now sufficiently developed both in terms of capital and technology such that it is possible to split the deposit and lending functions. The author argues that delinking deposits and lending would eliminate the root cause of financial market instability and enable safe banking that is not dependent upon an increasingly complex regulatory system.

Levitin, Adam (2015), “Safe Banking,” Georgetown University Law Center, (January).


The Case for a Break Up. The authors argue for the breakup of JPMorgan into a number of pieces by business line. Under their proposal, JPMorgan would be broken up into a “traditional” bank and an “institutional” bank. The benefits of a split would result in the pieces being worth more than the whole, in part because the pieces would in smaller buckets for the G-SIB surcharge. However several synergies of operating a consolidated institution would be lost by executing the split.

Ramsden, Richard, Conor Fitzgerald, Daniel Paris and Kevin Senet (2015), “New Capital Rules Reignite the JPM Breakup Debate,” Goldman Sachs Equity Research, (January).


Resolution
Multiple vs. Single Point of Entry. The authors argue that in order to make resolution of SIFIs a credible alternative to bailouts, EU financial firms need to move to a holding company structure so that the focus of resolution can be at the holding company level. This will allow regulators to replace the current European approach to resolution commonly referred to as the “Multiple Points of Entry” (“MPOE”) with the “Single Point of Entry” (“SPOE”) approach.

Gordon, Jeffrey and Wolf-Georg Ringe (2015), “Bank Resolution in Europe: the Unfinished Agenda of Structural Reform,” Chapter for Forthcoming European Banking Union, (Oxford University Press).


Monetary Policy
Impact of Monetary Policy Shocks on Financial Stability. The authors compare the effects of monetary policy surprises on the balance sheet growth of commercial banks and the shadow banking sector. The paper finds that monetary policy shocks tend to reduce the asset growth of commercial banks, but increases the asset growth of shadow banks and securitization activity.

Nelson, Benjamin, Gabor Pinter and Konstantinos Theodoridis (2015), “Do contractionary monetary policy shocks expand shadow banking?” Bank of England, Working Paper, 521, (January).


Complexity
Banks Must Get Better at Managing Complexity. The Oliver Wyman report analyzes five important sources of complexity identified by their clients. They are: regulation; channel proliferation; systems fragmentation; product proliferation; and geographic expansion. Oliver Wyman proposes that banks adopt these five measures to reduce the cost of complexity: (i) use common metrics to develop self-knowledge of the financial institution and its customers; (ii) use advanced statistical analysis to make strategic decisions; (iii) automate or standardize core processes; (iv) delegate decision making to the subject matter experts who have the best information; and (v) build a strong corporate culture that supports consistent conduct standards.

Oliver Wyman (2015), “Managing Complexity: The state of the Financial Services Industry 2015.”


M&A Activity Continues. The authors analyze mergers and acquisitions in the financial institutions space. The memo finds that deals such as City National/RBC, BB&T/Susquehanna, and CIT/OneWest suggest that improved economic confidence and improved stability and visibility of the U.S. regulatory climate “will facilitate major mergers where the institutional size, strategic fit and perceived opportunity are just right.” The memo notes that regulatory factors impact, but do not impede, dealmaking.

Herlihy, Edward, Richard Kim, Lawrence Makow, Jeannemarie O’Brien, Nicholas Demmo, David Shapiro, Matthew Guest, Mark Veblen, Brandon Price and David Adlerstein (2015), “The M&A Landscape: Financial Institutions Rediscovering Themselves Amid Continued Regulatory Change, Intensifying Investor Activism and Technological Disruption,” Wachtell, Lipton, Rosen & Katz, (January).


Value of Large Banks
Acknowledging the Contribution of Finance to Society. The study outlines what finance academics can do to promote good finance. The author writes that finance academics should: (i) acknowledge that their view of the benefits of finance is inflated; (ii) they should be “the watchdogs of the financial industry, not its lapdogs;” (iii) get more involved in policy, not in politics; and (iv) do more from an educational point of view.

Zingales, Luigi (2015), “Does Finance Benefit Society?” Centre for Economic Policy, Discussion Papers, 10350, (January).


Accounting Standards
Reviewing Effects of Accounting Standards and Regulation on Bank Behavior. The paper reviews academic literature on the relationship between accounting and regulatory frameworks, and their effect on bank behavior. The review focuses on: (i) the fair value accounting; (ii) loan loss provisioning; (iii) application of prudential filters; and (iv) disclosure of accounting information.

Basel Committee on Banking Supervision (2015), “The interplay of accounting and regulation and its impact on bank behaviour: Literature review,” Bank for International Settlements, Working Paper, 28, (January).