The Future of Payments

105 BANKING PERSPECTIVES QUARTER 4 2018 CAPITAL, LIQUIDITY, AND LENDING CONTROLLING THE LONG-TERM PROBLEMS OF SHORT-TERM FUNDING (Scott & Johnson) This paper provides an overview of short-term wholesale funding in the U.S. financial system. The authors highlight the trade-offs: Runs on short-term liabilities are a key feature of all financial crises, but short-term funding also boosts efficiency for both borrowers and lenders. They find that regulation cannot determine the ideal level of short-term funding in the financial system because that level is likely cyclical. Instead, they encourage regulators to focus on minimizing the risk of runs and panics. MODELING YOUR STRESS AWAY (Niepmann, Friederike & Stebunovs) This paper analyzes changes in the sensitivity of banks’ projected credit losses to macroeconomic shocks between the 2014 and 2016 European Banking Authority’s stress tests. The authors argue that their results suggest that banks smoothed the impact of changes in macroeconomic scenarios on projected credit losses by changing their own internal models. The effect was more pronounced for banks using the internal ratings-based approach and those that experienced increases in losses due to an increased severity of the scenario. REGULATION AND RISK SHUFFLING IN BANK SECURITIES PORTFOLIOS (Fuster & Vickery) This staff report analyzes the effects of tying regulatory capital to current market values rather than historical values, thereby making regulatory capital more volatile. As a part of the Basel III reforms, advanced-approaches banks and other banks that chose to participate now include “accumulated other comprehensive income” when calculating regulatory capital. AOCI is the net difference between the market and book value of securities held for investment purposes. By examining security-level data, the authors find that banks have changed their accounting of risky securities to mitigate volatility in regulatory capital in ways that could limit banks’ ability to respond to a period of market stress. REPO MARKET FUNCTIONING (Kotidis & van Horen) This paper uses a change in the Bank of England’s leverage ratio reporting requirements to study the effect of capital regulation on repo markets. The authors find that dealers subject to a more binding leverage ratio accepted less repo from their clients. In addition, the frequency of transactions are reduced and repo pricing worsens. MACROPRUDENTIAL POLICY CROSS-BORDER BANKING AND THE CIRCUMVENTION OF MACROPRUDENTIAL AND CAPITAL CONTROL MEASURES (Cerutti & Zhou) This paper analyzes the joint effect of macroprudential policy and capital control measures on cross-border banking flows. The authors find that both types of measures have international spillover effects and that many of these effects are possibly associated with circumvention or arbitrage motives. They find no evidence that additional capital controls could mitigate spillovers. BANK STRUCTURE AND SYSTEMIC RISK WHY DO BANKS TARGET ROE? (Pennacchi & Santos) This paper summarizes a recent staff report that examines why banks focus on return on equity rather than other measures of performance. This was not always the case: Prior to the 1970s, banks targeted earnings-per-share much like non-financial corporations. Using a model of a bank that includes both deposit insurance and charter value, the authors find that conditions like those that occurred in the 1970s leads banks to hold less capital, making ROE look better and EPS growth look work. REDUCING MORAL HAZARD AT THE EXPENSE OF MARKET DISCIPLINE: THE EFFECTIVENESS OF DOUBLE LIABILITY BEFORE AND DURING THE GREAT DEPRESSION (Anderson, Barth & Choi) This paper investigates the effectiveness of double liability at constraining bank risk-taking and providing a safety