Sovereign Bond-Backed Securities: A Feasibility Study
with Philip Lane and others (2018)
Report of the ESRB High-Level Task Force on Safe Assets
Volume I: main findings
Volume II: technical analysis
SUMMARY: Vox-EU (also published in Pisani-Ferry and Zettelmeyer (eds), Chapter 6, "Risk Sharing Plus Market Discipline")
PRESENTATION: Slides and Video
MEDIA: The Economist; Wall Street Journal (here and here); Financial Times (here, here and here)
CITED BY: The European Commission in its regulatory proposal for sovereign bond-backed securities; ECB Vice-President Vítor Constâncio (here and here); Banco de España Governor Pablo Hernández de Cos
ABSTRACT: This report assesses the feasibility and impact of creating a market for sovereign bond-backed securities as a tool to enhance financial stability. The main finding is that a gradual, demand-led development of the market might be feasible under certain conditions. One necessary condition is that an enabling product regulation recognises the unique design and risk properties of the securities, reflecting the lower risk of the senior security and the higher risks of the subordinated securities. An enabling product regulation covering holdings of sovereign bond-backed securities across regulated financial sectors could provide for a prudentially adequate treatment.
with Philip Lane and others (2018)
Report of the ESRB High-Level Task Force on Safe Assets
Volume I: main findings
Volume II: technical analysis
SUMMARY: Vox-EU (also published in Pisani-Ferry and Zettelmeyer (eds), Chapter 6, "Risk Sharing Plus Market Discipline")
PRESENTATION: Slides and Video
MEDIA: The Economist; Wall Street Journal (here and here); Financial Times (here, here and here)
CITED BY: The European Commission in its regulatory proposal for sovereign bond-backed securities; ECB Vice-President Vítor Constâncio (here and here); Banco de España Governor Pablo Hernández de Cos
ABSTRACT: This report assesses the feasibility and impact of creating a market for sovereign bond-backed securities as a tool to enhance financial stability. The main finding is that a gradual, demand-led development of the market might be feasible under certain conditions. One necessary condition is that an enabling product regulation recognises the unique design and risk properties of the securities, reflecting the lower risk of the senior security and the higher risks of the subordinated securities. An enabling product regulation covering holdings of sovereign bond-backed securities across regulated financial sectors could provide for a prudentially adequate treatment.
The Distribution of Interest Rate Risk in the Euro Area
with Peter Hoffmann and Benjamin Klaus (2018)
ECB Financial Stability Review (Special Feature C)
ABSTRACT: This special feature analyses the distribution of interest rate risk in the euro area economy using balance sheet data and information on derivatives positions from significant credit institutions. On aggregate, banks’ interest rate risk exposure is small relative to their loss absorption capacity, but exposure varies across institutions. This variation is driven by loan rate fixation practices at country level. Banks use derivatives for hedging, but retain residual interest rate risk exposures. In fixed-rate countries the main vulnerability to rising interest rates lies with the banks that have the greatest interest rate risk, while households would be directly affected in countries with predominantly variable-rate loans. In the latter case, increased loan servicing costs due to rising interest rates could affect banks through lower asset quality.
with Peter Hoffmann and Benjamin Klaus (2018)
ECB Financial Stability Review (Special Feature C)
ABSTRACT: This special feature analyses the distribution of interest rate risk in the euro area economy using balance sheet data and information on derivatives positions from significant credit institutions. On aggregate, banks’ interest rate risk exposure is small relative to their loss absorption capacity, but exposure varies across institutions. This variation is driven by loan rate fixation practices at country level. Banks use derivatives for hedging, but retain residual interest rate risk exposures. In fixed-rate countries the main vulnerability to rising interest rates lies with the banks that have the greatest interest rate risk, while households would be directly affected in countries with predominantly variable-rate loans. In the latter case, increased loan servicing costs due to rising interest rates could affect banks through lower asset quality.
From the Horse's Mouth: Surveying Responses to Stress by Banks and Insurers
with Jeroen Brinkhoff and Olaf Weeken (2018)
ESRB Occasional Paper 15
CITED BY: ECB President Mario Draghi
ABSTRACT: Existing stress tests do not capture feedback loops between individual institutions and the financial system. To identify feedback loops, the European Systemic Risk Board has developed macroprudential surveys that ask banks and insurers how they would behave in a macroeconomic stress scenario. In a pilot application of these surveys, we find evidence of herding behaviour in the banking sector, notably concerning credit retrenchment. Results show that the consequences can be large, potentially undoing the initial effects of banks’ remedial actions by worsening their solvency position. In contrast, insurers’ responses to the survey provide little evidence of herding in response to macroeconomic stress. These results highlight the usefulness of macroprudential surveys in identifying feedback loops.
with Jeroen Brinkhoff and Olaf Weeken (2018)
ESRB Occasional Paper 15
CITED BY: ECB President Mario Draghi
ABSTRACT: Existing stress tests do not capture feedback loops between individual institutions and the financial system. To identify feedback loops, the European Systemic Risk Board has developed macroprudential surveys that ask banks and insurers how they would behave in a macroeconomic stress scenario. In a pilot application of these surveys, we find evidence of herding behaviour in the banking sector, notably concerning credit retrenchment. Results show that the consequences can be large, potentially undoing the initial effects of banks’ remedial actions by worsening their solvency position. In contrast, insurers’ responses to the survey provide little evidence of herding in response to macroeconomic stress. These results highlight the usefulness of macroprudential surveys in identifying feedback loops.
Review of OTC Derivatives Market Reforms
with members of an expert network of the Financial Stability Board (2017)
Financial Stability Board Report
ABSTRACT: In 2009, recognising the role of OTC derivatives markets in the global financial crisis, G20 leaders committed to reform these markets, with the objectives of mitigating systemic risk, improving transparency, and protecting against market abuse. This review shows that implementation of these reforms is now well progressed, although this has taken longer than originally intended due to the scale and complexity of reforms. While systemic risk has been meaningfully mitigated, there is mixed evidence concerning the impact of market reforms on spreads and liquidity in OTC derivatives markets.
with members of an expert network of the Financial Stability Board (2017)
Financial Stability Board Report
ABSTRACT: In 2009, recognising the role of OTC derivatives markets in the global financial crisis, G20 leaders committed to reform these markets, with the objectives of mitigating systemic risk, improving transparency, and protecting against market abuse. This review shows that implementation of these reforms is now well progressed, although this has taken longer than originally intended due to the scale and complexity of reforms. While systemic risk has been meaningfully mitigated, there is mixed evidence concerning the impact of market reforms on spreads and liquidity in OTC derivatives markets.
Bank Liquidity Requirements: How to Get More Bang for your Buck
with Iñaki Aldasoro, Ester Faia, Gerardo Ferrara, Zijun Liu and Tomohiro Ota (2016)
Bank Underground
ABSTRACT: We make the case for a macroprudential approach to liquidity requirements in the cross-section of banks. Currently, the liquidity coverage requirement is applied uniformly across banks. This microprudential approach overlooks banks’ relative systemic importance: owing to their size, complexity and position in the interbank funding network, some banks can cause inordinate damage to the rest of the banking system. When this externality is taken into account, we show that systemically important banks should be subject to more stringent liquidity requirements. This cross-sectional macroprudential approach promises “more bang for the buck”: systemic risk can be reduced without increasing the stringency of liquidity requirements for the banking system as a whole.
with Iñaki Aldasoro, Ester Faia, Gerardo Ferrara, Zijun Liu and Tomohiro Ota (2016)
Bank Underground
ABSTRACT: We make the case for a macroprudential approach to liquidity requirements in the cross-section of banks. Currently, the liquidity coverage requirement is applied uniformly across banks. This microprudential approach overlooks banks’ relative systemic importance: owing to their size, complexity and position in the interbank funding network, some banks can cause inordinate damage to the rest of the banking system. When this externality is taken into account, we show that systemically important banks should be subject to more stringent liquidity requirements. This cross-sectional macroprudential approach promises “more bang for the buck”: systemic risk can be reduced without increasing the stringency of liquidity requirements for the banking system as a whole.
Too Late, Too Sudden: Transition to a Low-Carbon Economy and Systemic Risk
with Daniel Gros, Philip Lane, Sini Matikainen, Marco Pagano, Dirk Schoenmaker and Javier Suarez (2016)
ESRB Advisory Scientific Committee Report 6
MEDIA: The Guardian
CITED BY: European Commission in its communication to the Parliament and Council regarding the 2015 Paris Agreement
ABSTRACT: Keeping global warming below 2°C will require substantial reductions in global greenhouse gas emissions over the next few decades. To reduce emissions, economies must reduce their carbon intensity. In an adverse scenario, the transition to a low-carbon economy occurs late and abruptly. This scenario would affect systemic risk via three main channels: (i) the macroeconomic impact of sudden changes in energy use; (ii) the revaluation of carbon-intensive assets; and (iii) a rise in the incidence of natural catastrophes. The overall systemic risk implications depend on the level of financial institutions’ exposure to carbon-intensive assets and the specific form of emission abatement policies, both of which are highly uncertain. In the short-term, increased disclosure and further research could help to better quantify macroeconomic risks. In the medium-term, the availability of granular data and dedicated low-frequency stress tests will provide information about the impact of the adverse scenario on the financial system.
with Daniel Gros, Philip Lane, Sini Matikainen, Marco Pagano, Dirk Schoenmaker and Javier Suarez (2016)
ESRB Advisory Scientific Committee Report 6
MEDIA: The Guardian
CITED BY: European Commission in its communication to the Parliament and Council regarding the 2015 Paris Agreement
ABSTRACT: Keeping global warming below 2°C will require substantial reductions in global greenhouse gas emissions over the next few decades. To reduce emissions, economies must reduce their carbon intensity. In an adverse scenario, the transition to a low-carbon economy occurs late and abruptly. This scenario would affect systemic risk via three main channels: (i) the macroeconomic impact of sudden changes in energy use; (ii) the revaluation of carbon-intensive assets; and (iii) a rise in the incidence of natural catastrophes. The overall systemic risk implications depend on the level of financial institutions’ exposure to carbon-intensive assets and the specific form of emission abatement policies, both of which are highly uncertain. In the short-term, increased disclosure and further research could help to better quantify macroeconomic risks. In the medium-term, the availability of granular data and dedicated low-frequency stress tests will provide information about the impact of the adverse scenario on the financial system.
Indirect Contagion: the Policy Problem
with Laurent Clerc, Alberto Giovannini, Tuomas Peltonen, Richard Portes and Martin Scheicher (2016)
ESRB Occasional Paper 9
CITED BY: ECB President Mario Draghi; Central Bank of Ireland Governor Philip Lane (here and here)
ABSTRACT: Indirect contagion spreads market failure through two channels, even in the absence of direct contractual links between counterparties. First, scarce funding liquidity and low market liquidity reinforce each other in a negative spiral. This is the market price channel. Second, bad news can adversely affect a broad range of financial firms and markets via "information spillovers". A wide array of policy reforms over 2008-15 has helped to mitigate the effects of these two channels of indirect contagion. However, additional reforms may be necessary. We highlight three. First, the macroprudential application of liquidity regulation – both in the time series and the cross-section – could help to dampen illiquidity spirals more efficiently. Second, regulatory restrictions on margins and haircuts in SFT and derivative transactions – either by setting time-varying minimum levels or step limits on the change – could also reduce systemic liquidity risk. Third, enhanced disclosure of information – both via regular reports during normal times and targeted disclosure during crises – could mitigate negative information spillovers.
with Laurent Clerc, Alberto Giovannini, Tuomas Peltonen, Richard Portes and Martin Scheicher (2016)
ESRB Occasional Paper 9
CITED BY: ECB President Mario Draghi; Central Bank of Ireland Governor Philip Lane (here and here)
ABSTRACT: Indirect contagion spreads market failure through two channels, even in the absence of direct contractual links between counterparties. First, scarce funding liquidity and low market liquidity reinforce each other in a negative spiral. This is the market price channel. Second, bad news can adversely affect a broad range of financial firms and markets via "information spillovers". A wide array of policy reforms over 2008-15 has helped to mitigate the effects of these two channels of indirect contagion. However, additional reforms may be necessary. We highlight three. First, the macroprudential application of liquidity regulation – both in the time series and the cross-section – could help to dampen illiquidity spirals more efficiently. Second, regulatory restrictions on margins and haircuts in SFT and derivative transactions – either by setting time-varying minimum levels or step limits on the change – could also reduce systemic liquidity risk. Third, enhanced disclosure of information – both via regular reports during normal times and targeted disclosure during crises – could mitigate negative information spillovers.
Allocating Macro-prudential Powers
with Daniel Gros, Marco Pagano and Dirk Schoenmaker (2014)
ESRB Advisory Scientific Committee Report 5
ABSTRACT: Monetary, macro-prudential and micro-prudential policies are intimately linked. The macroprudential authority should be allocated to the body where the overall balance of synergies (between policy objectives) over conflicts and the required expertise are the largest. This report reviews the pros and cons of the four institutional models for the allocation of macro-prudential powers: (1) the government, (2) the central bank, (3) the financial authority and (4) a committee with representatives from these three bodies.
with Daniel Gros, Marco Pagano and Dirk Schoenmaker (2014)
ESRB Advisory Scientific Committee Report 5
ABSTRACT: Monetary, macro-prudential and micro-prudential policies are intimately linked. The macroprudential authority should be allocated to the body where the overall balance of synergies (between policy objectives) over conflicts and the required expertise are the largest. This report reviews the pros and cons of the four institutional models for the allocation of macro-prudential powers: (1) the government, (2) the central bank, (3) the financial authority and (4) a committee with representatives from these three bodies.
Is Europe Overbanked?
with Marco Pagano, Viral Acharya, Arnoud Boot, Markus Brunnermeier, Claudia Buch, Martin Hellwig, André Sapir and Ieke van den Burg (2014)
ESRB Advisory Scientific Committee Report 4
MEDIA: The Economist; Wall Street Journal; Financial Times; Reuters; Bloomberg; Les Echos; Frankfurter Allgemeine Zeitung; Neue Zuercher Zeitung; Deutsche Welle
CITED BY: ECB President Mario Draghi (here, here and here at 17:28); SSM Chair Danièle Nouy; ECB Vice-President Vítor Constâncio; ECB Executive Board member Benoît Cœuré; EBA Chair Andrea Enria; Central Bank of Ireland Governor Philip Lane (here and here); Bank of Finland Governor Erkki Liikanen (here, here and here); and Bundesbank President Jens Weidmann
ABSTRACT: Banking has grown too much in Europe – in three senses. First, the European banking system has reached a size where its contribution to real economic growth is likely to be nil or negative. Second, the European financial structure is biased towards banks, which results in excessively volatile credit creation, more frequent financial crises and lower economic growth. Third, large universal banks – which perform a wide range of banking services, and are peculiarly common in Europe – contribute more to systemic risk than small and narrowly focused banks. Current policies are insufficient to deal with these three problems.
with Marco Pagano, Viral Acharya, Arnoud Boot, Markus Brunnermeier, Claudia Buch, Martin Hellwig, André Sapir and Ieke van den Burg (2014)
ESRB Advisory Scientific Committee Report 4
MEDIA: The Economist; Wall Street Journal; Financial Times; Reuters; Bloomberg; Les Echos; Frankfurter Allgemeine Zeitung; Neue Zuercher Zeitung; Deutsche Welle
CITED BY: ECB President Mario Draghi (here, here and here at 17:28); SSM Chair Danièle Nouy; ECB Vice-President Vítor Constâncio; ECB Executive Board member Benoît Cœuré; EBA Chair Andrea Enria; Central Bank of Ireland Governor Philip Lane (here and here); Bank of Finland Governor Erkki Liikanen (here, here and here); and Bundesbank President Jens Weidmann
ABSTRACT: Banking has grown too much in Europe – in three senses. First, the European banking system has reached a size where its contribution to real economic growth is likely to be nil or negative. Second, the European financial structure is biased towards banks, which results in excessively volatile credit creation, more frequent financial crises and lower economic growth. Third, large universal banks – which perform a wide range of banking services, and are peculiarly common in Europe – contribute more to systemic risk than small and narrowly focused banks. Current policies are insufficient to deal with these three problems.
Operationalising Macro-prudential Policy in the Banking Sector
with Andrea Maechler and others (2014)
ESRB Handbook
ABSTRACT: The entry into force of the EU capital requirements directive and regulation ("the CRD IV package") at the beginning of 2014 was a milestone in the development of a macro-prudential policy framework in the EU. The new rules provide Member States with a common legal framework and a set of macro-prudential instruments to mitigate systemic risk in the banking sector. This handbook aims to assist macro-prudential authorities to operationalise instruments set out in new prudential rules for the EU banking sector.
with Andrea Maechler and others (2014)
ESRB Handbook
ABSTRACT: The entry into force of the EU capital requirements directive and regulation ("the CRD IV package") at the beginning of 2014 was a milestone in the development of a macro-prudential policy framework in the EU. The new rules provide Member States with a common legal framework and a set of macro-prudential instruments to mitigate systemic risk in the banking sector. This handbook aims to assist macro-prudential authorities to operationalise instruments set out in new prudential rules for the EU banking sector.
Risk Management through the Lens of Macroprudential Policy
with Jeroen Brinkhoff, Francesco Mazzaferro, Carmelo Salleo and Olaf Weeken (2013)
Journal of Risk Management in Financial Institutions, 6(2): 120-128
ABSTRACT: Five years after the eruption of the financial crisis its causes are relatively well understood. Slowly, analysis is revealing the mechanisms by which contagion propagates through the financial system, highlighting the importance of systemic risk. The profound global regulatory overhaul in response to the crisis in large part reflected a general admission that systemic risk had been neglected in prudential regulation. This insight has motivated the creation of new macro-prudential authorities, including the European Systemic Risk Board (ESRB). Two years since the creation of the ESRB, a new set of analytical tools and policy instruments is taking shape. These instruments will affect how financial institutions operate, and thus the work of risk managers. Finally, the article puts the role of risk managers into the bigger picture of the system as a whole.
with Jeroen Brinkhoff, Francesco Mazzaferro, Carmelo Salleo and Olaf Weeken (2013)
Journal of Risk Management in Financial Institutions, 6(2): 120-128
ABSTRACT: Five years after the eruption of the financial crisis its causes are relatively well understood. Slowly, analysis is revealing the mechanisms by which contagion propagates through the financial system, highlighting the importance of systemic risk. The profound global regulatory overhaul in response to the crisis in large part reflected a general admission that systemic risk had been neglected in prudential regulation. This insight has motivated the creation of new macro-prudential authorities, including the European Systemic Risk Board (ESRB). Two years since the creation of the ESRB, a new set of analytical tools and policy instruments is taking shape. These instruments will affect how financial institutions operate, and thus the work of risk managers. Finally, the article puts the role of risk managers into the bigger picture of the system as a whole.
The Structure and Resilience of the European Interbank Market
with Ivan Alves, Stijn Ferrari, Pietro Franchini, Jean-Cyprien Heam, Pavol Jurca, Sebastiano Laviola, Franka Liedorp, Antonio Sanchez, Santiago Tavolaro and Guillaume Vuillemey (2013)
ESRB Occasional Paper 3
ABSTRACT: The paper reviews the extant literature on financial network analysis; describes the characteristics of the European interbank market; analyses measures of network fragility; and provides a dynamic network analysis of the interbank market.
with Ivan Alves, Stijn Ferrari, Pietro Franchini, Jean-Cyprien Heam, Pavol Jurca, Sebastiano Laviola, Franka Liedorp, Antonio Sanchez, Santiago Tavolaro and Guillaume Vuillemey (2013)
ESRB Occasional Paper 3
ABSTRACT: The paper reviews the extant literature on financial network analysis; describes the characteristics of the European interbank market; analyses measures of network fragility; and provides a dynamic network analysis of the interbank market.
Financial Stability Challenges for EU Acceding and Candidate Countries
with Roland Beck (lead) and others (2012)
ECB Occasional Paper 136
ABSTRACT: This Occasional Paper reviews financial stability challenges in countries preparing for EU membership with candidate country status. It follows a macro-prudential approach, emphasising systemic risks of financial systems as a whole. After recalling that some EU candidate countries went through a pronounced boom-and-bust credit cycle in recent years, the paper identifies current challenges for bank-based financial sectors as mainly stemming from: (i) high or rising domestic credit risk; (ii) unhedged borrowing in foreign currencies; and (iii) strains related to the euro area debt crisis, which is impacting the EU candidate countries via a number of channels. The main channels of transmission of the euro area debt crisis to the EU candidate countries operate via: (i) trade and foreign direct investment; (ii) an increased market focus on sovereign risk; and (iii) “deleveraging”, e.g. via a decline of external funding to local subsidiaries of EU parent banks.
with Roland Beck (lead) and others (2012)
ECB Occasional Paper 136
ABSTRACT: This Occasional Paper reviews financial stability challenges in countries preparing for EU membership with candidate country status. It follows a macro-prudential approach, emphasising systemic risks of financial systems as a whole. After recalling that some EU candidate countries went through a pronounced boom-and-bust credit cycle in recent years, the paper identifies current challenges for bank-based financial sectors as mainly stemming from: (i) high or rising domestic credit risk; (ii) unhedged borrowing in foreign currencies; and (iii) strains related to the euro area debt crisis, which is impacting the EU candidate countries via a number of channels. The main channels of transmission of the euro area debt crisis to the EU candidate countries operate via: (i) trade and foreign direct investment; (ii) an increased market focus on sovereign risk; and (iii) “deleveraging”, e.g. via a decline of external funding to local subsidiaries of EU parent banks.
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