As you celebrate this Labor Day weekend, we hope you enjoy these readings from the financial regulatory world. As always, the views expressed in these articles do not necessarily represent the views of the initiative, its co-chairs, task force members or the Bipartisan Policy Center (BPC).
What we’re reading on liquidity
Wild Ride on Wall Street: Early Test of Liquidity?
By Aaron Klein and Kristofer Readling, Financial Regulatory Reform Initiative, BPC
“The stock market’s wild swing last week, including its sharpest sell-off since 2009, could provide an early indication of whether concerns about broader market liquidity declining are accurate, and if so, to what degree are financial regulatory reform or market evolution the cause.” Read the post.
Liquidity during Flash Events
By Ernst Schaumburg, Assistant Vice President, Integrated Policy Analysis and Ron Yang, Research Analyst, Federal Reserve Bank of New York
“‘Flash events,’ extremely large price moves and reversals over just a few minutes, have occurred in some of the world’s most liquid markets in recent years. What’s made these events remarkable is that they seem to have been unrelated to any discernable [sic] fundamental economic news that may have taken place during the events. In this post, we consider a few of the important similarities and differences among three major flash events in the U.S. equities, euro–dollar foreign exchange (FX), and U.S. Treasury markets that occurred between May 2010 and March 2015. All three flash events involved high trading volumes and long-term impacts on depth, but the U.S. Treasury event stands out in terms of both price volatility and price continuity.” Read the post.
Global Financial Markets Liquidity Study
By PricewaterhouseCoopers LLP
“In analysing the new market dynamics, including the effects that market-based and prudential regulations are having on market liquidity, this report provides an analysis of specific regulatory initiatives that are presenting challenges for banks’ traditional role as market makers. These substantial challenges impact the ability of bank dealers to facilitate liquidity and the redistribution of risk in times of volatility, potentially introducing new and unforeseen risks to our markets and economy. The report tries to weigh the costs and benefits of regulation, and identify those regulatory initiatives that in aggregate, could have greater adverse impacts on market liquidity than may have been was envisaged when designed individually, especially when the interactions of market-based and prudential regulations on market participants are considered.” Read the report.
What we’re reading from Jackson Hole, Wyoming, site of the Federal Reserve Bank of Kansas City’s Annual Economic Symposium
U.S. Inflation Developments
By Stanley Fischer, Vice Chairman, Board of Governors of the Federal Reserve System
“We should however be cautious in our assessment that inflation expectations are remaining stable. One reason is that measures of inflation compensation in the market for Treasury securities have moved down somewhat since last summer (chart 7). But these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities. … As I have discussed, given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further. While some effects of the rise in the dollar may be spread over time, some of the effects on inflation are likely already starting to fade.” Read the speech.
Inflation in a Globalised World
By Mark Carney, Governor, Bank of England
“Moreover, it is the divergence of monetary policies itself rather than the stance of one central bank in isolation that points to more volatility in exchange rates and asset markets with associated effects on global liquidity conditions. Over the medium term, financial reform will change the nature of this cycle. Once implemented, measures to end Too-Big-To-Fail should reduce the risk of extreme spillovers from failures of systemically important firms. Measures such as leverage ratios, higher capital charges on trading books, minimum haircuts for repo transactions, central clearing of standardised derivatives should all dampen endogenous credit creation at the core of the system and thereby limit the amplitude of the global financial cycle. Indeed, the dog that hasn’t barked in the wake of recent market turbulence has been any hint of distress at any major financial institution.” Read the speech.
What we’re reading on payments regulation
“Thus, while APPs and banks increasingly compete head to head, APPs face dramatically less regulatory oversight of their data security and privacy practices than do banks, with real consequences for their customers. While this gap has existed for years, it has become more problematic in recent years as the APP industry has grown, leading to increased risk of security lapses and increased consequences of such lapses. Improper data security protections could lead not only to unauthorized disclosure of sensitive personal or financial information stored by an APP, but could also lead to fraudulent transactions conducted through the APP. Both risks are important to consumers. And ultimately, banks often bear the costs of closing/replacing cards or accounts, investigating incidents of fraud, refunding fraudulent charges, and monitoring accounts for fraudulent activities.” Read the report.
Innovation, Deregulation, and the Life Cycle of a Financial Service Industry,” International Monetary Fund, Working Paper
By Fumiko Hayashi, Bin Grace Li, and Zhu Wang
“This paper examines innovation, deregulation, and firm dynamics over the life cycle of the U.S. ATM and debit card industry. In doing so, we construct a dynamic equilibrium model to study how a major product innovation (introducing the new debit card function) interacted with banking deregulation drove the industry shakeout. Calibrating the model to a novel dataset on ATM network entry, exit, size, and product offerings shows that our theory fits the quantitative pattern of the industry well. The model also allows us to conduct counterfactual analyses to evaluate the respective roles that innovation and deregulation played in the industry evolution.” Read the paper.
What we’re reading on consumer protection
Monthly Complaint Report, Vol. 2
By Consumer Financial Protection Bureau
“As of August 1, 2015, the CFPB has handled approximately 677,200 complaints, including 26,700 complaints in July 2015. …Consumer loan complaints showed the greatest percentage increase from May – July 2014 (718 complaints) to May – July 2015 (1,154 complaints), representing about a 61 percent increase. Bank account or services complaints showed the greatest percentage decrease from May- July 2014 (1,976 complaints) to May – July 2015 (1,895 complaints), representing about a 4 percent decline.” Read the report.
What we’re reading on systemic risk
Realized Bank Risk during the Great Recession,” International Finance Discussion Papers 1140, Board of Governors, Federal Reserve System
By Altunbas, Yener, Professor of Economics, Bangor University, Simone Manganelli, Head of Financial Research, European Central Bank and David Marques-Ibanez, Economist
“We show that in the run-up to the crisis different bank characteristics can explain a significant portion of the cross-sectional realization of bank risk during the 2007-2009 financial crisis. Banks with large size, low levels of capital, unstable funding and aggressive credit expansion in the years before the crisis experienced more troubles after the Lehman default. …Our regression quantile analysis reveals how dependence on less stable balance sheet funding, more aggressive growth strategy and lower capital are conducive to more realized risk, in particular for the group of the riskier institutions.” Read the paper.
Systemic Risk Assessment in Low Income Countries: Balancing Financial Stability and Development
By Daniela Marchettini, Economist, and Rodolfo Maino, Senior Economist, International Monetary Fund
“First, when measuring excess credit with the gap with respect to the long-term trend in LICs, the analysis shows no apparent link between credit booms and banking crises in the Middle East and North Africa (MENA) and SSA regions. This finding reflects the fact that, in economies in the early stages of financial development, rapid credit expansions are mostly connected to financial deepening rather than to the buildup of financial vulnerabilities, thus calling into question the use of the gap with respect to the long-term trend as an indicator of financial stress in LICs. …Our second result shows indeed that complementing the measure of excess credit based on the historical trend with an indicator that links a country’s financial development to its structural characteristics enhances the capacity to predict banking crises and distinguish ‘bad’ from ‘good’ booms in LICs.” Read the paper.