Size Of Balance Sheet Research Articles

Assessing the Impact of Federal Reserve Policies on Equity Market Valuations: An Instrumental Variables Approach

This study investigates the impact of Central Bank interventions on the pricing dynamics of select stock markets. The research utilizes the instrumental variables three-stage least square (3SLS) model approach. It analyses the effects of variations in the Federal Reserve’s balance sheet size across three distinct intervention scenarios: the 2008–2013 Great Recession, the 2020–2021 COVID-19 pandemic periods, and an overarching analysis spanning these timelines. Our methodology includes estimations of the Seemingly Unrelated Regression Equations (SURE), and the results are robust under the two-step Generalized Method of Moments (GMM). Our findings indicate that changes in the size of the Fed’s balance sheet correlate significantly with the pricing of principal U.S. equity market indices. This correlation reflects a time-dependent effect emanating from the Fed’s balance sheet expansion, marking a growing divergence between the adaptability of pricing mechanisms in equity and debt markets. Notably, the Federal Reserve’s interventions during the COVID-19 crisis are associated with an increase of approximately 0.0403 basis points per billion in treasury yields. This research makes a significant contribution to the understanding of financial asset pricing, particularly by elucidating the extent to which interventions in government debt securities engender price distortions in certain equity markets.

Assessing the Impact of the ECB’s Unconventional Monetary Policy on the European Stock Markets

This study assesses the effects of the European Central Bank’s (ECB) unconventional monetary policy (UMP) on the prices of selected European stock market indices during the European sovereign debt (2010–2012) and the COVID-19 pandemic (2020–2022) crises interventions. This research employs the instrumental variables (IV) two-stage least squares (2SLS) model approach to evaluate the effects of changes in the size of the ECB’s balance sheet on the pricing of key equity market indices in Europe. The results of this study suggest that the ECB’s asset value expansion had the opposite statistically significant effects on the European stock market indices’ prices between the interventions. That is, an increase in the ECB’s balance sheet size was associated with a decrease in the prices of the indices during the sovereign debt crisis and with a rise during the COVID-19 pandemic. This research pinpoints the price sensitivity of each of the European equity indices to the ECB’s UMP and determines the different outcomes of the ECB’s quantitative easing policy between the interventions.

Brazilian banks risk-taking and systemic risk

This study analyzes the marginal contribution of Brazilian banks to the systemic risk. The objective is to identify whether banks that share common characteristics similarly contribute to systemic financial shocks. First, the risk assumed by a sample of listed banks is measured from the accounting, market, and regulatory perspectives. Sample banks were segregated using an unsupervised clustering model. The results were compared with the methodology currently used by the Central Bank of Brazil to segment the banking institutions. Finally, we evaluate the banking groups’ marginal contribution to systemic financial risk using ΔCoVaR. These results suggest that institutions that share similar characteristics in relation to their risk profiles behave similarly during times of greater market stress. Notably, size, geographic diversification, and liquidity were common attributes among banks contributing significantly to systemic risk during financial crises. This study advances the field of banking finance by introducing an analytical framework that goes beyond the traditional focus on bank balance sheet size, aligning with international standards for evaluating the systemic importance of financial institutions.

The new monetary policy regime under central bank’s abundant balance sheet: the case of the Federal Reserve

PurposeThe transmission of monetary policy has received considerable attention due to the sizable enlargement of the Federal Reserve’s balance sheet and consequently of the large reserve balances held by the Depository Institutions. This paper aims to investigate whether changes in the quantity of the reserve balances during the so-called normalization period and the COVID-19 crisis put significant pressure on short-term interest rates and specifically on the Effective Federal Funds rate (EFFR).Design/methodology/approachUnder the new monetary policy regime, with two newly administered interest rates, the authors use the spread of the Federal Funds rates and the Interest on Reserve Balances (as a measure of the price of liquidity. With the means of various models such as the structural vector autoregression, the authors investigate, for two different subsample periods, the effectiveness of the monetary policy and the creation of (any) liquidity effects.FindingsThe results showed that when the Fed decreases its balance sheet size, during the normalization period, significant liquidity effects are present meaning that the authorities could influence the stage of the short-term interest rates under the new monetary policy regime. However, this relationship appears to weaken considerably as the level of reserve balances, particularly in response to the COVID-19 pandemic, increases substantially. The authors enriched the findings by highlighting the role of the benchmark repo rate. During the COVID-19 period, and in light of abundant reserve balances, the repo rate reacts more vigorously to a reduction in reserves, whereas an increase in the repo rate seems to exert a strong positive influence on the EFFR.Originality/valueThe findings are very important for the efficiency of the monetary transmission mechanism. An expanded balance sheet is still considered an arcane concept in regard to the structure and its effects on monetary policy implementation. This is one of the only few studies that investigates the effect of the abundant reserve balances on the short-term interest rates for two different in nature subsample periods. It shows as well the interplay between short-term interest rates, secured and unsecured.

Normalizing the Central Bank's Balance Sheet: Implications for Inflation and Debt Dynamics

AbstractWe explore the effects of reducing the overall size of the central bank's balance sheet and lowering its maturity structure. To do so, we consider an environment where fiscal policy is traditionally passive and the central bank follows the Taylor principle. In addition, the monetary authority has also explicit size and compositional rules regarding its balance sheet. Agents in this economy face limited commitment in some markets and government bonds can be used as collateral. When short‐ and long‐term public debt exhibit premia, changes in the central bank's balance sheet have implications for long‐run inflation and real allocations. To ensure a unique locally stable steady state, the central bank should target a low enough maturity composition of its balance sheet. In our numerical exercise, calibrated to the United States, we find that long‐term debt holdings by the central bank should be less than 0.5 times of their short‐term positions. Moreover, the process of balance sheet normalization should aggressively respond to the total debt issued in the economy relative to its target. These findings depend on the degree of liquidity of long‐term bonds. The more liquid long‐term bonds are, the lower is the value of the composition threshold and the parameter space consistent with unique and stable equilibria is smaller. In addition, we consider a modified Taylor rule that takes into account the premium. Such a rule increases the prevalence of multiplicity of steady states and delivers lower welfare. Thus, we argue that the traditional Taylor rule is appropriate for managing interest rates in the presence of premia.

Substitutability between Balance Sheet Reductions and Policy Rate Hikes: Some Illustrations and a Discussion

This note explores the substitutability between policy rate hikes and reductions in the size of the Federal Reserve's balance sheet for the removal of policy accommodation. We do so using a version of the FRB/US model augmented to incorporate the effects of changes in the Federal Reserve's asset holdings on term premiums.

Leverage and systemic risk pro-cyclicality in the Chinese financial system

In this paper, we investigate the relationship between balance sheet size and leverage (i.e., leverage pro-cyclicality) and the pro-cyclicality of systemic risk using three systemic risk measures such as ΔCoVaR (Adrian and Brunnermeier (2016)), MES (Acharya et al. (2017)), SRISK (Brownlees and Engle (2016)). We conduct an extensive panel data analysis using a sample of 264 Chinese listed financial institutions (43 commercial banks, 74 finance services and 147 real estate finance services) over 2005:4–2019:4. We also study the impact of different phases of the financial turmoil by considering three subperiods, the “Global Financial Crisis” (2007:1–2009:4), the “Monetary Policy Restriction” (2010:1–2014:4), and the “2015 Chinese Stock Crash” (2015:1–2019:4). We find that leverage pro-cyclicality mainly affects CBs, in particular during the global financial crisis and the monetary policy restriction. We also find that larger financial institutions increase systemic risk, in particular commercial banks, which from 2016 started increasing shadow banking activities, and the real estate financial services with their activity closer to commercial banking.

Liquidity regulation and bank lending

Bank liquidity shortages during the global financial crisis of 2007–2009 led to the introduction of liquidity regulations, the impact of which has attracted the attention of academics and policymakers. In this paper, we investigate the impact of liquidity regulation on bank lending. As a setting, we use the Netherlands, where a Liquidity Balance Rule (LBR) was introduced in 2003. The LBR was imposed on Dutch banks only and did not apply to other banks operating elsewhere within the Eurozone. Using this differential regulatory treatment to overcome identification concerns and a difference-in-differences approach, we find that the LBR increased the volume of lending by Dutch banks relative to other banks located in the Eurozone. Increased equity, an inflow of retail deposits and subsequent increase in balance sheet size allowed Dutch banks to increase lending despite having to meet the LBR requirements. The LBR also affected the loan composition of Dutch banks (with corporate and retail lending increasing more than mortgage lending) and the maturity profile of loan portfolios. Our results have relevance for policymakers tasked with monitoring the impact of liquidity regulations on banks and the real economy.

Leverage and balance-sheet size: a comparative study between Islamic and conventional banks

ABSTRACT We carry out a comparative analysis of procyclical leverage between Islamic banks and conventional banks in the GCC countries and Malaysia. We collect an unbalanced panel data set including 57 conventional banks and 73 Islamic banks covering the period 2000–2019. First, we document strong evidence of procyclical leverage for our sample banks. Second, our results highlight that conventional banks have statistically stronger leverage procyclicality than Islamic banks, even after controlling for accounting profitability, economic conditions, bank regulations, and wholesale funding. Moreover, we document that the differential in the leverage procyclicality across Islamic banks and conventional banks has been stronger after the global financial crisis, and seems to be more pronounced in small banks compared with large banks. Our findings suggest that the differential in the leverage procyclicality across the two types of banks is related to their different business models. An implication of our results is that the low leverage procyclicality of Islamic banks is a key factor contributing to the stability of a dual banking system.

Identifying the Factors Affecting Financial Condition of Malaysia

This research focuses on the domestic and external determinants of Malaysia’s financial condition, ranging from January 2003 and March 2019. To represent the domestic determinants, a total amount of twelve financial indicators are adopted to compute three indices using the Principal Component Approach (PCA). Three of the indices embody three respective financial segments, particularly the banking system, the foreign exchange market, and the capital market within the Malaysian financial system. These three segments offer a glimpse of the Malaysian financial condition. For the external determinant, the US total assets of all Federal Reserve Banks are adopted as the proxy for the size of the US balance sheet. This research intends to evaluate the validity of the long-run association and its corresponding level of effect between the computed indices and the US balance sheet size via the conduct of the ARDL bounds test approach. The research findings have verified the validity of the long-run association between the Malaysian financial condition and the US balance sheet size. There is a substantial role played by the US balance sheet size in affecting the well-being of Malaysian financial condition, given the statistical significance is shown in the association between the US balance sheet size and the financial-segment-based indices, whereby its strongest influence is found on the banking system condition.

Measuring the effectiveness of US monetary policy during the COVID‐19 recession

The COVID‐19 recession that started in March 2020 led to an unprecedented decline in economic activity across the globe. To fight this recession, policy makers in central banks engaged in expansionary monetary policy. This paper asks whether the measures adopted by the US Federal Reserve (Fed) have been effective in boosting real activity and calming financial markets. To measure these effects at high frequencies, we propose a novel mixed frequency vector autoregressive (MF‐VAR) model. This model allows us to combine weekly and monthly information within a unified framework. Our model combines a set of macroeconomic aggregates such as industrial production, unemployment rates, and inflation with high‐frequency information from financial markets such as stock prices, interest rate spreads, and weekly information on the Fed's balance sheet size. The latter set of high‐frequency time series is used to dynamically interpolate the monthly time series to obtain weekly macroeconomic measures. We use this setup to simulate counterfactuals in absence of monetary stimulus. The results show that the monetary expansion caused higher output growth and stock market returns, more favorable long‐term financing conditions and a depreciation of the US dollar compared with a no‐policy benchmark scenario.

Stock market implications of Fed's balance sheet size

PurposeConsidering the relationship between the central bank balance sheet and unconventional monetary policy after the 2008 financial crisis, it is crucial to see how the unconventional monetary policy, given near-zero interest rates, affects future stock market performance. This paper analyzes the impact of the Fed's balance sheet size on stock market performance.Design/methodology/approachTo analyze the Fed's balance sheet size's long-term stock market implications, this paper uses the asset pricing framework of market return predictability such as Ordinary least squares (OLS) and Generalized method of moments (GMM) analysis.FindingsFindings in this paper suggest that the Fed's balance sheet size, deflated by asset market wealth, presents evidence of return predictability during 1926–2015 that is robust against standard controls. These results can be explained through the redistribution of risk and the wealth channels of monetary policy transmission. The changing balance sheet size of a central bank (1) affects systemic risk, yields and expectations and (2) signals the future direction of monetary policy and thus economic outlook.Research limitations/implicationsThe main implication of these findings is that policymakers should avoid a severe imbalance between a central bank's balance sheet size and assets market wealth.Originality/valueThe empirical evidence in this paper documents a century-old relation between the Fed's balance sheet size and US stock market return using the Fed's balance sheet data for the last 100 years and stock market returns from the Center for research in security prices (CRSP) database.

The impact of size, composition and duration of the central bank balance sheet on inflation expectations and market prices

We analyse the effects of announcements of changes in the Eurosystem’s balance sheet size, duration and composition on inflation expectations, the exchange rate, the 10-year euro area government bond yield and stock returns, using local projections. We explicitly take into account interaction effects between the three balance sheet dimensions. We provide evidence for the duration extraction channel of monetary policy transmission as we find that the bond yield is sensitive to the combined impact of shocks to balance sheet size and duration. The exchange rate is also affected by a joint size-duration shock. Moreover, the bond yield and exchange rate are sensitive to the joint effect of changes in size and composition. The results indicate that interactions between balance sheet dimensions matter.

The Impact of Size, Composition and Duration of the Central Bank Balance Sheet on Inflation Expectations and Market Prices

We analyse the effects of announcements of changes in the Eurosystem’s balance sheet size, duration and composition on inflation expectations, the exchange rate and the 10-year euro area government bond yield, using local projections. We explicitly take into account interaction effects between the three balance sheet dimensions. We provide evidence for the duration extraction channel of monetary policy transmission, as we find that the bond yield is sensitive to the combined impact of shocks to balance sheet size and duration. The exchange rate is also affected by a joint size-duration shock. Moreover, the bond yield and exchange rate are sensitive to the joint effect of changes in size and composition. The results indicate that interactions between balance sheet dimensions matter.

Solvency Distress Contagion Risk: Network Structure, Bank Heterogeneity and Systemic Resilience

We systematically analyse how network structure and bank characteristics affect solvency distress contagion risk in interbank networks. As interbank networks become more connected and more regular in structure, the contagion risk of system-wide shocks and individual bank defaults initially increases and then decreases, all else being equal. The low density heterogeneous network structures that typify real interbank networks are particularly prone to solvency distress contagion risk, when banks are similar in balance sheet size and capitalisation. However, when networks are calibrated to UK data, the higher capitalisation of large, highly-connected banks relative to their interbank exposures significantly increases the resilience of the system and reduces the importance of network structure. These findings reinforce the importance and effectiveness of imposing higher capital buffers on systemically important banks and of policies that limit interbank exposures. We also demonstrate that for real-world interbank networks, simple network metrics other than individual bank connectedness do not provide robust indicators for monitoring solvency contagion risk, suggesting that policymakers should continue efforts to model these risks explicitly rather than rely on simple aggregate indicators.

The Implications of Liquidity Regulation for Monetary Policy Implementation and the Central Bank Balance Sheet Size: An Empirical Analysis of the Euro Area

We analyse the impact of the Liquidity Coverage Ratio (LCR) on the demand for central bank reserves in the euro area with difference-in-differences estimation techniques. Using a novel dataset and an identification strategy that exploits the cross-country heterogeneity in the regulatory treatment of reserves for LCR purposes prior to the announcement of a harmonised euro area standard as a quasi-natural experiment, we find evidence that points to LCR-induced demand for reserves. Specifically, our results suggest that banks with low LCRs relative to peers increased their central bank reserve holdings as a result of the LCR regulation. Our findings have economically meaningful implications for the operational framework of monetary policy and imply that the Eurosystem’s balance sheet may need to remain larger than it was prior to the financial crisis and the associated introduction of new liquidity regulation.

Swap transactions and profitability relationship: an empirical research on the Turkish banking sector

Purpose- The increase in volatility in exchange rates in the last 5 years has increased the level of exchange risk for the Turkish banking sector, whose liabilities are mainly composed of foreign currency funds. To manage the currency risk, the tendency towards derivative financial instruments has increased and swap transactions have a share of 85% in the total derivatives’ portfolio as of the end of 2019, according to BRSA data. Studies in the literature on the subject of the Turkish banking sector focus on the effect of derivative financial instruments on banks' risk level. In studies on the effect of derivative transactions on profitability, it is seen that the derivative transaction’s portfolio is evaluated as a whole. In this context, taking into account that swap transactions are carried out to make a profit in addition to being a risk management tool, the purpose of the study is to determine the causality between profitability and swap transactions recorded by banks within the scope of Derivative Transactions for Trading Purposes. Methodology- In the research, the data of the first 8 private banks according to balance sheet size were analyzed. State-owned banks were excluded from the study due to their capital structures, working principles, competition conditions, and their functions being relatively different from private banks. The variables to be analyzed in the study are net profit and swap transaction volume data that banks account for under Derivative Transactions for Trading Purposes by IFRS 9. The data were obtained from financial statements and audit reports disclosed to the public by banks. These data are for 20 quarters covering the years 2015-2019. In this context, short and long-term causality analysis was performed between swap volume and net profit. It has been determined whether the causality relationship between the variables is one-way or two-way. Panel unit root tests, Johansen cointegration test, Wald test, and Granger causality test were performed respectively to achieve the purpose of the study. Findings- Cointegration between swap volume and net profit of banks included in the analysis has been determined. For this reason, short and long-term causality analysis was performed by applying the Vector Error Correction Model (VECM). As a result of the causality test, it was concluded that there is long-term bidirectional causality among the variables and one-sided causality in the short-term. Short-term causality is from swap volume to net profit. Conclusion- As a result of the analysis of the quarterly swap volume and net profit data of the eight banks operating in the Turkish banking sector in terms of balance sheet size for the period 2015-2019, it is understood that both variables affect each other in the long-term. In the short run, the causality is one-sided and it is concluded that the swap volume affects the net profit. It is believed that a study on the effect of currency swaps, which has a significant share in the swap portfolio, on profitability will be useful in the studies to be carried out in the following period.

Nexus between Corporate Governance and Financial Performance: Corroboration from Indian Banks

Corporate governance (CG) is now a world phenomenon and the nucleus of economic regulations. History evidenced that failure in corporate governance might lead to economic turmoil. Governance of banks is particularly important for a country like India which is still in the path of economic development. In this paper, we have tried to establish the nexus between corporate governance practices and financial performance of selected Indian public sector banks. The study is empirical in nature and is based on secondary data collected from CMIE Prowess database. We have considered ten public sector banks based on their balance sheet size covering seven years ending on 2019. We have used Correlation and Regression Model to achieve our objectives. Two performance variables, eight corporate governance variables and two control variables have been used for this purpose. Based on the diagnostic tests, we applied fixed effects generalised least square (GLS) regression. Our results showed that financial performance (ROA and ROE) is negatively associated with board size, board meetings, board committees and board independence. On the contrary, we found a positive relationship between the number of woman directors, executive directors, non-executive directors and banks' performance measures. Finally, we suggest that public sector banks should not have a board size beyond a certain limit. Our study will provide a new dimension to the existing literatures regarding the impact of governance and banking sector in particular.

Financial contagion in a core-periphery interbank network

ABSTRACTThis paper studies financial contagion in a core-periphery interbank network where core banks are large in balance sheet size while periphery banks are smaller and link only with the core banks. Core banks are all bilaterally linked and intermediate liquidity for periphery banks. We establish analytic conditions under which financial contagion propagates in the core-periphery network and examine the extent to which heterogeneity associated with size and number of banks affects these conditions. We show that the failure of core banks does not necessarily imply contagious failure of periphery banks; the core-periphery network structure exhibits a ‘robust-yet-fragile’ tendency with increased size of core banks; and the resilience of the network to contagion depends on the number of core banks, the number of periphery banks, and the level of interbank liquidity intermediated between the core banks. We also find that, under certain conditions, the core-periphery network is more resilient than the complete network with increased size of core banks.

A large central bank balance sheet? Floor vs corridor systems in a New Keynesian environment

The quantitative easing (QE) policies implemented in recent years by central banks have had a profound impact on the working of money markets, giving rise to large excess reserves and pushing down key interbank rates against their floor – the interest rate on reserves. With macroeconomic fundamentals improving, central banks now face the dilemma as to whether to maintain this large balance sheet/floor system, or else to reduce their balance sheet size towards pre-crisis trends and operate traditional corridor systems. We address this issue using a New Keynesian model featuring heterogeneous banks that trade funds in an interbank market characterized by matching frictions. In this environment, balance sheet expansions push market rates towards their floor by slackening the interbank market. A large balance sheet regime is found to deliver ampler ‘policy space’ by widening the steady-state distance between the interest on reserves and its effective lower bound (ELB). Nonetheless, a lean-balance-sheet regime that resorts to temporary but prompt QE in response to recessions severe enough for the ELB to bind achieves similar stabilization and welfare outcomes as a large-balance-sheet regime in which interest-rate policy is the primary adjustment margin thanks to the larger policy space.