Financial Stability Considerations Research Articles

Cross-border regulatory spillovers and macroprudential policy coordination

We develop a core–periphery model with financial frictions and cross-border banking to assess the magnitude of regulatory spillovers and the gains from macroprudential policy coordination. A core global bank lends to its affiliates in the periphery and banks in both regions are subject to risk-sensitive capital regulation. Following an expansionary monetary policy in the core, a countercyclical response in capital requirements in that region induces the global bank to increase cross-border lending. We calculate welfare gains associated with countercyclical capital buffers under a range of policy regimes, including independent policymaking, full coordination, and reciprocity—a regime in which capital ratios set in the core are imposed on the global bank’s affiliates abroad. One of our key results is that, even when regulatory spillovers are strong, reciprocity can make all parties better off if regulators attach a sufficient weight to financial stability considerations. With a standard, utility-based welfare criterion, reciprocity may also perform better than independent policymaking when regulatory spillovers are weak.

Does CEO Power Affect the Relations between CEO Compensation and Risk-Taking?

Purpose - This study investigates the effect of incentive compensation and CEO power on a firm’s risk-taking behavior, leveraging stock return volatility and earnings volatility as the key indicators of risk-taking.
 Design/Methodology/Approach - A comprehensive analysis is conducted using data from 1,958 U.S. firms over a 28-year period (1992- 2019). The study employ both ordinary least square (OLS) regression and two-stage least square (2SLS) regression for analysis. Pay-volatility sensitivity (PVS) and CEO-pay slice (CPS) are used as proxies for incentive compensation and CEO power, respectively.
 Findings - The findings offer solid empirical proof that PVS and CPS have a negative influence on both earnings volatility and stock return volatility. Furthermore, the detrimental effect of PVS on managerial risk-taking is significantly more pronounced for CEOs with lower CPS compared with those with higher CPS. While incentive compensation appears to deter CEOs from embracing higher risks, CEOs with more power are less risk-averse when offered incentive compensation compared to their less powerful counterparts.
 Research Implications - This study significantly contributes to existing literature by revealing the interactive effects between CEO power and incentive compensation on a firm’s risk-taking behavior. Understanding these dynamics is pivotal as it offers a nuanced view of how CEO compensation structures and power hierarchies within a firm influence its risk-taking propensity, which is critical for both firm performance and broader financial stability considerations. The insights derived from this analysis can inform more balanced executive compensation structures and governance models that ensure an optimal level of risk-taking.

The Financial Appeal Bodies of the European Union: Nature and Future of the Appeal Panel of the Single Resolution Board

Abstract 936The three financial appeal bodies established in the EU (Board of Appeal of the European Supervisory Authorities, Administrative Board of Review of the SSM, and Appeal Panel of the Single Resolution Board) have certainly a number of advantages. Particularly, their technical expertise in matters of financial supervision and resolution makes them well placed to understand the intricacies, complexities and reactions of financial markets. The members of these bodies are individuals of high repute, with a proven record of relevant knowledge and professional experience and are not bound by any instructions, thereby acting independently and in the public interest. Yet, there are also drawbacks as the nature of these financial appeal bodies is hybrid, quasi-judicial, combining features from both advisory committees and courts of justice. Also, the legal regime applicable to these financial appeal bodies is both complex and not uniform. The rationale of the new European financial regulatory regime post GFC, which prompted the creation of the appeal bodies, resides in the primacy of financial stability and public interest considerations. Although there is no doubt that administrative decisions need to be motivated if they are to be reviewed, most of such decisions in the area of banking and finance are very complex and yet timing is crucial for them to be effective. On these grounds, legitimacy and accountability are of utmost importance for any democratic system to properly function; however, the more complex the activity, the more difficult it is to establish clear standards of conduct and specific outcomes.937

Money laundering, media and European banks

PurposeThis paper aims to assess, from an empirical perspective, the research question if public media reports which relate concrete banks to concrete allegations of money laundering have an adverse impact on banks stock prices and what are the drivers of such impact?Design/methodology/approachThe paper makes use of event study methodology and uses the constant mean and the market model. The event window is calibrated towards a five-day window, and the estimation window has a length of 90 days, in line with best academic practices. Drivers are identified by correlation analysis. and the market model uses ordinary least squares regression.FindingsThe application of event study methodologies yields the results that stock prices of affected banks generate, at the date of the news appearance, statistically significant negative abnormal returns under both the market model and the constant mean model. As negative abnormal returns have been mainly found at the date of the event itself, the findings confirm that the impacts of money laundering may be severe but short natured. In addition, the paper finds that the identified negative abnormal returns may be driven by the banks’ size in terms of total assets, by the bank’s profitability in terms of return on assets and by the bank’s sustainability risk.Practical implicationsThe findings have implications in terms of banking and supervisory practices. In specific, the findings help to argue that banking consolidation is needed to lower the impacts of AML cases, as stock prices of larger banks show less sensitivity. In addition, the findings could be used to determine financial sanctions against banks violating AML regulation. Finally, the findings imply that AML news can have severe and fast-moving financial stability considerations and are, therefore, important in crisis situations.Originality/valueAs there appears to be no substantial research that applies event study methodology to the money laundering context, the combination of research question and methodology has an innovative character. In addition, there is no clear literature on media and money laundering.

The Role of Financial Stability Considerations in Monetary Policy and the Interaction with Macroprudential Policy in the Euro Area

The Role of Financial Stability Considerations in Monetary Policy and the Interaction with Macroprudential Policy in the Euro Area

Financial Stability Considerations in the Conduct of Monetary Policy

Financial Stability Considerations in the Conduct of Monetary Policy

The European Commission’s Equivalence Decisions for Third-country Central Counterparties: Between Financial Stability and Political Considerations

The European Commission’s Equivalence Decisions for Third-country Central Counterparties: Between Financial Stability and Political Considerations

The evolution of monetary rules with financial stability considerations

ABSTRACT In this study, we estimate and investigate the evolution of monetary rules in China and the United States in the 21st century. Our goal is to examine whether financial stability has been taken into consideration in the decision-making of monetary policy. By proposing a new method, we estimate the structural breaks, split the entire time period into multiple monetary regimes, and estimate an extended Taylor rule with financial stability considerations and its evolution over time. Our findings show that China’s monetary policy emphasized the financial stress of the U.S. immediately before and during the 2008 global financial crisis. However, the coefficient for the U.S. financial stress has decreased since then, which shows a weaker concern on this index, and instead, the Chinese policymakers are emphasizing stronger on their domestic financial market.

Monetary and macroprudential policy coordination with biased preferences

This paper studies the extent to which biased policy preferences, motivated by narrow institutional mandates, affect the gains from coordination between monetary policy (which may respond to financial imbalances) and macroprudential regulation (in the form of capital requirements) in responding to financial stability considerations, and whether these mandates can be set optimally. Numerical experiments show that, depending on the degree of bias in policy preferences, coordination may not entail burden sharing (in the sense of one policymaker reacting more, and the other less, aggressively to financial stability concerns) and may not be Pareto improving relative to the Nash equilibrium—even though it may generate significant gains for the economy as a whole. The optimal institutional mandate, based on maximizing household welfare under coordination, internalizes the impact of the cost of each policymaker’s own instrument use on policy decisions. As a result, there may be an inverse relationship between the degree of bias in preferences and the instrument manipulation cost.

Financial Stability Considerations for Monetary Policy: Empirical Evidence and Challenges

This paper reviews literature on the empirical relationship between vulnerabilities in the financial system and the macroeconomy, and how monetary policy affects that connection. Financial vulnerabilities build up over time, with both risk appetite and risk taking rising during economic expansions. To some extent, financial crises are predictable and have severe real economic consequences when they occur. Empirically it is difficult to link monetary policy to financial vulnerabilities, in part because financial cycles have long durations, making it difficult to separate effects of changes in monetary policy from other business cycle effects.

Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms

This paper reviews the theoretical literature at the intersection of macroeconomics and finance to draw lessons on the connection between vulnerabilities in the financial system and the macroeconomy, and on how monetary policy affects that connection. This literature finds that financial vulnerabilities are inherent to financial systems and tend to be procyclical. Moreover, financial vulnerabilities amplify the effects of adverse shocks to the economy, so that even a small shock to fundamentals or a small revision of beliefs can create a self-reinforcing feedback loop that impairs credit provision, lowers asset prices, and depresses economic activity and inflation. Finally, monetary policy may affect the buildup of vulnerabilities, but the sign of the impact along some of its transmission channels is theoretically ambiguous and may vary with the state of the economy.

Financial Stability Considerations for Monetary Policy: Empirical Evidence and Challenges

Financial Stability Considerations for Monetary Policy: Empirical Evidence and Challenges

Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms

Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms

Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms

Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms

The Evolution of Monetary Rules with Financial Stability Considerations

The Evolution of Monetary Rules with Financial Stability Considerations

Inter-portfolio credit risk contagion including macroeconomic and financial factors: A case study for Ecuador

Daily banking practice suggests that there may be contagion effects between portfolios, a fact that has been explicitly recognized through current regulation. This paper describes a model that distinguishes between delinquency in each portfolio and allows inter-portfolio credit risk contagion, including macroeconomic and financial factors. Also, multivariate scenarios regarding portfolios’ credit risks were simulated.The private banking system of Ecuador was explored from January 2005 to December 2018. Delinquency among consumers, microcredit, and housing portfolios and their exogenous determinants were simultaneously quantified using a Bayesian vector autoregressive model. The results show that shocks in exogenous variables are often transmitted immediately in all portfolios. Simultaneously, the autoregressive terms take up to six months to affect these variables, but not cumulatively. A unit of shock in consumer delinquency causes an increase in microcredit delinquency immediately, and this effect is maintained until one month later, where it stabilizes and disappears at the tenth month. Furthermore, a unit of shock in microcredit delinquency produces an increase in consumer delinquency only in the medium term, after seven months.Including inter-portfolio linkages in credit, risk quantification allows to understand the micro-dynamics of absolute risk better and to evaluate the systemic importance of individual shocks since their impact spreads among portfolios with a domino effect. Further research in this area might focus on how to use these techniques as operational tools to incorporate financial stability considerations into control risk policy decision-making.

The 2021 review of the monetary policy strategy of the Eurosystem : an economy of forces

This study delves into the rationale behind the 2021 review of the monetary policy strategy of the Eurosystem and elaborates on the main elements of the new strategy and its implications for monetary policy-making going forward. The profound changes in the economic landscape that have taken place since the last review in 2003 prompted the European Central Bank and the euro area national central banks to embark on a comprehensive review of the monetary policy strategy of the Eurosystem. The aim has been to ensure that the strategy reflects upon these unique challenges and remains well suited in pursuit of the primary objective of price stability. The key outcome of the strategy review, unveiled in July 2021, has been the reformulation of the price stability objective so as to adopt a symmetric commitment to the 2% inflation target over the medium term, as well as the confirmation of the flexible use of unconventional monetary policy tools when the economy operates close to the effective lower bound of interest rates. In addition, the new strategy has further incorporated financial stability and climate change considerations into the monetary policy framework. The present study outlines the enhancements embedded in the new strategy, as regards the fulfilment of the price stability mandate of the Eurosystem. It also discusses the ways in which the new strategy could have, to some extent, addressed the challenges faced by the euro area and its individual members, with a focus on Greece, over the past crisis years.

Financial stability and the Fed: Evidence from congressional hearings

AbstractThis article retraces how financial stability considerations interacted with US monetary policy before and during the Great Recession. Using text‐mining techniques, this article innovates by constructing indicators for financial stability sentiment expressed during testimonies of five Federal Reserve Chairs. Including these text‐based measures adds explanatory power to Taylor‐rule models. Negative financial stability sentiment coincided with a more accommodative monetary policy stance than implied by standard Taylor‐rule factors, even during the decades before the Great Recession. These findings are consistent with a preference for monetary policy reacting to financial instability rather than acting pre‐emptively to a perceived build‐up of risks.

Technological progress and monetary policy: Managing the fourth industrial revolution

This paper looks at the implications for monetary policy of the widespread adoption of artificial intelligence and machine learning, which is sometimes called the “fourth industrial revolution.” The paper reviews experiences from the previous three industrial revolutions, developing a template of shared characteristics: new technology displaces workers; investor hype linked to the new technology leads to financial excesses; new types of jobs are created; productivity and potential output rise; prices and inflation fall; and real debt burdens increase, which can provoke crises when asset prices crash.The experience of the Federal Reserve during 1995–2006 is particularly instructive. The paper uses the Bank of Canada’s main structural model, ToTEM (Terms-of-Trade Economic Model), to replicate that experience and consider options for monetary policy. Under a Taylor rule, monetary policy may allow growth to run as long as inflation remains subdued, easing the burden of adjustment on those workers directly affected by the new technology, while macroprudential policies help check financial excesses. This argues for a family of Taylor rules enhanced by the addition of financial stability considerations.

The Role of Financial Stability Considerations in Monetary Policy and the Interaction with Macroprudential Policy in the Euro Area

Since the European Central Bank’s (ECB’s) 2003 strategy review, the importance of macro-financial amplification channels for monetary policy has increasingly gained recognition. This paper takes stock of this evolution and discusses the desirability of further incremental enhancements in the role of financial stability considerations in the ECB’s monetary policy strategy. The paper starts with the premise that macroprudential policy, along with microprudential supervision, is the first line of defence against the build-up of financial imbalances. It also recognises that the pursuit of price stability through monetary policy, and of financial stability through macroprudential policy, are to a large extent complementary. Nevertheless, macroprudential policy may not be able to ensure financial stability independently of monetary policy, because of spillovers originating from the common transmission channels through which the two policies produce their effects. For example, a low interest rate environment can create incentives to engage in more risk-taking, or can adversely impact the profitability of financial intermediaries and hence their capacity to absorb shocks. The paper argues that the existence of such spillovers creates a conceptual case for monetary policy to take financial stability considerations into account. It then goes on to discuss what this conclusion might imply in practice for the ECB. One option would be to exploit the flexible length of the medium-term horizon over which price stability is to be achieved. Longer deviations from price stability could occasionally be tolerated, if they resulted in materially lower risks for financial stability and, ultimately, for future price stability. ...