High-quality Assets Research Articles

Persuading Multiple Audiences: An Information Design Approach to Banking Regulation

A policy-maker concerned with the potential default of a bank conducts an asset quality review and a liquidity stress test under the scrutiny of multiple types of market participants (audiences). Surprisingly, the optimal comprehensive assessment is opaque when the bank has high-quality assets, and transparent when the bank has poor-quality assets. Additionally, the policy-maker imposes debt buybacks and contingent recapitalizations. I find that without the latter, disclosure of information about the bank's fundamentals may backfire. When the policy-maker lacks the technology to test the bank's private information, she designs a liquidity-provision program whereby the government offers to buy assets from the bank in exchange for cash and a public disclosure of the bank's liquidity position. Interventions display a non-monotone pecking order: the private sector funds banks with either high or poor-quality assets, while institutions with assets of intermediate quality participate in the government's liquidity program. My results shed light on the optimal way to disclose information in environments with multiple audiences and multi-dimensional fundamentals.

Liquidity Regulation and Financial Intermediaries

We document several effects of the Liquidity Coverage Ratio (LCR) rule on dealers' financing and intermediation of securities. For identification, we exploit the fact that the US implementation is more stringent than that in foreign jurisdictions. In line with LCR incentives, US dealers reduce their reliance on repos as a way to finance inventories of high-quality assets and increase the maturity of lower-quality repos relative to foreign dealers; additionally, US dealers cut back on trades that downgrade their own collateral. Dealers are nevertheless still providing significant maturity transformation. We also show that significant de-risking occurs immediately after the 2007-09 crisis, before post-crisis regulations.

Confidence banking and strategic default

Securitization relies on confidence. As securities are tied to a particular asset (or pool of assets), and investors lose when the asset defaults, the security issuer usually provides further coverage by promising to use the proceedings from other, non-securitized, assets. Although these promises are difficult to enforce, the issuer may still have incentives to strategically avoid default in order to build a reputation of holding high-quality assets. Confidence makes securitization more dependent on the issuer’s reputation than other forms of financing and more volatile to forces behind reputation concerns, such as expectations about future profits.

Undefeated equilibria of the Shi–Trejos–Wright model under adverse selection

Decentralized markets where assets are useful as media of exchange are also usually subject to private information. To analyze the liquidity and prices of such assets, I adapt the Shi (1995), Trejos and Wright (1995) model with Lucas trees under adverse selection. While most studies focus on either a pooling or separating equilibrium, I apply the undefeated equilibrium refinement by Mailath et al. (1993) to make the selection based on fundamentals. Under pooling, the high-quality asset holder accepts a pooled price, and under separating signals quality through asset retention. Applying the refinement results in a regime switch from no-information (pooling) to information revelation (separating) following a negative shock to the quality or quantity of lemons. This change leads to a discontinuous fall in aggregate welfare.

Liquidity Regulation and Financial Intermediaries

We document several effects of the Liquidity Coverage Ratio (LCR) rule on dealers' financing and intermediation of securities. For identification, we exploit the fact that the US implementation is more stringent than that in foreign jurisdictions. In line with LCR incentives, US dealers reduce their reliance on repos as a way to finance inventories of high-quality assets and increase the maturity of lower-quality repos relative to foreign dealers; additionally, US dealers cut back on trades that downgrade their own collateral. Dealers are nevertheless still providing significant maturity transformation. We also show that significant de-risking occurs immediately after the 2007-09 crisis, before post-crisis regulations.

Pengaruh Likuiditas Dan Kualitas Aset terhadap Profitabilitas pada Bank Umum Nasional (Studi pada Bursa Efek Indonesia Periode 2010-2014)

This study exmines the factors that affect the profitability of the national commercial banks. This study used data 32 commercial banks that go pulic in Indoesia Stock Exchange period 2010-2014. Sampling was done by purposive sampling method. This study used multiple linear regression analysis using SPSS 20. Independent variable of this study is Liquidity (LDR) and Asset Quality (NPL).The results of the study explain that Liquidity is a positive effects on Profitability. Liquidity be a measure of the success a bank to obtain high profitability. The lower the LDR reflects the bank has not been able to optimize third-party funds (DPK), which will be distributed to customers as a credit. Asset Quality negatively affect Profitability. High-Quality assets in a bank means more credit problems experienced by banks and will result in losses in the bank.

Adverse Selection with Heterogeneously Informed Agents

A model of over-the-counter markets is proposed. Some asset buyers are informed in that they can identify high-quality assets. Heterogeneous sellers with private information choose what type of buyers they want to trade with. When the measure of informed buyers is low, there exists a unique and stable equilibrium, and interestingly, price, trading volume and welfare typically decrease with more informed buyers. When the measure of informed buyers is intermediate, multiple equilibria arise, and price, trading volume and welfare may decrease or increase with more informed buyers depending on the equilibrium being played. A switch from one equilibrium to another can lead to large drops in liquidity, price, trading volume and welfare, like a financial crisis. The measure of informed buyers is then endogenized by allowing buyers to invest in a technology that enables them to identify high-quality assets. In this case, the model features endogenous strategic complementarity in acquiring the information technology. Multiple equilibria still exist, with different measures of informed buyers, but a scheme of tax/subsidy on information acquisition sometimes leads to the unique equilibrium.

How to Stabilize the Banking System: Lessons from the London Money Market

This paper argues that the British financial system in the era prior to World War I provides modern policymakers with a successful model of how to stabilize the banking system. This model had two components: incentives were structured to ensure that all banks that originated or traded assets on the money market sought only to trade in high-quality assets, and macro-prudential regulation promoted the segregation of money markets from capital markets, monitored the growth of money market credit, and restricted trade on the money market in assets issued by entities and sectors whose money market liabilities were growing so fast that the most reasonable explanation was that the money market was being used to finance longer-term investment. These facts indicate that policymakers can successfully stabilize the banking system through a combination of structural reform and regulation of the growth of credit.

How to stabilize the banking system: lessons from the pre-1914 London money market

This article argues that the British financial system in the era prior to World War I provides modern policymakers with a successful model of how to stabilize the banking system. This model had two components: incentives were structured to ensure that all banks that originated or traded assets on the money market sought only to trade in high-quality assets; and macro-prudential regulation promoted the segregation of money markets from capital markets, monitored the growth of money market credit, and restricted trade on the money market in assets issued by entities and sectors whose money market liabilities were growing so fast that the most reasonable explanation was that the money market was being used to finance longer-term investment. These facts indicate that policymakers can successfully stabilize the banking system through a combination of structural reform and regulation of the growth of credit.

Savings Gluts and Financial Fragility

We investigate the effects of an increase in liquidity (a glut ) on the incentives to originate high quality assets, and on the fragility of the financial sector. Originators incur private costs when originating high quality assets. Assets are subsequently distributed in two markets: A private market where informed intermediaries operate, and an exchange where uninformed investors trade. Uninformed investors pay the same price irrespective of the quality of the assets, which discourages good origination. Informed investors identify and pick the best assets by offering a premium over the uninformed price, which encourages originators to supply good assets. We show that there is a positive origination effect of an increase in savings of uninformed investors when the overall level of savings is low, but the opposite is true when liquidity is abundant, so that an increase in savings has a non-monotone effect on origination incentives. Leverage increases monotonically with savings and is highest precisely when incentives for good asset origination are at their lowest. Thus plentiful liquidity leads to fragile balance sheets: On the asset side non-performing assets accumulate and on the liability side more of those assets are funded with debt. We relate our findings to some of the stylized facts observed in financial markets in the lead up to the Great Recession.

CCPs and network stability in OTC derivatives markets

Among the reforms to OTC derivative markets since the global financial crisis is a commitment to collateralize counterparty exposures and to clear standardized contracts via central counterparties (CCPs). The reforms aim to reduce interconnectedness and improve counterparty risk management in these important markets. At the same time, however, the reforms necessarily concentrate risk in one or a few nodes in the financial network and also increase institutions’ demand for high-quality assets to meet collateral requirements. This paper looks more closely at the implications of increased CCP clearing for both the topology and stability of the financial network. Building on Heath et al. (2013) and Markose (2012), the analysis supports the view that the concentration of risk in CCPs could generate instability if not appropriately managed. Nevertheless, maintaining CCP prefunded financial resources in accordance with international standards and dispersing any unfunded losses widely through the system can limit the potential for a CCP to transmit stress even in very extreme market conditions. The analysis uses the Bank for International Settlements Macroeconomic Assessment Group on Derivatives (MAGD) data set on the derivatives positions of the 41 largest bank participants in global OTC derivative markets in 2012.

The Paradox of Financial Fire Sales

How can fire sales for financial assets happen when the economy contains well-capitalized, but non-specialist investors? Our explanation combines rational expectations equilibrium and lemons models. When specialist (informed) market participants are liquidity-constrained, prices become less informative. This creates an adverse selection problem, decreasing the supply of high-quality assets, and lowering valuations by non-specialist (uninformed) investors, who become unwilling to supply capital to support the price. Arbitrage capital can multiply itself by making uninformed capital function as informed capital in normal times, but this stabilizing mechanism fails during a crisis.

Eurosystem Collateral Policy and Framework — Post-Lehman Time as a New Collateral Space

Collateral plays a central role in monetary policy. In recent years, its importance has increased as uncollateralised inter-bank borrowing has gradually been replaced by collateralised central bank lending. This has in turn affected collateral availability and the need for high-quality assets. The European Central Bank has reacted to this development by creating a series of different measures to broaden collateral availability, including changing the eligibility rules (e.g. reducing rating thresholds for certain asset classes) or extending the eligible assets (e.g. allowing national central banks to accept bank loans as collateral). In the context of these developments, this article assesses and comments on various aspects of the Eurosystem collateral policy and overall framework. In particular, it examines the economic implications of the current ECB collateral policy for asset allocation and relative asset price developments from a cross-country perspective.

Managing markets for toxic assets

A model in which banks trade toxic assets to raise funds for investment is analyzed. Toxic assets generate an adverse selection problem and, consequently, the interbank asset market provides insufficient liquidity. Investment is inefficiently low because acquiring funding requires banks to sell high-quality assets for less than their “fair” value. Equity injections reduce liquidity and may be counterproductive as a policy for increasing investment. Paradoxically, if it is directed to firms with the greatest liquidity needs, an equity injection will reduce investment further. Asset purchase programs, like the Public–Private Investment Program, often have favorable impacts on liquidity, investment and welfare.

Covered Bonds Regulatory Update: The Good, the Bad, and the United States

While covered bond regulation has been stalled in the United States, partly because of concerns raised by the U.S. Federal Deposit Insurance Corporation (FDIC), an increasing number of non-U.S. covered bond issuers have considered accessing the U.S. market through SEC-registered covered bonds, and regulators outside of the United States have increasingly moved toward more comprehensive regulation of covered bonds. New regulatory regimes seem to create tension between regulatory incentives to purchase and hold covered bonds as high-quality assets and significant limitations on their issuance. This article explores these themes, first discussing the new covered bond legislation in Canada, which illustrates the move from a relatively unregulated system to a heavily regulated system. The article then discusses regulatory developments outside of North America, which exemplify the tension that may be created by new regulatory systems. The article explores recent legislations limiting covered bond issuance as a source of asset encumbrance and then examines CRD IV and Solvency II, two regulatory reforms that incentivize banks and insurers to acquire and to retain covered bonds. <b>TOPICS:</b>Fixed income and structured finance, legal/regulatory/public policy, developed

Basel III and Asset Securitization

Asset securitization via special purpose entities involves the process of transforming assets into securities that are issued to investors. These investors hold the rights to payments supported by the cash flows from an asset pool held by the said entity. In this paper, we discuss the mechanism by which low- and high-quality entities securitize low- and high-quality assets, respectively, into collateralized debt obligations. During the 2007–2009 financial crisis, asset securitization was seriously inhibited. In response to this, for instance, new Basel III capital and liquidity regulations were introduced. Here, we find that we can explicitly determine the transaction costs related to low-quality asset securitization. Also, in the case of dynamic and static multipliers, the effects of unexpected negative shocks such as rating downgrades on asset price and input, debt obligation price and output, and profit will be quantified. In this case, we note that Basel III has been designed to provide countercyclical capital buffers to negate procyclicality. Moreover, we will develop an illustrative example of low-quality asset securitization for subprime mortgages. Furthermore, numerical examples to illustrate the key results will be provided. In addition, connections between Basel III and asset securitization will be highlighted.

CDS and the Liquidity Provision in the Bond Market

We study the effect of credit default swap (CDS) on the corporate bond market. We argue that CDS, by reducing the need of investors to liquidate the bonds in the face of credit deterioration of the issuer, reduces fire sale risk and provides bond liquidity. Given that bond investors are segmented by regulation – i.e., insurance companies, banks, and pension funds are subject to the risk-based capital requirements and in principle only hold high quality assets, – we expect the liquidity provision role of CDS to be concentrated among investment grade bonds. We test this hypothesis using a comprehensive sample of US corporate bonds with CDS contracts information over the 2001-2009 period. We show that the presence of CDS reduces yield spreads and increases liquidity for investment grade bonds. This effect is stronger during the financial crisis period. We provide a proper instrumental variable identification that pins down the need for CDS contracts by exploiting the level of loan concentration of the banks which the bond issuer borrows from. We also examine two events that have been shown to trigger forced sales by bond investors: bond rating downgrades from investment grade to high yield, and the selling pressure of property insurance companies following Hurricane Katrina. In both cases, the presence of CDS contracts lowers the impact of fire sales by reducing the drop in bond liquidity and the rise in yield spreads. Our results have important normative implications, as they suggest that – at least for the class of investment grade bonds – CDS may actually help to reduce risk contagion around financial crises.

The Move Toward Risk Retention for Sponsors of Asset Backed Securities

This paper will analyze the changes proposed by Dodd Frank's requirement for risk retention by sponsors of asset backed securities and consider the effect of the changes on reducing moral hazard problems for originators that previously had no “skin in the game.” The goal of the paper is to determine whether this shift in the law away from rating agencies and toward risk retention properly creates a safer market for securitized assets. There are three main concerns. First, is it necessary to reduce reliance on rating agencies? Second, if the law does reduce reliance on rating agencies, will the new proposals for risk retention create the proper incentives for sponsors to securitize only high quality assets? Finally, should there be exceptions to risk retention, and if so, how should the exceptions be defined?

Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality

We develop a dynamic equilibrium model of asset markets with adverse selection. There exists a unique equilibrium in which better quality assets trade at higher prices but with a lower price-dividend ratio in less liquid markets. Sellers of high-quality assets signal quality by accepting a lower trading probability. We show how the distribution of sellers' private information affects an asset's price and liquidity, how a change in that distribution can cause a fire sale and a flight to quality, and how asset purchase and subsidy programs may raise prices and liquidity and reverse the flight to quality. (JEL D82, G12)

VEDANTA Resources PLC: Whose Development is it Anyway?

VEDANTA Resources PLC is a London-based multi-national enterprise whose vision is to be a world-class, diversified resources company providing superior returns to its shareholders with high quality assets, low cost operations, and sustainable development. While it may be difficult to argue with the intent of the first two objectives, many questions have arisen regarding sustainable development. The company’s operations have been steeped in controversy on a wide range of parameters. Surprisingly, this is true of the company’s operations across different locations. This case examines the rise of the company from a small-time trading company to a conglomerate operating in five continents, and the manner in which the avowed objectives have been sought to be achieved, along with contrarian viewpoints expressed by other stakeholders.