Non-banking Sector Research Articles

Redesigning the Contours of the Future Financial System

This paper explores the private- and public-sector responses to the crisis and some of the probable outcomes. Aside from improved supervision of individual institutions, greater emphasis needs to be put on financial regulations that reflect the systemic nature of financial risks and the role that macroeconomic policies play. Global consistency of regulation and financial sector taxation will be essential to mitigate systemic risks, avoid unintended distortions, and help ensure a level playing field. This note suggests the key aspects of the future contours will likely be: ? Banks are expected to return to their more traditional function as stricter regulation will limit the risks and activities they can undertake. ? The nonbanking sector will likely have a greater competitive advantage—both in supplying credit and providing investors with nonbank services—and will thus grow. ? The perimeter of regulation will need to expand to take into account risks in the nonbank sector. ? Market infrastructure will be reinforced to protect investors and will need to provide simplicity and transparency to make risks clearer and the financial system safer. ? The global financial system is likely to be smaller and less levered than in the recent past, and could well be less innovative and dynamic, at least for a while.

What Can the Data Tell Us About Carry Trades in Japanese Yen?

This paper examines the available data that may shed light on the carry trade in Japanese yen. We define an individual or a sector to be engaged in the carry trade if it has a short position in yen and a long position in other currencies. The tendency of large yen movements to be skewed toward appreciations is consistent with the existence of substantial carry positions, and other evidence from market prices provides some modest support for an effect from the carry trade. Data on bank loans and bond holdings by currency reveal a large apparent yen carry position of the Japanese official sector and modest carry positions in the Japanese and foreign banking sectors. The Japanese private non-banking sector has a large long foreign-currency position, but does not have a short yen position, and is thus not engaged in the yen carry trade in the aggregate. However, it is possible that exporters and investors in Japan use the derivatives markets to hedge some of their long foreign-currency exposure, with the private non-banking sector outside of Japan (including most hedge funds) likely to be taking on most of the associated carry exposure.

What Can the Data Tell Us about Carry Trades in Japanese Yen?

This paper examines the available data that may shed light on the carry trade in Japanese yen. We define an individual or a sector to be engaged in the carry trade if it has a short position in yen and a long position in other currencies. The tendency of large yen movements to be skewed toward appreciations is consistent with the existence of substantial carry positions, and other evidence from market prices provides some modest support for an effect from the carry trade. Data on bank loans and bond holdings by currency reveal a large apparent yen carry position of the Japanese official sector and modest carry positions in the Japanese and foreign banking sectors. The Japanese private non-banking sector has a large long foreign-currency position, but does not have a short yen position, and is thus not engaged in the yen carry trade in the aggregate. However, it is possible that exporters and investors in Japan use the derivatives markets to hedge some of their long foreign-currency exposure, with the private non-banking sector outside of Japan (including most hedge funds) likely to be taking on most of the associated carry exposure.

Modelling the central bank repo rate in a dynamic general equilibrium framework

This paper incorporates two components of a modern monetary system into a standard real business cycle model: a central bank which lends reserves to commercial banks and charges a repo interest rate; and banks which make loans under a fractional reserve system and thereby create money. We examine the response of our model to shocks in the monetary base, in the currency–deposits ratio and in the required reserve ratio. Our main finding is that all these monetary shocks lead to changes in the composition of total investment between the banking and the non-banking sectors.

Technological Innovations and the Interest Rate

We build a dynamic general equilibrium model that adds a banking sector to the standard RBC model. We look at the response of the real interest rate to innovations in the banks' technology and in the nonbank firms' technology. While technological innovations in the nonbanking sector put upward pressure on the interest rate, technological innovations in banks exert downward pressure on the interest rate. This implies that, if the technological innovations in banks are strong enough, stochastic simulation experiments generate negative correlations between the real interest rate and current and future values of real output. This is especially significant because negative correlations between the interest rate and output are a key post-war U.S. business cycle fact difficult to replicate in benchmark dynamic models.

The Evidence on Product-Market Diversifying Acquisitions and Joint Ventures by U.S. Banks

We examine the acquisition and joint venture strategies of U.S. banks from 1980 to 1998 to diversify into non-banking sectors. We find that the market responds favorably to both types of expansions, with the gains being shared between acquiring banks and their targets and venture banks and their non-bank partners, respectively. Acquisitions expose acquiring banks to significant increases in nonsystematic, market, and total risk, while joint ventures result in significant decreases in the nonsystematic and total risk measures for participating banks. Our results suggest that product-market expansions, in general, provide U.S. banks with value-enhancing opportunities, and that joint ventures may improve both the return and risk characteristics of the partner banks.

Macroeconomic Fluctuations and Bank Lending: Evidence for Germany and the Euro Area

This paper analyzes how bank lending to the private nonbank sector responds dynamically to aggregate supply, demand and monetary policy shocks in Germany and the euro area. The results suggest that the dynamic responses in the two areas are broadly similar, although there are some differences in the relative contribution of the three shocks to the development of output, prices, interest rates and bank loans over time. In order to assess the role of bank lending in the transmission of macroeconomic shocks, we perform counterfactual simulations and analyze the dynamic responses of German loan sub-aggregates in order to test the distributional implications of potential credit market frictions. The results suggest that there is no evidence that loans amplify the transmission of macroeconomic fluctuations or that a financial accelerator via bank lending exists.

Macroeconomic Fluctuations and Bank Lending: Evidence for Germany and the Euro Area

This paper analyzes how bank lending to the private nonbank sector responds dynamically to aggregate supply, demand and monetary policy shocks in Germany and the euro area. The results suggest that the dynamic responses in the two areas are broadly similar, although there are some differences in the relative contribution of the three shocks to the development of output, prices, interest rates and bank loans over time. In order to assess the role of bank lending in the transmission of macroeconomic shocks, we perform counterfactual simulations and analyze the dynamic responses of German loan sub-aggregates in order to test the distributional implications of potential credit market frictions. The results suggest that there is no evidence that loans amplify the transmission of macroeconomic fluctuations or that a bank lending channel exists.

The Determinants of Private Sector Credit in Industrialised Countries: Do Property Prices Matter?

Episodes of boom and bust in credit markets have often coincided with cycles in economic activity and property markets. The coincidence of these cycles has already been widely documented in the literature, but few studies address the issue in a formal way. In this study we analyse the determinants of credit to the private non-bank sector in 16 industrialised countries since 1980 based on a cointegrating VAR. Cointegration tests suggest that the long-run development of credit cannot be explained by standard credit demand factors. But once real property prices, measured as a weighted average of real residential and real commercial property prices, are added to the system, we are able to identify long-run relationships linking real credit positively to real GDP and real property prices and negatively to the real interest rate. These long-run relationships may be interpreted as long-run extended credit demand relationships, but we may also capture effects on credit supply. Impulse response analysis based on a standard Cholesky decomposition reveals that there is significant two-way dynamic interaction between bank credit and property prices. We also find that innovations to the short-term real interest rate have a strong and significant negative effect on bank credit, GDP and property prices.

English commercial bank liquidity, 1860–1913

This article presents new half-yearly time series for the asset ratios of commercial banks in England and Wales, 1860-1913. The series reveal new evidence on the nature of the banks' business and are, therefore, relevant to the debate on the role of banks in British economic development. The new estimates are used to examine trends and short-term changes in bank liquidity. Analysis is concerned with the changing stability of bank asset structure and with substitutability across different asset ratios. The main finding is of a sharp, long-term increase in liquidity and a concomitant decline in bank credit to the non-bank, private sector. The article also highlights the significance of short-term shocks to the trend increase in bank liquidity. The new findings are supportive of the argument that, over time, English banks became less involved with the non-bank private sector. In general, the results confirm that the English and Welsh bank asset structure became more liquid over time. However, no detailed breakdown of bank loans to the non-bank, private sector (for example, between business loans and personal loans), is available for this period. Moreover, the current study offers no evidence as to the trend in financial provision to the business sector from institutions other than the commercial banks. Nevertheless, the results are clear in showing a strong upward trend in commercial bank liquidity and a relative decline in private sector credit provision by the commercial banks.

Czech Republic: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Monetary and Financial Policy Transparency; Banking Supervision; Insurance Regulation; Securities Regulation; Corporate Governance; and Payments Systems

The resilience of the Czech financial system to macroeconomic shocks and structural weaknesses has strengthened considerably as a result of recent reform efforts. Stress tests indicate that the Czech banking system now shows only moderate vulnerability to market and credit risks. To enable more effective monitoring of the activities of integrated firms and markets, coordination and cooperation between supervisory agencies requires strengthening. Regarding the nonbanking sectors, the adoption of the mutual fund model for pension funds would improve transparency, and needs to be implemented as soon as possible.

Money demand and stabilisation in Zimbabwe

During the 1980s the potential instability of Zimbabwe's unsustainably high budget deficit was reduced by the smooth transfer of resources from the private to the public sector via the domestic financial system, which affected private demand for financial assets. Import, exchange and price controls operated to suppress private-sector demand. This led to the build-up of private savings, which was on-lent to the government via liquid asset requirements and the crowding out of domestic deposits in the nonbank private sector's portfolio by government securities. This article uses Johansen's procedure for analysing cointegration to model the demand for real money balances in Zimbabwe, in order to determine the extent to which these constraints on the domestic asset market suppressed the demand for money in Zimbabwe.

A structural VARMA approach to modelling the money supply process

A conceptual framework for research on the money supply process is presented and illustrated with empirical multivariate time series analyses of the Spanish case in monthly data from 1964 to 1990. Existing behavioural distinctions between monetary authority, private banking and private nonbanking sectors are employed, and these are formulated within a general, linear, nonexplosive, invertible multivariate stochastic process for the components of money multipliers. Behavioural distinctions are thus drawn directly in a very general, though empirically accessible, dynamic and stochastic framework. Identification hypotheses are suggested, allowing for a usable behavioural interpretation. The illustrative empirical work for the Spanish case reveals various directions in which the theoretical generality is relevant in practice.

A Model of Private Bank-Note Issue

A random-matching model (of money) is formulated in which there is complete public knowledge of the trading histories of a subset of the population, called the banking sector, and no public knowledge of the trading histories of the complement of that subset, called the nonbank sector. Each person, whether a banker or a nonbanker, is assumed to have the technological capability to create indivisible, distinct, and durable objects called notes. If outside money is indivisible and sufficiently scarce, then an optimal mechanism is shown to have note issue and note redemption (destruction) by members of the banking sector.Journal of Economic LiteratureClassification Numbers: E40, E42.

Long- and short-run demand for currency by the non-bank private sector

A study of the demand for currency which differs in two ways from other studies is reported. First, the long-run demand is specified solely as a function of a transactions variable unlike other studies which typically include the rate of interest in its long-run function. The reason for this specification stems from the fact that cointegration tests reject the interest rate variable as a long-run determinant of the demand for currency. Second, this study does not assume a constant speed of adjustment in the short-run demand equation. Instead, the empirical analysis supported the hypothesis that the role of the rate of interest is to influence the demand for currency in the short run, by affecting the speed at which actual stocks adjust to their long-run levels.

The market valuation effects of reserve regulation

We demonstrate that the financial market's reaction to changes in reserve regulation implies that reserve requirements are an excise tax on banking activities. Changes in reserve requirements do not influence yields on Treasury securities or returns on broad-based portfolios of nonfinancial stocks and thus do not impound new information about monetary policy. Moreover, changes in reserve requirements have an impact on nonbank financial firms that is opposite in sign to that of banks. This suggests that reserve requirements shift the locus of some financial activities from the banking sector to the nonbank sector of the financial system.

FINANCIAL TRANSACTIONS WITHIN BANK HOLDING COMPANIES

AbstractThis study explores financial transactions within bank holding companies in both a theoretical and an empirical context. Empirical analysis focuses on two major types of interaffiliate financial transactions—extensions of credit and transfers of assets—between holding company banks and their nonbank affiliates (defined to include the parent company and nonbank subsidiaries of the parent) over the period 1976–1980. The data generally point to a net downstream flow of funds from the nonbank sector to the bank sector of a holding company, with the downstream fund flows particularly strong in the case of extensions of credit. In part, this result may reflect the statutory restrictions on bank lending to affiliates, particularly the collateral requirements.

Payments Systems: Theory and Policy

The goal of this paper is to provide a simplified financial framework for examining a number of theoretical and policy issues raised by the existence and operation of interbank payments arragements. To this end, payments arrangements are assumed to be embedded in an exogenous, real sector. The organization of payments activities, including their risks, is examined under increasingly general assumptions about the process of transferring payment from one agent in the nonbank sector to another. The most general framework presented in this paper consists of a multibank economy with trade and bank credit. The framework developed is inteded for the analysis of payments arrangements in which transactions costs, information costs, and capital market imperfections significantly affect behavior.

A Model of the Demand for British Government Stocks by Non-Bank Residents 1967-77

This paper develops an econometric model of the demand for gilt-edged securities and other long term public sector debt by the non-bank private sector. We chose to work initially at this high level of sectoral aggregation since it is the one most commonly used in studies of the demand for money and the term structure of interest rates. The high level of aggregation permits comparisons with earlier work and also allows alternative theoretical hypothesies to be tested in a straightforward way. We started out by testing the simplest of these alternatives - the so called 'Expectations Hypothesis'. This suggests that the difference between the observed yields on short and long term bonds equals the capital gain expected on the latter. (See for example Roll (I970), p. 36 n.) The immediate empirical implication of this theory is that differences in these returns which are observed ex post, taking into account capital gains, are unexpected and therefore should not be systematically related to variables which are observable ex ante. However our work showed that such ex post relationships could be found suggesting that a more general hypothesis was necessary to describe the data. An alternative approach is to attempt to estimate the demand function in some appropriate way. The usual method, following the original work of Modigliani and Sutch (I966) is to invert the demand function and explain the yield gap in terms of expected capital gains and relative asset supplies. However such models of the term structure are only valid econometrically if the supply variables are in fact exogenous, an assumption which is unlikely to have been true in the United Kingdom. Moreover, Rowan and O'Brien (I970) have shown that a proper application of this approach should involve the imposition of a set of structural restrictions. These have an important influence on the results but are usually disregarded at the empirical stage. In order to avoid these problems we chose to estimate the demand function directly, using instrumental variables to handle interest rates and other current endogenous variables. Previous models of the term structure have assumed an autoregressive expectations formation process and allowed for this by introducing lagged interest rate terms directly into the regression. However, the resulting estimates * This model was originally developed for use in the financial sector of the Treasury macro model (Spencer and Mowl, 1978). I am grateful to Peter Middleton, Colin Mowl, Steven Bell and other colleagues for encouragement and helpful advice. The paper has benefited from comments by David Hendry, John Flemming, Marcus Miller and other members of the Treasury's academic panel as well as the referees of this JOURNAL. The views expressed in this paper are those of the author and not necessarily those of the Treasury.

An application of duality theory: A portfolio composition of the West-German private non-bank sector, 1968–1975

The objective of this paper is to apply the duality approach in the theory of consumer behavior for deriving demand systems to analyse the allocation of assets and liabilities of the private non-bank sector. A commodity approach is chosen where service flows of assets, physical capital and liabilities enter the direct utility function and the corresponding interest rates and price of capital enter the indirect utility function. The approach results in a system of demand and supply functions for optimal stocks consistent with utility maximization. For econometric implementation an overall model in an asset aggregate, capital and a liability aggregate is fitted first. Next, two submodels are constructed for an optimal allocation of the asset aggregate and the liability aggregate to its various components that made up the aggregate. Empirical results for time series data of the German private non-bank sector are presented.