US Financial System Research Articles

A dominance test for measuring financial connectedness

This paper introduces a dominance test that allows to determine whether or not a financial institution can be classified as being more systemically important than another in a multivariate framework. The dominance test relies on a new risk measure, the ΔNetCoVaR that is specifically tailored to capture the joint extreme co-movements between institutions belonging to a network. The asymptotic theory for the statistical test is provided under mild regularity conditions concerning the joint distribution of asset returns which is assumed to be elliptically contoured. The proposed risk measure and risk measurement framework is used to analyse the US financial system during the recent Global Financial Crises. In the empirical analysis, the returns are assumed to be Elliptically Stable distributed and the estimation is carried out through the Sparse Multivariate Method of Simulated Quantiles, handling both the lack of an analytic expression for the probability density function and the potential high-dimensionality of the problem.

Economics, Equilibrium Methods, and Multi-Scale Modeling

In this paper, I draw a parallel between the stability of physical systems and that of economic ones, such as the US financial system. I argue that the use of equilibrium assumptions is central to the analysis of dynamic behavior for both kinds of systems, and that we ought to interpret such idealizing strategies as footholds for causal exploration and explanation. Our considerations suggest multi-scale modeling as a natural home for such reasoning strategies, which can provide a backdrop for the assessment and (hopefully) prevention of financial crises. Equilibrium assumptions are critical elements of the epistemic scaffolding that make up multi-scale models, which we should understand as a means of constructing explanations of dynamic behavior.

Tracking Financial Fragility

In constructing an indicator of financial fragility, the choice of which filter (or transformation) to apply to the data series that appear to trend in sample is often considered a technicality, but in fact turns out to matter a great deal. The fundamental assumption about the likely nature of observed trends in the data, for example, the ratio of credit to GDP, has direct effects on the measured gap or vulnerability. We discuss shortcomings of the most common filters used in the literature and policy circle, and propose a fairly simple and intuitive alternative - the local level filter. To the extent that validation will always be a challenge when the number of observed financial crises (in the US) is small, we conduct a simulation exercise to make the case. We also conduct a cross country analysis to show how qualitatively different the estimated credit gaps were as of 2017, and hence their policy implications in 29 countries. Finally, we construct an indicator of financial fragility for the US economy based on the view that systemic fragility stems mainly from high level of debts (among households and corporations) associated with high valuations for collateral assets (real estate, stocks). An indicator based on the local level filter signals elevated financial fragility in the US financial system currently, whereas the HP filter and the ten-year moving average provide much more benign readings.

ORGANIZED CRIME IN THE FINANCIAL SYSTEM: FOREIGN EXPERIENCE

The aim of the article is to analyse combating organized crime in the financial system of Ukraine and abroad; develop specific proposals to optimize the legislative provision of such activities on the basis of the study of positive foreign experience with a view to its further implementation into the relevant legal regulations of our state. The subject of the study is the interrogation of legal regulations of leading foreign countries that regulate the issue of combating organized crime in the financial sphere, the principles of the activities of these countries’ respective organizations aimed at counteracting organized crime in the financial system, as well as state mechanisms for countering organized crime in the US financial system, European and other countries. Methodology. The study is based on general scientific and special-scientific methods and techniques of scientific knowledge. The dialectical method enabled to formulate the definition and determine the essence of the subjects in the system of combating crime, as well as mechanisms of anti-shadowing of the Ukrainian economy. The normative-dogmatic method enabled to interpret the content of legal regulations of domestic legislation that regulate the issue of organized crime in the financial system. The comparative legal method enabled to compare doctrinal approaches to the issue of organized crime in the financial system of Ukraine and abroad. The same method was used to analyse legislation of foreign countries regarding the issue under the study. Methods of analysis and synthesis enabled to study individual units of the institute of organized crime in the financial system. The sociological method was used to evaluate the results of the survey, conducted among employees of the National Police of Ukraine, on the need to take into account foreign experience in counteracting organized crime in the financial system. The method of legal modelling allowed making proposals regarding the improvement of the institute for combating organized crime in the financial system of Ukraine. Practical implications. The analysis of foreign experience of police activity, as well as special bodies and organizations, in combating organized crime in the financial system, carried out on the basis of a comparative legal study of principles, provided for in the international legal documents and their use in the police activities of democratic states, determined the expediency of their implementation in the police activities of the bodies of the National Police of Ukraine. Relevance/originality. The study proved that the legal basis for combating organized crime in the financial system of the examined states is the constitution and national laws, as well as specialized legal regulations, which define the status, rights and duties, the responsibility of employees of special subjects in combating organized crime in the financial system. In addition, in foreign countries, competencies are clearly distributed between national and special authorities to exclude duplication of powers. In view of the proved necessity of creating an effective system of counteraction to organized crime in the financial system of Ukraine, positive foreign experience implementation can become the driving force to strengthen the rule of law and legal order in our state.

Financial Regulation: Still Unsettled a Decade After the Crisis

A decade after the darkest moments of the financial crisis, both the US financial system and the legal framework for its regulation are still in flux. The post-crisis regulatory framework has made systemically important banks much more resilient. They are substantially better capitalized and less dependent on runnable short-term funding. But the current regulatory framework does not deal effectively with threats to financial stability outside the perimeter of regulated banking organizations, notably from forms of shadow banking. Moreover, with the political tide having for the moment turned decisively toward deregulation, there is some question whether the resiliency improvements of the largest banks will be preserved. This article assesses the accomplishments, unfinished business, and outstanding issues in the post-crisis approach to prudential regulation.

To what extent the global financial crisis deteriorated loan quality of US commercial banks

This paper aims to study the extent to which the global financial crisis worsened the loan quality of US commercial banks. That is, we specify the factors behind non-performing loans with a focus on the effect of the crisis as an additional determinant. Thus, we use dynamic panel GMM estimation on three size groups of 184 US commercial banks over 2000-2013 period. Our findings show that bad loans in the three sub-samples are differently affected by the bank-specific and macroeconomic variables. Moreover, our results indicate that the crisis factor has a positive and statistically significant effect on non-performing loans of US banks with small ones being mostly influenced. This finding can be clarified by the policies of financial intervention that favoured larger banks so as to save the US financial system. Also, the diversification of large banks enables them to overcome the contagious crisis effect.

Editorial

Editorial

Managing Russia sanctions

Sanctions related to Russia continue to increase in volume and detail, bringing greater compliance complexity and cost. This paper focuses on US and EU sanctions. It looks at three aspects any company engaging in Russian-related business needs to consider. Understanding its Russian business in the sense of which parts of the company are doing business, with whom and about what; understanding the sanctions risks relating to its Russian business in the sense of which sanctions are in scope and what is prohibited; and lastly understanding the compliance challenges of its Russian business. The specific compliance challenges considered are banking arrangements, exposure to the US financial system, capital markets transactions, identifying sanctioned Russian individuals and entities, interacting with Russian clients, sectoral sanctions, US secondary sanctions and further sanctions. By taking account of these aspects, any company should be better placed to manage Russia sanctions rather than be managed by them.

A MacIntyrean Perspective on the Collapse of a Money Market Fund

This paper conducts an ethical analysis of the 2008 closure of a US money market fund entitled the reserve primary fund (RPF), which triggered the first run in the money market sector and a resultant liquidity crisis that harmed the entire US financial system. Although many academics and regulators have studied and written about RPF, the question whether the decision that caused the fund to collapse represented any ethical dilemma, has not been addressed to date. With this purpose in mind, the paper will examine the events that culminated in the closure of RPF according to Alasdair MacIntyre’s virtue ethics approach. In so doing, the paper aims to extend the applicability of MacIntyre’s concepts to the finance industry in general, and to provide a framework to predict and so potentially prevent crises like that exemplified by the RPF case.

Transatlantic Extraterritoriality and the Regulation of Derivatives: The Need for an Integrated Approach between Washington and Brussels, the Uncertainties of BREXIT and New Directions in the US

This paper examines the common approach reached between Commodities Future Trading Commission (CFTC) and the European Commission (EC) on derivatives regulation. The paper reviews issues resolved and explores the issues that remain which are leading to fragmentation of the $553tn global derivatives market. While many differences have been resolved, it would have been better for the markets had both the European Union [EU] and United States [US] adopted a collaborative approach when reforming derivatives after the Financial Crisis (2008). This decision of the EU and US to proceed separately and draw up their own respective versions of the over the counter [OTC] derivatives regulatory landscape was a misstep which affected the efficient operation of capital markets. The question now is whether co-operation between US and EU regulators can survive the disruption posed by Brexit and the Trump Administration and the new directions the UK and US might take in terms of derivatives regulation. The long-term effect that Brexit may have on the regulation of derivatives will depend on the new post-Brexit relationship that the UK and the EU agree upon. It is essential that the smooth functioning of the international derivatives trading market and the critical role that London plays as the global centre for Euro denominated clearing must continue without regard to whether a political agreement can be reached on the withdrawal of the UK from the EU. A discussion as to the post-Brexit role that the City of London should play in respect of Euro denominated clearing and the services the City performs for EU clearing members and trading venues needs to be had to give the EU the assurance it requires to have oversight over central counterparties (CCPs) operating in third countries (such as post-Brexit UK) that perform systematically important functions for EU clearing members and trading venues. In the US, if the Trump Administration can reform current CFTC regulation to reduce the extraterritorial impact that current US swaps trading rules have on non-US market participants, this could be beneficial to reduce the fragmentation that is occurring in the global swaps trading pool. It is encouraging to see CFTC Chairman Giancarlo propose implementing a two-tier system that would separate foreign jurisdictions into those that are “comparable” and those that are “non-comparable” in order to afford comparable jurisdictions greater control over their own regulatory matters so long as such matters do not pose a risk to the US financial system. However, such a reform will require Congress to act and they will look to what the EU is doing in respect of its European Market Infrastructure Regulation on derivatives, central counterparties and trade repositories (EMIR 2.2) reforms before committing the CFTC to reducing the control it asserts on non-US market participants. The role of European Security and Markets Authority (ESMA) and its plans to introduce EMIR 2.2 at this juncture will play a pivotal role in determining whether the possibility of further reducing the extraterritorial application of derivatives regulation globally will continue.

The Blind Monks and the Elephant: Contrasting Narratives of Financial Crisis

We explore three persuasive narratives of the US subprime crisis. First the role played by pecuniary externalities in amplifying shocks to the quality of risk‐assets held by Investment Banks; second is adverse selection in marketing these assets; and third is financial panic. Their relevance is attested by the emergency support provided by the US Federal Reserve Bank and Treasury; and by subsequent findings in courts of law. While these contrasting narratives illuminate different aspects of the crisis, we conclude it was because they all had a part to play that the US financial system was so exposed to radical failure.

The American Role in the Basel Committee on Banking Supervision: What Next?

The United States has clearly benefited from its post-WWII role as the leader of the international financial system. As the international financial system evolves towards a more multi-polar global system, a continuing leadership role by the United States is critical to promote the free market, democratic model that has provided those benefits. This requires that the United States maintain a prominent position in the BCBS and in all other international standard setting bodies. On the one hand, the strength of the US financial system, in part, is tied to the capacity of the US regulators and policymakers to influence the decision-making process of these international fora to produce standards and policies that are consistent with US policies and the health of US financial institutions. On the other hand, the United States must navigate a changing environment in which its former dominance will be questioned and new players will become more important. This will require an understanding both of the importance of these institutions to the liberal economic order and to the United States interests and the skill to promote the United States in the changing environment. The future will be created by the present, and the present depends on reliable leadership and engagement with the world. A vision of the national interest based on narrow transactional calculations could lead to an American abdication of its post-WWII role and the development of an international financial system that not only will fail to serve the world, but will impair the prosperity of the United States. The posture of the US Treasury to date gives cause for cautious optimism, but actions in other spheres give equal cause for concern.

Rationalizing Enforcement in the US Financial System

In the last decade, public enforcement of the laws governing the U.S. financial system has received widespread attention, but neither policymakers, academics nor private institutions have produced a comprehensive overview and assessment of the public enforcement system for the U.S. financial system. This Report, Rationalizing Enforcement of the U.S. Financial System (the “Report”), attempts to do just that. While we make recommendations aimed at improving aspects of the enforcement system, the primary purpose of this Report is to lay out a succinct description for the public, policymakers, and others about how the enforcement system works. The Report is divided into four chapters: Chapter 1: Enhancing the Structure of the U.S. Enforcement System – Improving Coordination and Procedural Fairness; Chapter 2: Rationalizing the Setting of Sanctions; Chapter 3: Ensuring Appropriate Use of Monetary Sanctions; and Chapter 4: Promoting Individual Accountability. Chapter 1 describes the highly-fragmented structure of the U.S. public enforcement system and the potential for overlapping enforcement actions by multiple agencies resulting from the same underlying misconduct. We also describe the lack of laws and policies mandating coordination, with the DOJ’s new anti-“piling on” policy being a recent exception, and separately, the discretion some agencies have to engage in forum shopping by unilaterally selecting the forum in which they bring enforcement actions. The chapter sets forth recommendations to formalize and standardize coordination policies and limit the ability of agencies to engage in forum shopping. Chapter 2 sets forth the laws, rules and policies that guide and constrain the setting of monetary sanctions in enforcement actions. We explain that agencies generally have vast discretion in setting sanctions because statutes and policies provide limited practical constraints. We recommend that agencies develop core principles or guideposts to avoid arbitrary, inconsistent and disproportionate penalties. We then describe the byzantine approach many agencies take to publicly disclosing information about enforcement action outcomes and present our own data analysis on monetary sanctions over a 17-year period. The chapter concludes with recommendations for enhancing transparency of enforcement action outcomes. Chapter 3 describes how monetary sanctions collected in enforcement actions are spent. In particular, the chapter describes the lack of public disclosure and sets forth recommendations to increase transparency and appropriately restrict the use of collected monetary sanctions. Chapter 4 explores the issue of individual accountability. We find that while the government has significant legal and investigative tools to identify and hold culpable individuals and firms accountable, it can face more significant challenges with respect to individuals. We set forth recommendations that we believe will better enable enforcement authorities and firms to work together to identify culpable individuals and build successful cases against them.

Donald Trumps Ziel, den „Sumpf trocken zu legen“. Zum US-Wirtschaftsaufschwung seit 2009

The current economic situation in the United States can be seen as the result of three factors. The first is the long-term shift to a neo-liberal order. The second factor is the US business cycle. Periods of economic expansion in the 1980s, the 1990s and the early 2000s were each brought to an end by increasingly severe crises, the most recent of which in 2007-2009 came perilously close to causing a collapse of the US financial system. The most recent expansion, which began in mid-2009, has been unusually weak, and is already relatively long by comparison with other recent expansions.The third factor is the presidency of Donald Trump which began in January 2017. Despite a populist rhetoric and the dependence of his electoral victory on mobilising white working-class support, in government he has pursued an unashamed series of measures which primarily benefit the very richest sectors of US society.

Pozycja w systemie władzy USA oraz zadania Rady ds. Monitorowania Stabilności Finansowej

Present article discusses some of the key issues introduced to the US federal law in 2010 to ensure the stability of the financial sector in the United States. Special attention was paid to two issues, i.e. the rules and procedures under which the FSOC may considered a non-banking finance company to be important from the point of view of stability of the US financial sector (and in such situation trigger supplementary supervision by the FRS) and the procedure for controlled liquidation of a financial company considered by the FSOC to be a risk to the stability of the US financial system.

A revisit to how linkages fuel dependent economic policy initiatives

PurposeThe authors aim to report empirical linkages between the US and Brazil, Russia, India and China (BRIC) financial stress indices catalyzing catalyzing dependent economic policy initiatives (an extended version of Singh and Singh, 2017a).Design/methodology/approachInitially, the study develops financial stress indices for the respective BRIC financial markets. Later, it captures linkages among the said US-BRIC indices by using Johansen cointegration, vector autoregression/vector error correction models (VECM), generalized impulse response functions, Toda–Yamamoto Granger causality, variance decomposition analyses and bivariate generalized autoregressive conditional heteroskedasticity (GARCH) model under constant conditional correlation framework, in general. Markov regime switching and efficient causality tests proposed by Hill (2007) are also used.FindingsOverall, there are both short-run and long-run dynamic interactions observed between the US and Indian financial stress indices. For rest of the markets, only short-run interactions are found to be in existence. The time-varying co-movement coefficients report financial contagion impact of the US financial crisis on Russian and Indian financial systems only. Contrary to this, Brazilian and Chinese financial systems are largely exhibiting interdependence with the US financial system. Efficient causality tests report indirect impact of the Russian financial system on Brazilian via auxiliary Indian financial system.Originality/valueThe present study is the first of its kind capturing linkages among the US-BRIC financial stress indices by using diverse econometric models. The results support different market participants and policymakers in understanding effectiveness and implementation of economic policies while considering their cross-market interactions as well.

Analyzing systemic risk using non-linear marginal expected shortfall and its minimum spanning tree

The aim of this paper is to propose a new theoretical framework for analyzing the systemic risk using the marginal expected shortfall (MES) and its correlation-based minimum spanning tree (MST). At first, we develop two parametric models of MES with their closed-form solutions based on the Capital Asset Pricing Model. Our models are derived from the non-symmetric quadratic form, which allows them to consolidate the non-linear relationship between the stock and market returns. Secondly, we discover the evidences related to the utility of our models and the possible association in between the non-linear relationship and the emergence of severe systemic risk by considering the US financial system as a benchmark. In this context, the evolution of MES also can be regarded as a reasonable proxy of systemic risk. Lastly, we analyze the structural properties of the systemic risk using the MST based on the computed series of MES. The topology of MST conveys the presence of sectoral clustering and strong co-movements of systemic risk leaded by few hubs during the crisis. Specifically, we discover that the Depositories are the majority sector leading the connections during the Non-Crisis period, whereas the Broker-Dealers are majority during the Crisis period.

Financial shocks, financial stability, and optimal Taylor rules

We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing an economy following financial shocks. The analysis is conducted in a DSGE model with loan and bond markets, each featuring financial frictions. This allows for a wide set of financial shocks and transmission mechanisms and can be calibrated to match the bond-to-bank finance ratio featured in the US financial system. Overall, we find that monetary policy that reacts to credit growth, a form of the so-called “leaning against the wind”, improves the ability of the central bank to achieve its mandate in the wake of financial shocks. The specific policy implications depend partly on the origin and the persistence of the financial shock, but overall not on the assignment of a mandate for financial stability in the central bank’s objective function.

How linkages fuel dependent economic policy initiatives

PurposeWith the globalization and liberalization in terms of increasing financial flows across the countries, the policy makers around the world are not independent in the context of monetary and fiscal policy initiatives. In this regard, this paper aims to attempt to quantify and capture long run, short run as well as time-varying linkages among the two financial stress indices, namely, Kansas City Financial Stress Index (KCFSI) and Indian Financial Stress Index (IFSI) across the monthly period (2004 to 2014).Design/methodology/approachOwing to the non-existence of a standardized financial stress index with regards to the Indian financial system, the study has developed an index/stress indicator using principal component analysis. Furthermore, to comprehend the linkages, the study uses bivariate Johansen cointegration model, vector error correction model, impulse response functions (IRF), variance decomposition analysis (VDA), Toda-Yamamoto’s Granger causality test and, finally, bivariate generalized autoregressive conditional heteroskedastic (BVGARCH) (1,1) model under constant conditional correlation (CCC) framework.FindingsThe results report a stochastic trend among the two indices wherein the US financial system acts as a source of a shock causing disequilibrium in the long run co-movement. About 40 per cent of the adjustments take place in one month and rest in the coming months. Both the IRF and VDA report a greater degree impact of the US financial stress on the Indian financial system. Moreover, there is a uni-directional short run causality running from the stress in the US financial system to the Indian financial stress. Furthermore, the co-movement between the US and Indian financial stress reached to its maximum significant level during the sub-prime crisis even confirmed by the Markov switching model results.Practical implicationsOverall, the results provide an insight to the financial market investors both domestic as well as international in their act of risk management. The financial stress prevailing in an economy further has an impact on different economic factors like foreign exchange rates, interest rates, yield curves, equity market returns and volatility. So, the empirical results support strong implications for the Indian policy makers as well as investors in the Indian financial markets.Originality/valueThe present study contributes to the literature in three senses. First, the study considers indices reflecting financial stress in the Indian as well as US financial system. Second, the study captures long run as well as short run linkages among the financial stress indices relating to a developed and an emerging market. Finally, the study uses CCC-BVGARCH (1,1) model to account for the time-varying co-movement among the financial stress indices. This helps in comprehending time-varying nature of the co-movement of the stress in the financial system prevalent in the respective markets.

Does US Financial Stress Explain Risk–Return Dynamics in Indian Equity Market? A Logistic Regression Approach

The present study attempts to capture the impact of the US financial stress on the risk–return dynamics in the Indian equity market by employing Markov regime switching and binary logistic regression model. The span of data ranges from 2004 to 2013. The study uses weekly closing local values of benchmark equity indices ‘CNX Nifty 50 and S&P 500’ and St. Louis Fed Financial Stress Index (SFSI). The said index captures stress in the US financial system on a weekly basis. The Markov results support the existence of ‘Bull’ regime as well as ‘Bear’ regime in the Indian equity market. Corresponding to this, the logistic regression model indicates a positive impact of the US financial stress on the probability for the existence of bear regime. Particularly, the probability for the existence of bull regime approaches zero, when the stress in the US financial system crosses the level of two. The results support strong implications for the investors in the Indian equity market against the stress in the US financial system.