Banking Liquidity, Failures, and Rescues
Featured Piece
In an op-ed, Prof. Yakov Amihud outlines How to stabilize Indian banks.Excerpt from the Economic Times -- "The government ownership in these banks is nearly 60%. Usage of coercive rights means that the government will be able to reduce its contribution to less than Rs 7,500 crore while retaining its ownership share intact, with the remaining amount in excess of Rs 5,000 crore coming from public shareholders."
In the Media
Stabilising Indian Banks through Coercive Rights, Yakov Amihud, T Sabri Oncu, The Economic Times, January 24, 2013.“How to Reduce Risk on Wall Street? Make the Banks Pay,” Matthew Richardson, Nouriel Roubini, The Washington Post, April 11, 2010.
“Making Sense of Obama’s Bank Reform Plans,” by Professors Viral Acharya, Matthew Richardson, Vox, January 24, 2010.
“Obama’s bank plan is a start,” by Professors Viral Acharya, Matthew Richardson, FT.com, January 22, 2010.
“Insolvent Banks should feel Market Discipline,” Matthew Richardon, Nouriel Roubini, Financial Times, May 6, 2009.
“We Can’t Subsidize the Banks Forever,” Matthew Richardson, Nouriel Roubini, Wall Street Journal, May 5, 2009.
“Give Credit to Timothy Geithner New Toxic Asset Plan,” Matthew Richardson, Nouriel Roubini, Daily News, March 24, 2009.
“There’s Virtue in Geithner’s Vague Bank Plan,” Matthew Richardson, Nouriel Roubini, Wall Street Journal, February 18, 2009.
“Nationalize the Banks! We’re all Swedes Now,” Matthew Richardson, Nouriel Roubini, The Washington Post, February 15, 2009.
“Expect Even More Shadow Banking Losses,” by Professors Viral Acharya, Phillipp Schnabl, Forbes.com, February 3, 2009.
“Formula for Fiscal Fitness,” David Backus, Matthew Richardson, Nouriel Roubini, NY Post, January 15, 2009.
“Getting Healthy Banks to Buy Troubled Ones,” by Professors Viral Acharya, FT.com, October 13, 2008.
Books
Bailouts or Bail-ins? Responding to Financial Crises in Emerging Economies, Nouriel Roubini, Brad Setser 2004.International Financial Crises and the New International Financial Architecture, Nouriel Roubini, Marc Uzan, 2004.
Papers
ABSTRACT (Click Here for Paper)
We analyze asset-backed commercial paper conduits, which experienced a shadow-banking “run” and played a central role in the early phase of the financial crisis of 2007-09. We document that commercial banks set up conduits to securitize assets worth $1.3 trillion while insuring the newly securitized assets using explicit guarantees. We show that regulatory arbitrage was the main motive behind setting up conduits: the guarantees were structured so as to reduce regulatory capital requirements, more so by banks with less capital, and while still providing recourse to bank balance sheets for outside investors. Consistent with such recourse, we find that conduits provided little risk transfer during the “run”: losses from conduits remained with banks rather than outside investors and banks with more exposure to conduits had lower stock returns.
We analyze asset-backed commercial paper conduits, which experienced a shadow-banking “run” and played a central role in the early phase of the financial crisis of 2007-09. We document that commercial banks set up conduits to securitize assets worth $1.3 trillion while insuring the newly securitized assets using explicit guarantees. We show that regulatory arbitrage was the main motive behind setting up conduits: the guarantees were structured so as to reduce regulatory capital requirements, more so by banks with less capital, and while still providing recourse to bank balance sheets for outside investors. Consistent with such recourse, we find that conduits provided little risk transfer during the “run”: losses from conduits remained with banks rather than outside investors and banks with more exposure to conduits had lower stock returns.
ABSTRACT (Click Here for Paper)
In this study, we analyze why commercial banks failed during the recent financial crisis. We find that traditional proxies for the CAMELS components, as well as measures of commercial real estate investments, do an excellent job in explaining the failures of banks that were closed during 2009, just as they did in the previous banking crisis of 1985 - 1992. Surprisingly, we do not find that residential mortgage-backed securities played a significant role in determining which banks failed and which banks survived. Our results offer support for the CAMELS approach to judging the safety and soundness of commercial banks, but calls into serious question the current system of regulatory risk weights and concentration limits on commercial real estate loans.
In this study, we analyze why commercial banks failed during the recent financial crisis. We find that traditional proxies for the CAMELS components, as well as measures of commercial real estate investments, do an excellent job in explaining the failures of banks that were closed during 2009, just as they did in the previous banking crisis of 1985 - 1992. Surprisingly, we do not find that residential mortgage-backed securities played a significant role in determining which banks failed and which banks survived. Our results offer support for the CAMELS approach to judging the safety and soundness of commercial banks, but calls into serious question the current system of regulatory risk weights and concentration limits on commercial real estate loans.
ABSTRACT (Click Here for Paper)
We study the liquidity demand of large settlement banks in the UK and its effect on the money markets before and during the sub-prime crisis of 2007-2008. We find that the liquidity demand of large settlement banks experienced a 30% increase in the period immediately following August 9, 2007, the day when money markets froze, igniting the crisis. Following this shift, liquidity demand had a precautionary nature in that it rose on days of high payment activity and for banks with greater credit risk. This caused overnight interbank rates to rise, an effect virtually absent in the pre-crisis period.
We study the liquidity demand of large settlement banks in the UK and its effect on the money markets before and during the sub-prime crisis of 2007-2008. We find that the liquidity demand of large settlement banks experienced a 30% increase in the period immediately following August 9, 2007, the day when money markets froze, igniting the crisis. Following this shift, liquidity demand had a precautionary nature in that it rose on days of high payment activity and for banks with greater credit risk. This caused overnight interbank rates to rise, an effect virtually absent in the pre-crisis period.
ABSTRACT (Click Here for Paper)
What is the effect of financial crises and their resolution on banks' choice of liquidity? When banks have relative expertise in employing risky assets, the market for these assets clears only at pre-sale prices following a large number of bank failures. The gains from acquiring assets at pre-sale prices make it attractive for banks to hold liquid assets. The resulting choice of bank liquidity is counter-cyclical, inefficiently low during economic booms but excessively high during crises. We present evidence consistent with these predictions. While interventions to resolve banking crises may be desirable ex post, they affect bank liquidity in subtle ways: liquidity support to failed banks or unconditional support to surviving banks reduces incentives to hold liquidity, whereas support to surviving banks conditional on their liquid asset holdings has the opposite effect.
What is the effect of financial crises and their resolution on banks' choice of liquidity? When banks have relative expertise in employing risky assets, the market for these assets clears only at pre-sale prices following a large number of bank failures. The gains from acquiring assets at pre-sale prices make it attractive for banks to hold liquid assets. The resulting choice of bank liquidity is counter-cyclical, inefficiently low during economic booms but excessively high during crises. We present evidence consistent with these predictions. While interventions to resolve banking crises may be desirable ex post, they affect bank liquidity in subtle ways: liquidity support to failed banks or unconditional support to surviving banks reduces incentives to hold liquidity, whereas support to surviving banks conditional on their liquid asset holdings has the opposite effect.
ABSTRACT
We argue that the fundamental cause of the financial crisis of 2007-09 was that large, complex financial institutions (“LCFIs”) took excessive leverage in the form of manufacturing tail risks that were systemic in nature and inadequately capitalized. We employ a set of headline facts about the build-up of such risk exposures to explain how and why LCFIs adopted this new banking model during 2003-2Q 2007, relative to earlier models. We compare the crisis to other episodes in the United States, in particular, the panic of 1907, the failure of Continental Illinois and the Savings and Loan crisis. We conclude that several principal imperfections, in particular, distortions induced by regulation and government guarantees, developed in decades preceding the current one, allowing LCFIs to take on excessive systemic risk. We also examine alternative explanations for the financial crisis. We conclude that while moral hazard problems in the originate-and-distribute model of banking, excess liquidity due to global imbalances and mispricing of risk due to behavioral biases have some merit as candidates, they fail to explain the complete spectrum of evidence on the crisis.
We argue that the fundamental cause of the financial crisis of 2007-09 was that large, complex financial institutions (“LCFIs”) took excessive leverage in the form of manufacturing tail risks that were systemic in nature and inadequately capitalized. We employ a set of headline facts about the build-up of such risk exposures to explain how and why LCFIs adopted this new banking model during 2003-2Q 2007, relative to earlier models. We compare the crisis to other episodes in the United States, in particular, the panic of 1907, the failure of Continental Illinois and the Savings and Loan crisis. We conclude that several principal imperfections, in particular, distortions induced by regulation and government guarantees, developed in decades preceding the current one, allowing LCFIs to take on excessive systemic risk. We also examine alternative explanations for the financial crisis. We conclude that while moral hazard problems in the originate-and-distribute model of banking, excess liquidity due to global imbalances and mispricing of risk due to behavioral biases have some merit as candidates, they fail to explain the complete spectrum of evidence on the crisis.
ABSTRACT (Click Here for Paper)
This paper provides a model of the interaction between risk-management practices and market liquidity. Our main finding is that a feedback effect can arise. Tighter risk management leads to market illiquidity, and this illiquidity further tightens risk management.
This paper provides a model of the interaction between risk-management practices and market liquidity. Our main finding is that a feedback effect can arise. Tighter risk management leads to market illiquidity, and this illiquidity further tightens risk management.
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