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2020 | OriginalPaper | Buchkapitel

7. Future Directions

verfasst von : Luc Nijs

Erschienen in: The Handbook of Global Shadow Banking, Volume II

Verlag: Springer International Publishing

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Abstract

The final chapter reads like an anthology of open-ended or still-evolving issues. Is more market-based finance the solution and what is the effect of more bank capital on growth, Nijs wonders. To what degree does the growing larger-than-ever global asset management industry pose intrinsic risks, and does securitization, which essentially is a capital reduction tool for banks, really generate enhanced access to capital for small- and medium-sized enterprises? Do we really know what we are doing when juggling ex ante and ex post regulation with macroprudential and monetary policies supported by supervisory frameworks, stress-tests and ongoing data gathering efforts? Do we know how all these simultaneously implemented efforts interact? Nijs gets the impression we are not. Do we really appreciate (or understand) the limits of all these tools against the background of unseen complexity, imperfect contractual relations, limited corporate liability and unparalleled dynamic financial networks? And how much finance do we really need? Does finance crowd out economic growth once it grows too large relative to the economy it is supposed to serve? Balancing liquidity, stability and meeting demand for safe assets in a world with credit-, liquidity- and maturity transformation occurring outside the regulated banking sector might be a stretched ambition. We might collectively be suffering from the neglected risk syndrome, and transforming the shadow banking sector into market-based finance might prove to be an illusion we all will regret one day.

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Vorheriges Kapitel Shadow Banking in (South) Africa

Nächstes Kapitel Statement of Principal Conclusions

Intellectually borrowed from G.W.F. Hegel: ‘die Eule der Minerva beginnt erst mit der einbrechenden Dämmerung ihren Flug’; in Grundlinien der Philosophie des Rechts oder Naturrecht und Staatswissenschaft im Grundrisse (1820).

There are very few studies that try to measure the direct effect of bank capital regulation.

Banks facing higher capital requirements can reduce credit supply as well as decrease credit demand by raising lending rates which may slow down economic growth.

N. Martynova, (2015), Effect of Bank Capital Requirements on Economic Growth: A Survey, BNB Working Papers, nr. 2015/467, pp. 2–6.

N. Martynova, (2015), Effect of Bank Capital Requirements on Economic Growth: A Survey, BNB Working Papers, nr. 2015/467.

See in detail and for quantifications: N. Martynova, (2015), ibid., pp. 10–14; F. Allen and E. Carletti, (2013), Deposits and Bank Capital Structure, ECO Working Paper Nr. 2013/03; M. Baker and J. Wurgler, (2013), Do Strict Capital Requirements Raise the Cost of Capital? Banking Regulation and the Low Risk Anomaly, NBER Working Paper Nr. 19,018; BCBS [Basel Committee on Banking Supervision], (2010), An Assessment of the Long-Term Economic Impact of Stronger Capital and Liquidity Requirements, Interim report, August; H. DeAngelo and R. M. Stulz, (2013), Why High Leverage Is Optimal for Banks, NBER Working Paper Nr. 19,139; A. Kashyap, et al., (2010), An Analysis of the Impact of ‘Substantially Heightened’ Capital Requirements on Large Financial Institutions, Journal of Economic Perspectives Vol. 25, pp. 3–28; P. Slovik, and B. Cournède, (2011), Macroeconomic Impact of Basel III, OECD Economics Department Working Papers, Nr. 844, OECD Publishing, and P. Bolton, and X. Freixas, (2006), Corporate Finance and the Monetary Transmission Mechanism, Review of Financial Studies Vol. 19, pp. 829–870.

C. Furfine, (2000), Evidence on the Response of US Banks to Changes in Capital Requirements, BIS Working Papers, Nr. 88.

N. Martynova, (2015), ibid., p. 8; see for a full overview pp. 6–9 and the most recent literature review: J. Noss and P. Toffano, (2014), Estimating the Impact of Changes in Bank Capital Requirements During a Credit Boom, Bank of England Working Paper Nr. 494.

N. Martynova, (2015), ibid., p. 10; also see: U. Albertazzi and D. J. Marchetti, (2010), Credit Supply, Flight to Quality and Evergreening: An Analysis of Bank-Firm Relationships After Lehman, Banca d’Italia Working Paper Nr. 756; J. Peek and E. Rosengren, (2000), Collateral Damage: Effects of the Japanese Bank Crisis on Real Activity in the United States, American Economic Review, Vol. 90, Issue 1, pp. 30–45, and A. Popov and G.F. Udell, (2012), Cross-Border Banking, Credit Access, and the Financial Crisis, Journal of International Economics Vol. 87, pp. 147–161.

J.-C. Rochet, (1992), Capital Requirements and the Behaviour of Commercial Banks, European Economic Review Vol. 36, issue 5, pp. 1137–1170.

N. Martynova, (2015), ibid., p. 16.

See in detail: J.W.B. Bos and P.C. van Santen, (2015), The Importance of Reallocation for Productivity Growth: Evidence from European and US Banking, Sveriges Riksbank, Working Paper, Nr. 296.

S.G. Cecchetti and E. Kharroubi, (2015), Why Does Financial Sector Growth Crowd Out Real Economic Growth, BIS Working Papers, Nr. 490, Monetary and Economic Department, Basel (also later on updated as NBER Working Paper Nr. 25,079, September 2018).

S. Cecchetti and E. Kharroubi, (2012), Reassessing the Impact of Finance on Growth, BIS Working Papers, Nr. 381.

See also: R. Levine, (1997), Financial Development and Economic Growth: Views and Agenda, Journal of Economic Literature, Vol. 35, pp. 688–726, and R. Levine, (2005), Finance and Growth: Theory and Evidence, Handbook of Economic Growth, Vol. 1, Elsevier, pp. 865–934. S.G. Cecchetti and E. Kharroubi, (2015), ibid., p. 24.

See regarding the financial sector growth: R. Greenwood and D. Scharfstein, (2012), The Growth of Modern Finance, mimeo Harvard Business School.

S.G. Cecchetti and E. Kharroubi, (2015), ibid., p. 3.

S.G. Cecchetti and E. Kharroubi, (2015), ibid., pp. 18–24.

S.G. Cecchetti and E. Kharroubi, (2015), ibid., p. 4.

S.G. Cecchetti and E. Kharroubi, (2015), ibid., p. 24.

S.G. Cecchetti and E. Kharroubi, (2015), ibid., p. 25.

See in detail: L. Nijs, (2015), Neoliberalism 2.0. Regulating and Financing Globalizing Markets. A Pigovian Approach to 21st Century Markets, Palgrave Macmillan, London. In particular chapters 1–3.

See, for example, L. Cornelis (ed.), (2014), Finance and Law. Twins in Trouble, Intersentia, Cambridge.

And in Europe there is a need for a better balance as in most countries the system is predominantly bank-focused. See, for example, Sveriges Riksbank, (2015), Less Bank Funding, More Market Funding in Structural Changes in the Swedish Financial System, Sveriges Riksbank Studies, February 2015, pp. 11–22.

An undiscussed issue here is the quality of the ratings and to what degree there is information asymmetry in those judgments; see, for example, C. Broto and L. Molina, (2014), Sovereign Ratings and Their Asymmetric Response to Fundamentals, Bank of Spain, Working Paper Nr. 1428.

S. Fleming and G. Chon, (2014), Rulemaking Proves Tricky When Dealing with Shadow Banking, Financial Times, June 18.

G. Wehinger, (2012), Bank Deleveraging, the Move from Bank to Market-Based Financing, and SME Financing, OECD Journal: Financial Market Trends, Vol. 2012/1, pp. 1–15.

S. Samuels, (2015), Withering Regulations Will Make for Shrivelled Banks, Financial Times, January 13.

G. Rachman, (2015), The West Has Lost Intellectual Self-Confidence, Financial Times, January 5.

FSB, (2014), Transforming Shadow Banking into Resilient Market-Based Financing, An Overview of Progress and a Roadmap for 2015, Basel, p. 1.

J.S. Masur and E. A. Posner, (2015), Towards a Pigovian State, University of Chicago Law School Working Paper, pp. 2–3 (later on published in University of Pennsylvania Law Review 2015, Vol. 164, pp. 93–147).

Masur and Posner, (2015), ibid., pp. 3–4.

Masur and Posner, (2015), ibid., pp. 21–27.

Masur and Posner, (2015), ibid., p. 31.

See also in detail: Julia A.D. Manasfi (Whittier), (2011), The Global Shadow Bank—Systemic Risk and Tax Policy Objectives: The Uncertain Case of Foreign Hedge Fund Lending to U.S. Borrowers and Transacting in U.S. Debt Securities, Florida Tax Review Vol 11, pp. 643 ff. She argues that the IRS code has not been keeping pace with financial innovation in recent decades and illustrates that, for example, foreign persons lending to US borrowers and transactions in US debt securities are covered by legislation, hardly covering the reality of shadow banking and complex financial innovation which leaves uncertainty about application and interpretation. She uses the case study of foreign hedge fund lending and US debt securities transactions and demonstrates how the current law provides inadequate guidance as to how these transactions will be taxed. This may increase systemic risk making the US financial system more fragile.

L. Zingales, (2015), Does Finance Benefit Society?, Harvard Business School and NBER/CEPR Working Paper, January.

J. Varellas III, (2016), Contract Law, Securitization and the Pre-Crisis Transformation of Banking, in Reshaping Markets. Economic Governance, the Global Financial Crisis and Liberal Utopia, (eds. B. Lomfeld, A. Somma and P. Zumbansen) in Cambridge University Press, Cambridge, pp. 45–59.

A. Barker and C. Binham, (2015), EU Seeks to Relax Securitisation Rules, Financial Times, February 17. The idea ‘that skin-in-the-game’ (i.e. the issuing financial institution would have to retain part of the issued securities) was needed has been and/or is up for revision in the context of high-quality securitizations. The idea is to relax some of the disclosure and due diligence requirements that normally come with issuing securitized products. See also: The Economist, (2014), Securitisation: It’s Back, January 11.

ECB/Bank of England, (2014), The Impaired Securitization Market: Causes, Roadblocks and How to Deal with Them, Brussel/London, pp. 2–3.

A. Admati and M. Hellwig, (2014), The Bankers’ New Clothes, Princeton University Press, Princeton, New Jersey.

See ECB/BoE, (2015), Joint response from the Bank of England and the European Central Bank to the Consultation Document of the European Commission (EC): ‘[a]n EU framework for simple, transparent and standardised securitisation’, Frankfurt/London, March 27. They further shared their views on the following key aspects of the consultation: criteria, prudential treatment, risk retention, transparency, SMEs and implementation.

That is frequently updated and upgraded by the European Banking Authority (EBA) through its opinions, technical standards and recommendations; see, for example, EBA, (2014), EBA Report on Securitisation Risk Retention, Due Diligence and Disclosure, December 22.

EC, (2015), Consultation Document, An EU Framework for Simple, Transparent and Standardized Securitization, Brussels, February 18.

A green paper was released in February 2015 to that effect. The objective of the EU program is threefold: (1) improving access to financing for all businesses across Europe and investment projects, in particular start-ups, SMEs and long-term projects, (2) increasing and diversifying the sources of funding from investors in the EU and all over the world and (3) and making the markets work more effectively so that the connections between investors and those who need funding are more efficient and effective, both within Member States and cross-border. See in detail: EC, (2015), Building a Capital Markets Union, COM(2015) 63 final, February 18.

See in detail: AFME, (2014), High-Quality Securitization for Europe. The Market at a Crossroads, London/Brussels, June.

T. Philippon, (2014), Has the US Finance Industry Become Less Efficient? On the Measurement of Financial Intermediation, Stern School of Business, Working Paper.

G. Bhat and J. Cai, (2014), The Relationship Between Bank Credit-Risk Management Procedures and Originate-to-Distribute Mortgage Quality During the Financial Crisis, Washington University Working Paper. See also: A. Purnanandam, (2011), Originate-to-distribute Model and the Subprime Mortgage Crisis, Review of Financial Studies, Vol. 24, pp. 1881–1915.

P.O. Lin et al., (2014), Originate-to-Distribute Model and UK Financial Institutions, in Challenges for Analysis of the Economy, the Businesses, and Social Progress, P. Kovács, et al. (eds.), pp. 656–665.

Accounting rules and the interplay between accounting rules and regulation continue to have a material impact on bank behavior; see, for example, BCBS, (2015), The Interplay of Accounting and Regulation and Its Impact on Bank Behaviour: Literature Review, Working Document Nr. 28, January, Basel.

EBA, (2014), EBA Report on Securitisation Risk Retention, Due Diligence and Disclosure, December 22, pp. 9–10.

See for the different strands of research on this matter: A. Amel-Zadeh, et al., (2014), Procyclical Leverage: Bank Regulation or Fair Value Accounting?, Rock Center for Corporate Governance at Stanford University Working Paper Nr. 147; A. Angkinand, et al., (2012), Market Discipline for Financial Institutions and Market for Information, Research Handbook on International Banking and Governance, (eds.) J. R. Barth, C. Lin and C. Wihlborg, Edward Elgar Publishing, Cheltenham, UK; M.E. Barth, et al., (2008), International Accounting Standards and Accounting Quality, Journal of Accounting Research, Vol. 46, pp. 467–498. U. Baumann, and E. Nier, (2004), Disclosure, Volatility, and Transparency: An Empirical Investigation into the Value of Bank Disclosure, Federal Reserve Bank of New York Economic Policy Review, pp. 31–45; J. Bertomeu, et al., (2011), Capital Structure, Cost of Capital, and Voluntary Disclosures, Accounting Review, Vol. 86, pp. 857 ff.; J. Bischof, (2012), Can Supervisory Disclosure Mitigate Bank Opaqueness and Reduce Uncertainties During a Financial Crisis? Evidence from the EU-Wide Stress-Testing Exercises, Working Paper, University of Mannheim; C. Borio and K. Tsatsaronis, (2005), Accounting, Prudential Regulation and Financial Stability: Elements of a Synthesis, BIS Working Papers, Nr. 180, Bank for International Settlements, Basel; R. Cifuentes, et al., (2005), Liquidity Risk and Contagion, Journal of the European Economic Association, Vol. 3, pp. 556–566. U. Wu and M. Bowe, (2010), Information Disclosure, Market Discipline and Management of Bank Capital: Evidence from the Chinese Financial Sector, Journal of Financial Services Research, Vol. 38, pp. 159–186; B. Xie, (2012), Does Fair Value Accounting Exacerbate the Pro-Cyclicality of Bank Lending?, Dissertation University of Southern California; D. Black and J. Gallemore, (2012), Bank Executive Overconfidence and Delayed Expected Loss Recognition, Working Paper; Y. Chen and I. Hasan, (2006), The Transparency of the Banking System and the Efficiency of Information-Based Bank Runs, Journal of Financial Intermediation, Vol. 15, pp. 307–331; E. Cubillas, et al., (2012), Banking Crises and Market Discipline: International Evidence, Journal of Banking and Finance, Vol. 36, pp. 2285–2298; A. Ellahie, (2012), Bank Stress Tests and Information Asymmetry, Working Paper, London Business School; M. Flannery, (2001), The Faces of Market Discipline, Journal of Financial Services Research, Vol. 20, pp. 107–119; C. Leuz and R. Verrecchia, (2000), Economic Consequences of Increased Disclosure, Journal of Accounting Research, Vol. 38, pp. 91–124; C. Leuz and P. Wysocki, (2008), Economic Consequences of Financial Reporting and Disclosure Regulation: A Review and Suggestions for Future Research, University of Chicago Working Paper; E. W. Nier, (2005), Bank Stability and Transparency, Journal of Financial Stability, Vol. 1, pp. 342–354. E. Nier, and U. Baumann, (2006), Market Discipline, Disclosure and Moral Hazard in Banking, Journal of Financial Intermediation, Vol. 15, pp. 332–361. R. Repullo and J. Suarez, (2012), The Procyclical Effects of Bank Capital Regulation, Review of Financial Studies, Vol. 26, Nr. 2, pp. 452–90; D. Foos, et al., (2010), Loan Growth and Riskiness of Banks, Journal of Banking and Finance, Vol. 34, pp. 2929–2940; P. Hamalainen, et al., (2005), A Framework for Market Discipline in Bank Regulatory Design, Journal of Business Finance & Accounting, Vol. 32, Nr. 1–2, pp. 183–209; R. Huang and L. Ratnovski, (2008), The Dark Side of Bank Wholesale Funding, Federal Reserve Bank of Philadelphia Working Paper Nr. 09-3; U. Khan, (2009), Does Fair Value Accounting Contribute to Systemic Risk in the Banking Industry? Columbia Business Working Paper.

Fair value accounting has been blamed to act procyclically for the trading book and incurred loss provisioning to have similar effects for the banking book.

BCBS, (2015), The Interplay of Accounting and Regulation and Its Impact on Bank Behaviour: Literature Review, Working Document Nr. 28, January, Basel, p. 1.

Other questions could have related to the provisioning on corporate loan books and their impact on bank behavior and prudential filters that have been introduced by regulators as a means to mitigate certain ‘procyclical behavior’ and to what degree they are now more ‘forward looking’.

The questions then would sound as follows: How does fair value accounting, in particular through an increased volatility of profit and loss figures, affect investment and risk management decisions in banks? What are the potential implications of the reaction of investors, for example, to regulatory disclosure of stress test results? How will this affect banks’ investments and their risk management? (p. 1).

BCBS, (2015), ibid., p. 3.

BCBS, (2015), ibid., pp. 2–3.

A.G. Haldane, (2011), Accounting for Bank Uncertainty, remarks at the Information for Better Markets conference, Institute of Chartered Accountants in England and Wales, London, 19 November.

See for a write-up and literature references BCBS, (2015).

BCBS, (2015), ibid., pp. 3–8.

BCBS, (2015), ibid., p. 22.

(1) To what extent do disclosure rules promote market discipline? (2) What are the consequences of disclosure rules on bank behavior? (3) Does the extent of market discipline differ in crisis versus normal times? (4) What shapes socially optimal disclosure rules? BCBS, (2015), ibid., p. 22.

BCBS, (2015), ibid., p. 23. ‘The externality and asymmetric information arguments suggest that, without intervention, banks may disclose less information than is socially optimal. Coordination problems imply that banks do not provide comparable information as they have no mechanism or incentive to cooperate over disclosures. In addition, there are external factors, including, for example, discretions allowed under accounting standards and capital regulations that further reduce the relevance of disclosures and aggravate coordination problems. These factors make it difficult for investors and creditors to assess a bank’s risk profile and compare risks across firms.’

‘Disclosure is the act of providing information to the market, while transparency arises only if the information is reliable and appropriately interpreted and used by the market. It is this concept of transparency that underpins effective market discipline’; BCBS, (2015), ibid., p. 24.

Market discipline refers to market-based incentive schemes in which investors in bank equity and liabilities, such as subordinated debt or uninsured deposits, effectively punish banks for taking greater risk either by demanding higher yields on or by cutting supply of such funding.

BCBS, (2015), ibid., p. 25.

See for literature reference BCBS, (2015), ibid., p. 25.

See for what is available in terms of research: BCBS, (2015), ibid., pp. 26–28. They also distinguish between the impact of market discipline in times of distress and normal economic times.

T. Dang, et al., (2012), Ignorance, Debt and Financial Crises, Working Paper, mimeo. They show that symmetric ignorance creates liquidity in money markets and that the provision of imperfect public information can trigger the production of private information—or, in other words, prompt market reactions and market discipline—that can lead participants to trade less, which has implications for the liquidity provision; see BCBS, (2015), ibid., p. 28.

M. Segoviano, et al., (2015), Securitization: The Road Ahead, IMF Staff Discussion Note, SDN/15/01, pp. 4 and 9–19.

‘Originate-to-distribute (OTD) model associated with the boom in securitization meant that originators often had little or no economic interest in the loans they underwrote and, hence, did not always originate loans that borrowers could realistically repay’; M. Segoviano, et al., (2015), ibid., p. 11.

The EU has made an effort in that direction through the Credit rating Agency Directive. It tries to achieve ‘(1) ensure greater transparency regarding the commercial relationship between issuers and rating agencies, including the separation of CRAs’ sales and analysis units; and (ii) provide investors with access to the results of stress tests and risk scenario analyses, as well as the underlying modelling assumptions used by rating agencies in arriving at their assessments of creditworthiness’; see: M. Segoviano, et al., (2015), ibid., p. 14. See for the Directive: Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies, O.J. L 302 of 17 November 2009, pp. 1–31; Regulation (EU) No 513/2011 of the European Parliament and of the Council of 11 May 2011 amending Regulation (EC) No 1060/2009 on credit rating agencies, L 145 of 31 May 2011, pp. 30–56; Commission Delegated Regulation No 946/2012 of 12 July 2012 supplementing Regulation (EC) No 1060/2009 of the European Parliament and of the Council with regard to rules of procedure on fines imposed to credit rating agencies by the European Securities and Markets Authority, including rules on the right of defense and temporal provisions, L 282 of 16 October 2012 pp. 23–26; Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating agencies Text with EEA relevance O.J. L 146 of 31 May 2013, pp. 1–33.

Commission Delegated Regulation (EU) 2015/3 of 30 September 2014 supplementing Regulation (EC) No 1060/2009 of the European Parliament and of the Council with regard to regulatory technical standards on disclosure requirements for structured finance instruments, Text with EEA relevance O.J. L 2 of 6 January 2015, pp. 57–119 and Commission Delegated Regulation (EU) 2015/1 of 30 September 2014 supplementing Regulation (EC) No 1060/2009 of the European Parliament and of the Council with regard to regulatory technical standards for the periodic reporting on fees charged by credit rating agencies for the purpose of ongoing supervision by the European Securities and Markets Authority Text with EEA relevance O.J. L 2 of 6 January 2015, pp. 1–23.

M. Segoviano, et al., (2015), ibid., p. 16.

M. Segoviano, et al., (2015), ibid., p. 16. See also BIS, (2014), Criteria for Identifying Simple, Transparent and Comparable Securitizations, Basel, December.

M. Segoviano, et al., (2015), Securitization: The Road Ahead, IMF Staff Discussion Note, SDN/15/01, p. 4.

See in detail M. Segoviano et al., (2013), Securitization: Lessons Learned and the Road Ahead, IMF Working Paper, Nr. WP/13/255.

Because it is ‘plain-vanilla’, the risks are often less or badly understood, see: M. Feroli, et al., (2014), Market Tantrums and Monetary Policy, Chicago Booth Research Paper 14–09, University of Chicago Booth School of Business, Chicago. Plain-vanilla funds are exposed to liquidity risk as the shares of those funds (often mutual funds or exchange-traded funds [ETFs]) are redeemable and tradable on a daily basis, although the assets invested into them are often, or at least can be much more, illiquid.

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. 93.

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. xiii.

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. 93.

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, pp. 56–64.

See for a full analysis on the role of asset managers and how they relate to the question of financial stability: IMF, (2015), Global Financial Stability Report, The Asset Management and Financial Stability, April, pp. 93–135 (chapter 3).

See most recently: D. Vayanos, and P. Woolley, (2013), An Institutional Theory of Momentum and Reversal, Review of Financial Studies, Vol. 26, Issue 5, pp. 1087–1145.

By analyzing the same indicator (investigative herding) or by eliciting information from the past trades of better-informed managers (informational cascades) and trade in the same direction.

S. Acharya and A. Pedraza, (2015), Asset Price Effects of Peer Benchmarking: Evidence from a Natural Experiment, Federal Reserve Bank of New York Staff Reports, Nr. 727, May. In order to identify trades purely due to peer benchmarking as separate from those based on fundamentals or private information, they exploit a natural experiment involving a change in a government-imposed underperformance penalty applicable to pension funds. This change in regulation is orthogonal (i.e. right-angled or perpendicular) to stock fundamentals and only affects incentives to track peer portfolios, allowing us to identify the component of demand that is caused by peer benchmarking; see also p. 2 for a broader write-up. Their study is the first that measures herding and its impact directly. Former studies have done so only indirectly and were measured as trade clustering; see pp. 2–3 for references and a write-up of the issues. This single largest issue is that ‘it is hard to distinguish actual herding from spurious herding’ in the former literature.

‘A statistically and economically significant effect on asset prices’ and ‘[t]rades motivated by peer benchmarking generate 3.53 percent of contemporaneous abnormal returns on the average stock. These excess returns are fully reversed after six months, indicating that peer-effects among pension funds tend to generate excess volatility in stock prices’ (p. 3).

S. Acharya and A. Pedraza, (2015), ibid., pp. 10–13.

S. Acharya and A. Pedraza, (2015), ibid., pp. 13–16.

S. Acharya and A. Pedraza, (2015), ibid., p. 3.

S. Acharya and A. Pedraza, (2015), ibid., p. 1.

A. Dasgupta and M. Verardo, (2011), Institutional Trade Persistence and Long-Term Equity Returns, Journal of Finance, Vol. 66, Issue 2, pp. 635–653; V. Guerrieri, and P. Kondor, (2012), Fund Managers, Career Concern and Asset Price Volatility, American Economic Review, Vol. 102, Issue 5, pp. 1986–2017, R. Gutierrez, and E. Kelley, (2009), Institutional Herding and Future Stock Returns, University of Oregon and University of Arizona Working Paper; N. Brown, et al., (2014), Analyst Recommendations, Mutual Fund Herding, and Overreaction in Stock Prices, Management Science, Vol. 60, Issue 1, pp. 1–20.

V. Acharya, et al., (2013), Seeking Alpha: Excess Risk Taking and Competition for Managerial Talent, NBER Working Paper Nr. 18,891; V. Guerrieri, and P. Kondor, (2012), Fund Managers, Career Concern and Asset Price Volatility, American Economic Review, Vol. 102, Issue 5, pp. 1986–2017; A. Dasgupta and M. Verardo, (2011), The Price Impact of Institutional Herding, Review of Financial Studies, Vol. 24, Issue 3, pp. 892–925.

S. Acharya and A. Pedraza, (2015), ibid., p. 4.

H.S. Shin, (2013), The Second Phase of Global Liquidity and Its Impact on Emerging Economies, Princeton University Manuscript.

L. Nijs, (2015), Neoliberalism 2.0: Regulating and Financing Globalizing Markets, A Pigovian Approach to 21st Century Markets, Palgrave Macmillan, London, chapter 6.

S. Acharya and A. Pedraza, (2015), ibid., p. 16.

D. Duarte et al., (2015), The Systemic Effects of Benchmarking, Questrom School of Business, (Boston) Working Paper, August 31, updated regularly all the way in to 2019.

D. Duarte et al., (2015), ibid., p. 3.

100

D. Duarte et al., (2015), ibid., p. 3.

101

D. Duarte et al., (2015), ibid., pp. 3–4.

102

D. Duarte et al., (2015), ibid., pp. 3–4.

103

J. Jones, (2015), Asset Bubbles: Re-Thinking Policy for the Age of Asset Management, IMF Working Paper, Nr. WP/15/27; S. Basak and A. Pavlova, (2013), Asset Prices and Institutional Investors, American Economic Review Vol. 103, pp. 1728–1758. A. Bua, et al., (2015), Asset Management Contracts and Equilibrium Prices, Working Paper, Boston University and London School of Economics; J. Cvitanic, et al., (2014), On Managerial Risk-Taking Incentives When Compensation May Be Hedged Against, Mathematics and Financial Economics Vol. 8, Issue 4, pp. 453–471; A.G. Haldane, (2014), The Age of Asset Management?, Speech given at the London Business School, London, UK; L. Ma, (2015), Portfolio Manager Compensation in the US Mutual Fund Industry, Working Paper.

104

D. Duarte et al., (2015), ibid., pp. 4–5.

105

IMF, (2015), Global Financial Stability Report, The Asset Management and Financial Stability, April, pp. 93–135 (chapter 3).

106

See in detail S. Chernenko and A. Sunderam, (2015), Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds, Working Paper, July 21, mimeo.

107

Ibid.; see also D.J. Elliott, (2014), Systemic Risk and the Asset Management Industry, Economic Studies at Brookings Institute, May.

108

D. Igan and M. Pinheiro, (2015), Delegated Portfolio Management, Benchmarking and the Effects on Financial Markets, IMF Working Paper Nr. WP/15/198.

109

G. La Spada, (2015), Competition, Reach for Yield, and Money Market Funds, Federal Reserve Bank of New York Staff Reports, Nr. 753, December. See also L. Schmidt, et al., (2015), Runs on Money Market Mutual Funds. Working Paper, mimeo; P. Strahan and B. Tanyeri, (2015), Once Burned, Twice Shy? Money Market Fund Responses to a Systemic Liquidity Shock, Journal of Financial and Quantitative Analysis, Vol. 50, Issue 1–2, pp. 119–144. Also: G. Chodorow-Reich, (2014), Effects of Unconventional Monetary Policy on Financial Institutions, Brookings Papers on Economic Activity (Spring), pp. 155–204; M. Di Maggio, and M. Kacperczyk, (2015), The Unintended Consequences of the Zero Lower Bound Policy, Working Paper, mimeo.

110

Risk premia trigger risk taking but affect funds with low and high default costs in opposite ways. Low risk-free rates increase the buffer of safe assets necessary to maintain the equilibrium default probability and therefore reduce risky investment for all funds. Both effects are peculiar to MMFs and come from their distinctive feature of a stable net asset value and consequent risk of ‘breaking the buck’; see: G. La Spada, (2015), ibid., p. 2.

111

J. Cunliffe, (2015), Market Liquidity and Market-Based Financing, Speech given by Sir Jon Cunliffe, Deputy Governor, Deputy Governor Financial Stability, Member of the Monetary Policy Committee, Member of the Financial Policy Committee and Member of the Prudential Regulation Authority Board British Bankers’ Association International Banking Conference, London, Thursday 22 October 2015, pp. 9–10.

112

S. Arslanalp and T. Tsuda, (2015), Emerging Market Portfolio Flows: The Role of Benchmark-Driven Investors, IMF Working Paper Nr. WP/15/263, Washington.

113

A. Mooney, (2015), Asset Managers Pour Billions into Direct Lending, Financial Times, December 13.

114

See, for example, IMF, (2014), Global Financial Stability Report, ibid., pp. 73, 82–86. Specifically, they comment that ‘[t]hese funds tend to be exposed to some liquidity and maturity risk but score low on other risk dimensions. At least in the euro area, however, bond funds now tend to hold less-liquid and longer-maturity assets than five years ago. Similarly, in the United States, investment funds—which entail some maturity risk, but do not display high risk scores in other areas—have been the fastest-growing form of shadow banking, expanding from 35 percent to 70 percent of GDP’ (p. 82).

115

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. 95.

116

See extensively on the topic: F. Avalos et al., (2015), Leverage on the Buy Side, BIS Working Paper Nr. 517, October.

117

See in detail: D. Elliott, (2014), Systemic Risk and the Asset Management Industry, Economic Studies at Brookings, Brookings Institution, Washington; A. Haldane, (2014), The Age of Asset Management?, Speech at the London Business School, April 4; Center for European Policy Studies–European Capital Markets Institute (CEPS-ECMI), (2012), ‘Rethinking Asset Management from Financial Stability to Investor Protection and Economic Growth’. Report of a CEPS-ECMI Task Force.

118

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. 95.

119

Therefore, these many macroprudential instruments have been designed as both macroprudential and capital flow management in nature; see, for example, IMF, (2015), Group of Twenty, Measures which are Both Macroprudential and Capital Flow Management Measures: IMF Approach, Washington, April 10.

120

See also: IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. 96.

121

IMF, (2015), Global Financial Stability Report. Navigating Monetary Policy Challenges and Managing Risk, April, p. 98.

122

‘This evaluation can take direct or indirect forms: (1) managers’ compensation can be linked to relative performance or (2) investors inject money into funds that perform well relative to their benchmarks. The effect of the latter is similar to the effect of the former if compensation increases with assets under management (AUM)’. See IMF, (2015), ibid., p. 100; L. Ma, et al., (2013), Portfolio Manager Compensation in the U.S. Mutual Fund Industry, Working Paper.

123

See in detail IMF, (2015), ibid., pp. 100–101 with related literature.

124

S. Basak and A. Pavlova, (2014), Asset Prices and Institutional Investors, American Economic Review, Vol. 103, Issue 5, pp. 1728–1758.

125

See in detail: IMF, (2015), ibid., pp. 101–103.

126

For example, ‘affecting the balance sheets of other actors in financial markets; reducing collateral values; and reducing credit financing for banks, firms, and sovereigns’, IMF, (2015), ibid., p. 99.

127

See in detail: H. Hau and S. Lai, (2010), The Role of Equity Funds in the Financial Crisis Propagation, Research Paper Nr. 11–35, Swiss Finance Institute, Geneva; A. Manconi, et al., (2012), The Role of Institutional Investors in Propagating the Crisis of 2007–08, Journal of Financial Economics Vol. 104, Issue 3, pp. 491–518. See also for the IMF specific analysis: IMF, (2015), ibid., pp. 104–106.

128

IMF, (2015), ibid., p. 113.

129

See in detail: IMF, (2015), ibid., pp. 114–115.

130

A. Frazzini and O. A. Lamont, (2008), Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns, Journal of Financial Economics Vol. 88, Issue 2, pp. 299–322; IMF, (2015), ibid., 113.

131

The draft: Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO), (2014), Assessment Methodologies for Identifying Non-bank Non-insurer Global Systemically Important Financial Institutions, Consultation Document, Financial Stability Board, Basel. The 2015 revision: Assessment Methodologies for Identifying Nonbank Non-insurer Global Systemically Important Financial Institutions, The Second Consultation Document, Financial Stability Board, Basel.

132

IMF, (2015), Iibid., pp. 106–112.

133

N. Liang, (2015), Asset Management and Financial Stability, Presentation at the Brookings Institution, January 9. IMF, (2015), ibid., p. 118.

134

See in detail IMF, (2015), ibid., p. 118–120.

135

T. Adam, and A. Guettler, (2015), Pitfalls and Perils of Financial Innovation: The Use of CDS by Corporate Bond Funds, Journal of Banking and Finance, Journal of Banking and Finance, Vol. 55, pp. 204–214. They document that ‘(1) the use of credit default swaps (CDS) rose from 20 to 60 percent between 2004 and 2008; (2) CDS are mostly used to enhance credit risk taking, rather than hedging; (3) funds belonging to a larger fund family are more likely to use CDS; (4) underperforming funds often increase their CDS exposures to enhance returns; and (5) CDS users tend to perform worse on average than non-users’. See also: J. Tian, (2010), Shadow Banking System, Derivatives and Liquidity Risk, Working Paper, who built a model to better understand how liquidity risks translate in fire sales in the presence of derivatives and under which conditions derivatives are instrumental to reduce or neutralize liquidity risk.

136

See M.J. White, (2014), Enhancing Risk Monitoring and Regulatory Safeguards for the Asset Management Industry, speech delivered at the New York Times DealBook Opportunities for Tomorrow Conference, New York, December 11.

137

See in detail: G. Gelos, Gaston, (2011), International Mutual Funds, Capital Flow Volatility, and Contagion: A Survey, IMF Working Paper WP/11/92, International Monetary Fund, Washington.

138

IMF, (2015), ibid., p. 121.

139

B. Jones, (2015), Asset Bubbles: Re-thinking Policy for the Age of Asset Management, IMF Working Paper, WP/15/27, pp. 15–18. Jones provides an excellent overview of the literature on traditional and new age arguments of bubbles creation and persistence in the public markets. See also for recent literature overviews on ‘bubble creation and asset pricing bubbles’: A. Scherbina, (2013), Asset Price Bubbles. A Selective Survey, IMF Working Paper, Nr. WP/13/45. See also Jones with a novel pillar surveillance framework for identifying speculative bubbles: B. Jones, (2014), Identifying Speculative Bubbles. A Two-Pillar Surveillance Framework, IMF Working Paper Nr. WP/14/208.

140

B. Jones, (2015), ibid., pp. 19–30.

141

B. Jones, (2015), ibid.

142

B. Jones, (2015), ibid., p. 38.

143

B. Jones, (2015), ibid., pp. 31–36.

144

B. Jones, (2015), ibid., p. 38; see also: M. Feroli, et al., (2014), Market Tantrums and Monetary Policy, Working Paper presented at the 2014 U.S. Monetary Policy Forum, New York, February 28; A.G. Haldane, (2014), The Age of Asset Management? Speech at the London Business School, London, April; J.C. Stein, (2014), ‘Incorporating Financial Stability Considerations into a Monetary Policy Framework’, Remarks at the International Research Forum on Monetary Policy, Washington, DC, March 21.

145

See J.L. Haracz and D.J. Acland, (2015), Neuroeconomics of Asset-Price Bubbles: Toward the Prediction and Prevention of Major Bubbles, Goldman School of Public Policy, UC Berkeley Working Paper.

146

Trending in trading behavior and maturity transformation in modest volumes will not lead to issues of systemic risk.

147

T. Roncalli and G. Weisang, (2015), Asset Management and Systemic Risk, Working Paper, May 26, pp. 4–8.

148

‘In practice, however, not all financial risks are borne by the asset manager’ clients. Because of its fiduciary obligation, the asset manager is also exposed to some financial risks, in particular counterparty, credit and liquidity risks; T. Roncalli and Systemic Risk, (2015), ibid., p. 9.

149

T. Roncalli and G. Weisang, (2015), ibid., p. 8.

150

T. Roncalli and G. Weisang, (2015), ibid., pp. 9–11.

151

T. Roncalli and G. Weisang, (2015), ibid., p. 11 and in detail pp. 11–14. See for the FSB approach toward asset management: FSB, (2015), Assessment Methodologies for Identifying Non-bank Non-insurer Global Systemically Important Financial Institutions, 2nd Consultation Document, March 4, pp. 47–55.

152

FSB, (2015), Assessment Methodologies for Identifying Nonbank Non-insurer Global Systemically Important Financial Institutions, 2nd Consultation Document, March 4; Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO), March 2015; T. Roncalli and Systemic Risk, (2015), ibid., pp. 14–17.

153

T. Roncalli and G. Weisang, (2015), ibid., pp. 32–41.

154

A. Mooney, (2015), ECB’s Shadow-Bank Label for Funds Angers Asset Managers, Financial Times, November 1. See also: M. K. Philips, (2015), Shadow Casting, CFA Institute Magazine, July/August, pp. 24–28.

155

FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12. Prior to that release they issued a proposal document: FSB, (2016), Proposed Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, June 22, following which comments were submitted: Public responses to the June 2016 consultative document ‘Proposed Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities’, October 5. All to be retrieved via fsb.org. The OFR have already released their view years earlier, and classify the issues slightly differently; see: OFR, (2013), Asset Management and Financial Stability, September, pp. 9–21; and for the transmission channels pp. 21–23.

156

See for the banking counterpart: A. Krishnamurthy, et al., (2016), Measuring Liquidity Mismatch in the Banking Sector, NBER Working Paper Nr. 22,729.

157

The policy recommendations in this matter can be consulted under Annex 1: FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, pp. 39–41.

158

Updated data can at any given time be found at the International Investment Fund Association (www.iifa.ca)

159

See for annualized data the IOSCO Securities Markets Risk Outlook (via www.ioco.org)

160

See for details: FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, pp. 5–10.

161

See in detail: FSB, (2017), ibid., pp. 11–23.

162

See how the concept of ‘redemptions’ can be traced back to credit theory and the role of the state: É. Tymoigne, (2017), On the Centrality of Redemption: Linking the State and Credit Theories of Money Through a Financial Approach to Money, Levy Economics Institute of Bard College, Working Paper Nr. 890, May (including an interesting literature list pp. 21 ff.). The reasoning in short goes a bit like this ‘[o]ne of the main financial requirements of any monetary instrument is that it be redeemable at any time. As long as this is the case, the fair value of an unconvertible monetary instrument is its face value.’ Now the functional approach to money is that ‘money is what it does’, that is, monetary and mercantile mechanics are conflated or put differently ‘unconvertible monetary instruments are worthless’. However, from a financial point of view monetary notes have always been promissory notes and, as such, their financial characteristics are central to their value and liquidity. Redemption therefore plays a critical role in the state and credit views of money. ‘[P]ayments due to issuer and/or convertibility on demand are central to the possibility of par circulation.’

163

See also: S. Priazhkina, (2016), Liquidity Channels and Stability of Shadow Banking, Working Paper, mimeo.

164

Large amounts of literature have been released over the years regarding those topics. What is interesting however is the fact that in recent years it became clear that subcategories of investors also tend to develop herding behavior with specific characteristics for that niche group. See, for example, D. Broeders et al., (2016), Pension Funds’ Herding, DNB Working Paper Nr. 503, February. They categorize and conclude that ‘[w]eak herding occurs if pension funds have similar rebalancing strategies. Semi-strong herding arises when pension funds react similarly to other external shocks, such as changes in regulation and exceptional monetary policy operations. Finally, strong herding means that pension funds intentionally replicate changes in the strategic asset allocation of other pension funds. Without an economic reason.’ Regarding momentum trading, see: P. Barroso and P. Santa-Clara, (2012), Managing the Risk of Momentum, Nova School of Business Working Paper, April, mimeo; T.-L. Dao et al., (2016), Tail Protection for Long Investors: Trend Convexity at Work, Working Paper, July 11, mimeo; J. Brooks, (2017), A Half Century of Macro Momentum, AQR Report, August (via aqr.com) and P. Jusselin et al., (2017), Understanding the Momentum Risk Premium: An In-Depth Journey Through Trend-Following Strategies, Working Paper, September, mimeo.

165

A key problem in this debate is that it is difficult to measure liquidity transformation for asset managers. And that in contrast to shadow banks where maturity mismatch—the difference in maturity between assets and liabilities— this provides a reasonable measure of liquidity transformation. Chernenko and Sunderam argue: ‘[w]hile investors can withdraw unlimited quantities of deposits without any price impact, bank loans cannot be traded before maturity without creating substantial price impact. For asset managers, however, there is no comparable measure. Their assets are typically tradeable securities, though with varying levels of liquidity. Furthermore, some price impact can be passed on to investors because they own claims whose value is not fixed. Nevertheless, asset managers perform some amount of liquidity transformation because their ability to pool trades and space transactions over time flattens the price-quantity schedule faced by their investors.’ They use, in their analysis, the cash holdings of open-end mutual funds that invest in equities and long-term corporate bonds as a window into the liquidity transformation activities of asset managers. Their reasoning is that the way mutual funds manage their liquidity (in order to guarantee an open-end to investors) sheds some light on how much liquidity transformation funds are performing. So, a firm that acts as a pure pass-through and thus simply buys and sells asset will have little need for holding cash to manage liquidity and to ultimately meet redemptions. However, a fund investing in illiquid assets or engaging in substantial liquidity transformation will need material levels of cash to meet redemptions (or as they call it ‘will seek to use cash holdings to mitigate the costs associated with providing investors with claims that are more liquid than the underlying assets’). Cash management therefore acts as a proxy for liquidity transformation. See S. Chernenko and A. Sunderam, (2016), Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds, HBS Working Paper Nr. 2016-01, July 15, p. 2. Also as NBER Working Paper Series, Nr. 22,391, July 2016/ESRB Working Paper Nr. 23/2016.

166

J. Coval and E. Stafford, (2007), Asset Fire Sale (and Purchases) in Equity Markets, Journal of Financial Economics, Vol. 86, pp. 479–512. N. Cetorelli, et al., (2016), Are Asset Managers Vulnerable to Fire Sales? Blogpost Liberty Street Economics, February 18; R. Cont and E. Schaanning, (2017), Fire Sales, Indirect Contagion and Systemic Stress Testing, Norges Bank Working Paper 17-02, March 17.

167

See regarding the suggested standard set of liquidity management tools funds should/could have in place: IOSCO, (2015), Liquidity Management Tools in Collective Investment Schemes, Final Report, December.

168

Also see B.G. Malkiel, (2016), Next Steps in the Evolution of Stress Testing. Remarks at the Yale University School of Management Leaders Forum, September 26. For stress testing at banks, see: K. Dent and B. Westwood, (2016), Stress Testing of Banks: An Introduction, Bank of England Quarterly Bulletin, Q3, pp. 130–143, and T. Daniëls et al., (2017), A Top-Down Stress Testing Framework for the Dutch Banking Sector, Occasional Studies, Vol. 15, Issue 3, July; ECB, (2017), STAMP€: Stress-Test Analytics for Macroprudential Purposes in the Euro Area, eds. S. Dees, J. Henry and R. Martin, February. See also: S. Mnuchin and C.S. Phillips, (2017), A Financial System That Creates Economic Opportunities Asset Management and Insurance Report to President Donald J. Trump Executive Order 13772 on Core Principles for Regulating the United States Financial System, October, pp. 11–71, and in particular pp. 29–32.

169

Swing pricing allows a fund manager to transfer to redeeming or subscribing investors the costs associated with their trading activity (bid-ask spread and market impact, and other trading-associated costs), thus potentially discouraging large flows. The remaining, non-redeeming investors, are thus (largely) protected from dilution effects (the drop in value, aka diluted NAV, for those investors that remain). Proceeds recovered via swing pricing are reinvested for the benefit of the fund, enhancing returns for longer-term investors. It has the potential to reduce systemic risk and is enacted in already quite a number of jurisdictions. But does swing pricing help dampen flows out of funds, especially during periods of market stress? Improvements are still welcome and many trade-offs (systemic risk mitigation vs. investor protection) exist in swing parameter calibration. See in detail: S. Malik and P. Lindner, (2017), On Swing Pricing and Systemic Risk Mitigation, IMF Working Paper Nr. WP/17/159, July. Swing pricing can be partial (coming into effect only when net flows exceed a predefined swing threshold) or in full. The swing factor (typically in the range of 0.5 to 3%) determines the amount by which NAV for redeeming investors is adjusted downward. Swing threshold and swing factor are key to ensuring that swing pricing as a systemic risk mitigant functions properly. Successful implementation of swing pricing also requires a conducive market infrastructure allowing for daily gathering of daily information on trade flow and related costs. See for a detailed analysis of each of those elements p. 9 ff.

170

Side pockets are segregated and ring-fenced pools of (often) illiquid assets to separate them from the more mainstream liquid assets in the fund. The idea is that only continuing investors in the fund can benefit from the proceeds upon sale at a late stage. See in detail also regarding other fund termination practices: IOSCO, (2017), IOSCO Report on Good Practices for the Termination of Investment Funds, Final Report, November (via iosco.org).

171

Chernenko and Sunderam evidence that to provide investors with claims that are more liquid than the underlying assets, funds engage in substantial liquidity management. Specifically, they hold substantial amounts of cash, which they use to accommodate inflows and outflows rather than transacting in the underlying portfolio assets. This is particularly true for funds with illiquid assets and at times of low market liquidity. They studied the cash holdings of mutual funds and concluded that ‘mutual funds’ cash holdings are not large enough to fully mitigate price impact externalities created by the liquidity transformation they engage in. They see evidence in the fact that (1) funds that hold a larger fraction of the outstanding amount of the assets they invest in tend to hold more cash. And (2) alternative liquidity tools (e.g. redemption restrictions, credit lines and interfund lending programs) are imperfect substitutes for cash and that cash is the key tool funds use for liquidity management validating the idea that cash holdings are a good proxy for the level of liquidity transformation going on in a fund. See S. Chernenko and A. Sunderam, (2016), Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds, Harvard Business School Working Paper Nr. 2016-01, July 15/NBER Nr. 22,391, July. Four elements play a role here: (1) mutual funds use cash to accommodate inflows and outflows rather than transacting in equities and bonds; (2) asset liquidity affects the propensity of funds to use cash holdings to manage fund flows; (3) funds that perform more liquidity transformation hold significantly more cash (how much is driven by asset illiquidity, the volatility of fund flows and their interaction); (4) the interaction of asset illiquidity and flow volatility is positive and statistically significant. See on the relationship between fund flows, monetary policy and financial stability: A. Banegas et al., (2016), Mutual Fund Flows, Monetary Policy and Financial Stability, Finance and Economics Discussion Series Nr. 2016-071, July, Washington: Board of Governors of the Federal Reserve System. Monetary policy can have an impact on allocation decisions of mutual fund investors (depending in intensity based on the investment strategy). Evidence points both ways, that is, in case of tighter-than-expected as well as more dovish scenarios with material policy ramifications.

172

FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, ibid., p. 14.

173

See IOSCO, (2018), Open-Ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration, FR02/2018, February; IOSCO, (2018), Recommendations for Liquidity Risk Management for Collective Investment Schemes, Final Report, FR01/2018, February. Risk management tools discussed include: swing prices (pp. 23–26), anti-dilution levies (pp. 27–29), valuation according to bid-ask prices (pp. 29–30), redemption gates (pp. 30–32), side pockets (pp. 32–34), notice periods (pp. 34–36), suspension of redemption (pp. 36–40) and redemptions in-kind (pp. 41–43), as well as focus on the stress-testing capabilities (pp. 44 ff.)

174

See the initial consultation in this matter: IOSCO, (2017), Open-Ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration, CR05/2017, July 6. Also: F. Franzoni and M. C. Schmalz, (2017), Fund Flows and Market States, The Review of Financial Studies, Vol. 30, Issue 8, pp. 2621–2673.

175

See in detail: FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, pp. 24–29.

176

See D. Deli et al., (2015), Use of Derivatives by Registered Investment Companies, SEC White Papers, Nr. 2015/12, December.

177

S.W. Bauguess, (2017), Market Fragility and Interconnectedness in the Asset Management Industry. Keynote Address – Buy-Side Risk USA 2017 Conference Market Fragility and Interconnectedness in the Asset Management Industry, June 20; I. Goldstein, et al., (2016), Investor Flows and Fragility in Corporate Bond Funds, Journal of Financial Economics, Vol. 126, Issue 3, pp. 592–613. See also the final report of IOSCO regarding ‘Liquidity in Corporate Bond Markets Under Stressed Conditions’, See IOSCO, (2019), Liquidity in Corporate Bond Markets Under Stressed Conditions Final Report FR10/2019, June 21, via iosco.org

178

Through the AIFMD directive, including the right to intervene in case leverage buildup is representing a financial stability risk.

179

The IOSCO issued general guidelines regarding the reporting of exposures in IOSCO, (2016), Implementation Report: G20/FSB Recommendations related to Securities Markets, FR11/2016, October.

180

Often these measures are built on the FSB’s framework, see FSB, (2015), Transforming Shadow Banking into Resilient Market-Based Finance. Regulatory Framework for Haircuts on Non-centrally Cleared Securities Financing Transactions, November 12, which was extensively discussed elsewhere in this book.

181

In Europe this is implemented through CRD IV and in the US through section 619 of the Dodd-Frank Act (known as the Volcker Rule). See for the BCBS guidance in this matter: BCBS, (2013), Capital Requirements for Bank’s Equity Investments in Funds, December.

182

See, for example, the responses of the GARP (Global Association of Risk Professionals) and the combined MFA (Managed Funds Association)/AIMA (Alternative Investment Management Association) to the asset management report in the shadow banking and financial stability context (via fsb.org), both dated 21 September 2016.

183

Dunne and Shaw relate fund-specific characteristics, such as leverage or usage of derivatives, to funds’ exposure to a tail event in the fund sector (Marginal Expected Shortfall): see P. Dunne and F. Shaw, (2017), Investment Fund Risk: The Tale in the Tails. Working Paper Nr. 01/RT/17, Bank of Ireland, January.

184

See, for example, the IOSCO reporting measurements on the hedge fund industry including in recent years items such as leverage and liquidity management: see IOCO, (2017), Report on the Fourth IOSCO Hedge Funds Survey, Final Report, FR22/2017, November.

185

The FSB mandated IOSCO in this respect: see FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, p. 27.

186

P. Glasserman and H. Young, (2015), How Likely Is Contagion in Financial Networks? Journal of Banking and Finance, Vol. 50, pp. 383–399; P. Glasserman and H. Young, (2016), Contagion in Financial Networks. Journal of Economic Literature, Vol. 54, Issue 3, pp. 779–831.

187

These obligations might include ‘registration, account openings at foreign depositories, reporting to investors, authorization by the relevant authority, reconciling valuations, and capturing outstanding receivables such as interest claims’; see FSB, (2017), ibid., p. 31.

188

See in detail: FSB, (2017), ibid., pp. 35–38.

189

See for actual data on who does what and for how much volume the data provided at regular intervals by the International Securities Lending Association (ISLA) through their monthly market reports (via www.isla.co.uk); also see the Securities Lending Data Collection Pilot Project of the Office of Financial Research (OFR) in partnership with the Federal Reserve and Securities and Exchange Commission (via financialresearch.gov).

190

In short, the risks boil down to ‘maturity/liquidity transformation and leverage associated with cash collateral reinvestment, procyclicality associated with securities financing transactions, risk of a fire sale of collateral securities, and inadequate collateral valuation practices’; FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, p. 35. The agent lender indemnification risk can be added to that list as the absence of guarantee provided could lead to impairments, withdrawals and force borrowers to exit their positions affecting volatility, liquidity and price formation. It could also widespread and affect the ability of other agents to meet their indemnification commitments. Some of the risks associated with indemnification are similar to beneficial owner risks (counterparty, collateral value), others are novel and unaddressed by current practices and oversight: (1) asset managers in contrast to agent lender banks are not subject to Basel III rules and therefore often do not have a balance sheet large enough to absorb potential losses. That is in particular relevant as the AUM are often disproportionately large with their balance sheets; and (2) there is a certain opacity risk associated with indemnifications. It is often unknown what the maturity profile of these contingent liabilities is at asset managers. There is a whole set of tools that could help in this respect (p. 36). Forcing to reinsurance those indemnification risks could be on the table. It would not make the risk go away but shift it away from the asset manager’s balance sheet into a more regulated environment adequate for those risks. Given the different regulatory systems for agent lending activities a material risk of regulatory arbitrage exists. Systemic risk then would occur in case the value of the indemnification received is questioned leading to withdrawals squeezed short positions and collateral value erosion. Agent lender indemnification practices are very limited at this stage, and thus this risk is for the moment rather theoretical.

191

See for the technical study on the matter: A. Ellul et al., (2018), Insurers as Asset Managers and Systemic Risk, ESRB Working Paper Nr. 75, May. They present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds (‘reach-for-yield’). We then calibrate the model to insurer-level data and show that the VA writing insurers’ collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20–70% of insurers’ equity capital.

192

FSB, (2012), Securities Lending and Repos: Market Overview and Financial Stability Issues, Interim Report of the FSB Workstream on Securities Lending and Repos, April 27.

193

FSB, (2013), Strengthening Oversight and Regulation of Shadow Banking. Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos, August 29; and FSB, (2015), Transforming Shadow Banking into Resilient Market-Based Finance. Regulatory Framework for Haircuts on Non-Centrally Cleared Securities Financing Transactions, November 12.

194

Such tools include ‘stringent counterparty selection processes, collateral standards and haircuts, daily mark-to-market valuation, concentration limits, limits on the fraction of the portfolio lent at any one time, and periodic counterparty credit evaluations’. FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, p. 36.

195

J. Danielsson and J.P. Zigrand, (2015), Are Asset Managers Systemically Important?, Voxeu.org – Opinion Piece, August 05.

196

M. Getmansky et al., (2016), Portfolio Similarity and Asset Liquidation in the Insurance Industry, Working Paper, April 15, mimeo.

197

C. Fricke and D. Fricke, (2017), Vulnerable Asset Management? The Case of Mutual Funds, Deutsche Bundesbank Discussion Paper, Nr. 32/2017. They expand existing models (the abovementioned Danielsson and Zigrand model) by including the well-documented flow-performance relationship, which means that negative returns will be followed by additional outflows.

198

See in detail: FSB, (2017), ibid., pp. 43–47. L.C. Backer, (2016), Regulating Financial Markets: What We Might Learn From Sovereign Wealth Funds in Reshaping Markets. Economic Governance, the Global Financial Crisis and Liberal Utopia, (eds. B. Lomfeld, A. Somma and P. Zumbansen) in Cambridge University Press, Cambridge, pp. 229–254.

199

See, for example, the annual Willis Towers and Watson list of largest pension funds in the world (via www.willistowerswatson.com). Also: I. Ben-David et al., (2015), The Granular Nature of Large Institutional Investors, Fisher College of Business Working Paper Nr. 2015-03-09. The same is often true for investing in unicorns by mutual funds, who then essentially act as venture capitalists. This is increasingly true as most assets are concentrated in the hands of a handful of asset managers. Large funds and those with stable funding, conclude Chernenko et al. See S. Chernenko et al., (2017), Mutual Funds as Venture Capitalists? Evidence from Unicorns, NBER Working Paper Nr. 23,981, October.

200

Longevity risk (i.e. the risk that plan beneficiaries live longer than expected) is the best-known risk in this respect: see BCBS, (2013), Longevity Risk Transfer Markets: Market Structure, Growth Drivers and Impediments, and Potential Risks, December.

201

The top decile of the funds manages 85% or so of the assets; see for actual data www.sfwinstitute.org

202

See www.iwg-wsf.org for details.

203

See, for example, S.E. Stone and E.M. Truman, (2016), Uneven Progress on Sovereign Wealth Fund Transparency and Accountability, Policy Brief 16–18, October.

204

See for actual data: www.etfgi.com, the industry website for research and consultancy of the ETF and Exchange-traded products (ETP) industry.

205

See for details on ETFs and their modus operandi: IOSCO, (2013), Principles for the Regulation of Exchange Traded Funds Final Report, FR06/13, June. Given the explosive growth in terms of AUM, the opacity of new and more complex products, it was a matter of time before the industry would draw more scrutiny: see FT, (2017), $4tn Exchange Traded Fund Industry Draws More Scrutiny, FTfm, May 26. And like clockwork, half a year later IOSCO announced a further investigation into certain liquidity risk regarding a set of the product group: C. Flood, (2017), Global Regulatory Body to Launch Fresh Probe into ETFs, Financial Times, December, 2. IOSCO reported early 2018 on the—already discussed final—principles regarding the liquidity risks into open-ended mutual funds and ETFs: IOSCO, (2018), Recommendations for Liquidity Risk Management for Collective Investment Schemes Final Report, FR01/2018, February. This further question remained if and to what degree serious market distortions might occur as a result of the growth of ETFs and the impact on liquidity and valuations. The concern is that the use of ETFs could lead to market disruptions if large volumes of investors rushed for the exit during times of stress. The prime question is whether ETFs are leading to changes in market structure that could lead to misallocation of capital across different sectors in the financial space. Because of the fact that the ETF space is now occupied with such a diversified set of products, this due diligence might be suboptimal at this stage. Consequently, the question is: ‘[a]re we losing sight of fundamentals and valuation measures such as price earnings ratios because of the automatic nature of [capital] allocations by market capitalization-weighted ETFs?’ (Mr. Andrews, Secretary-General at IOSCO) in C. Flood, (2018), ibid. The role of authorized participants needs to become more transparent and formalized, although overkill is a recurring risk. For example, in Europe ETFs fall under the general fund rules (UCITS ETFs) and so coverage is guaranteed.

206

Some markets have rules that constrain the fluctuations of an ETF in a range above or below an estimate of their NAV (‘indicative NAV’ or ‘iNAV’) and therefore limit the risks of the ETF trading at significant premiums or discounts to its iNAV: FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12, p. 46.

207

See in detail: ESMA, (2014), Guidelines for Competent Authorities and UCITS Management Companies, ESMA/2014/937EN, August 1.

208

For example, M. Aquilina and W. Kraus, (2016), Market-Based Finance: Its Contribution and Emerging Issues, FCA Occasional Working Paper Nr. 18, May (via fca.org.uk).

209

N. Doyle et al., (2016), Shadow Banking in the Eurozone: Risks and Vulnerabilities in the Investment Fund Sector, Occasional Paper Series Nr. 174, June; G30, (2016), Shadow Banking and Capital Markets. Risks and Opportunities, Group of Thirty Working Paper, November.

210

See, for example, for an interesting exercise: R. Bookstaber and D.Y. Kenett, (2016), Looking Deeper, Seeing More: A Multilayer Map of the Financial System, OFR Brief Series 16-6, July 14. They produce a three-layered map representing short-term funding, assets and collateral flows. Risk is transformed and moves from one layer of the map to the next through transactions among large market players. Not only potential vulnerabilities are identified but, more importantly, the different (possible) path of contagion are examined. They indicate that ‘It can help in examining risks that are layer-specific, such as funding liquidity and leverage, collateral behind secured lending, and asset prices and liquidity. A multilayer map exposes new sources of vulnerability from dependency and interconnectivity across layers. Such connections can amplify and transform vulnerabilities into broader, systemic risks. A single-layer map cannot fully capture the array of activities in the financial system, or how different nodes are affected by shocks or disruptions. Risk is transformed as it moves from one layer of the map to the next’ (p. 10). Later on, this was complemented with a model coordinating the flow of information in the economy and how information spreads in networks. That is relevant as people with more and more accurate information tend to remain in the network longer. Highly connected networks where accurate information is readily available to participants can transform in ones with few connection and inaccurate information. Their results show and suggest that the information aggregation function of markets can fail solely because of the dynamics of information flows, irrespective of shocks or news: see P. Monin and R. Bookstaber, (2017), Information Flows, the Accuracy of Opinion, and Crashes in a Dynamic Network, OFR Staff Discussion Paper Nr. 17-01, March 2. Hedge funds among institutional investors seem best equipped to exploit the information acquisition process: N. Swem, (2017), Information in Financial Markets: Who gets It First?, Finance and Economics Discussion Series Nr. 23, Washington: Board of Governors of the Federal Reserve System, February.

211

Personally, I’m a fan of the Annual Financial Stability Reports produced by the OFR and their communication style: see in recent years, for example, OFR, (2018), Financial Stability Report 2017, (via financialresearch.gov) and in particular: Market Risks Remain Elevated (pp. 32 ff.), Vulnerabilities Remain in Funding and Liquidity (pp. 42 ff.) and Contagion Risk Signals Are Mixed (pp. 44 ff.). See also T. Adrian et al., (2017), Market Liquidity After the Financial Crisis, Annual Review of Financial Economics, Vol. 9, Nr. 1, pp. 43–89; M. Anderson et al., (2017), Is Post-crisis Bond Liquidity Lower?, National Bureau of Economic Research Working Paper Nr. 23,317.

212

The growing liquidity mismatch is clearly a growing concern within the investment fund sector. Open-ended funds tend to create the illusion of stable liquidity by promising daily callable claims to purchase assets. The reality is that many assets may not be very liquid in a period of market repricing or distress. On the contrary, and despite those daily redemption facilities, cash buffers and shares of liquid and short-term assets have been falling (N. Doyle et al., [2016] infra), increasing the risk of an adverse liquidity spiral.

213

N. Doyle et al., (2016), Shadow Banking in the Euro Area: Risks and Vulnerabilities in the Investment Fund Sector, ECB Working Paper Nr. 174, June, pp. 23–29.

214

N. Doyle et al., (2016), ibid., pp. 20–22.

215

A similar observation in the insurance industry and associated fire sale risk. See W. Wu and X. Zhou, (2017), Investment Commonality Across Insurance Companies: Fire Sale Risk and Corporate Yield Spreads, Finance and Economics Discussion Series Nr. 69, Washington: Board of Governors of the Federal Reserve System.

216

N. Doyle et al., (2016), ibid., p. 4. See for an overview of the material heterogeneity across funds types (pp. 15–16.

217

N. Doyle et al., (2016), ibid., p. 18.

218

See also: ECB (2010), Towards Macro-Financial Models with Realistic Characterizations of Financial Instability, Special Feature in Financial Stability Review, December, pp. 138–146.

219

Securities and Exchange Commission, (2015), Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of Comment Period for Investment Company Reporting Modernization Release, Release Nr. 33-9922, September 22; C. Weistroffer, and S. Steffen, (2015), The German Open-End Fund Crisis – A Valuation Problem?, Journal of Real Estate Finance and Economics, Vol. 50, Nr. 4, pp. 517–548.

220

See on this specific topic: BIS, (2010), The Role of Margin Requirements and Haircuts in Procyclicality, CGFS Paper Nr. 36, March.

221

See, for example, S. Chernenko and A. Sunderam, (2018), Do Fire Sales Create Externalities, NBER Working Paper Nr. 25,104, September. They conclude that there are meaningful fire sale externalities in the (equity) mutual fund industry. Also see E. Dávila, (2015), Dissecting Fire Sales Externalities, NYU Stern Working Paper, April, mimeo.

222

S. Chernenko and A. Sunderam, (2017), ibid., p. 3: ‘[s]pecifically, we show that when a given fund’s securities are held by other funds that internalize more of their price impact, the relationship between flows into these other funds and returns of the first fund is diminished.’

223

See for an alternative study on the matter: C. Fricke and D. Fricke, (2017), Vulnerable Asset Management? The Case of Mutual Funds, Deutsche Bundesbank Discussion Paper Nr. 32, October 30. Their main finding is that mutual funds’ aggregate vulnerability to fire sales is relatively small compared to related studies on the banking sector. This suggests that systemic risks among mutual funds are unlikely to be a major concern, at least when looking at this part of the financial system in isolation. We explore the determinants of individual funds’ vulnerability to systemic asset liquidations, highlighting the importance of funds’ liquidity transformation. Liquidity transformation should therefore be central in any monitoring efforts.

224

Which creates the issue that a disproportional amount of liquid assets need to be sold to compensate for the illiquid assets held.

225

N. Doyle et al., (2016), Shadow Banking in the Euro Area: Risks and Vulnerabilities in the Investment Fund Sector, ECB Working Paper Nr. 174, June, pp. 18–19. ECB (2015), Financial Stability Review, May and November.

226

Consequently, different fund types might trigger a different combination and intensity of risks: real estate funds score high on both, whereas equity funds score low on both. Bond funds as well as hedge funds are a mixed bag and their scoring will typically depend on their investment strategies and internal protocols.

227

See on the individual issues: J.-B. Gossé, et al. (2015), Interconnectedness Between Banks and Market-Based Financing Entities in Luxembourg, Revue de Stabilité financière 2015, Banque centrale du Luxembourg, pp. 127–152; J.-B. Haquin, et al., (2015), Measuring the Shadow Banking System – a Focused Approach, ESMA Report on Trends, Risks and Vulnerabilities Nr. 2, pp. 34–38; X. Jin, et al., (2015), Investment Funds. Vulnerabilities: A Tail-Risk Dynamic CIMDO Approach, Banque Centrale du Luxembourg, Cahier d’études, Working Paper Nr. 95, July; T. Roncalli and G. Weiang, (2015), Asset Managers and Systemic Risk, Working Paper, May 26, mimeo.

228

Those capital and liquidity rules also determine the demand and supply of capital and thereby also impact the rate of return as set by the aforementioned tâtonnement process.

229

Banks that hold mixed portfolios are those that engage in bank lending and hold (less liquid and/or illiquid) securities (like asset managers). They are known as ferry banks as they meander between the bank and nonbank segment of the financial spectrum. They spread contagion to other banks in the interbank markets with similar characteristics (with mixed portfolios). Those that only hold liquid assets will use their liquidity to adjust. These banks are obviously crucial in spreading contagion between both segments of the financial market. When such a bank is faced with declining asset prices, it will start a withdrawal process in the interbank market (as that is where their liquidity buffer sits and is the easiest to adjust on short-term notice) leading to a fire sale in that segment simply to readjust their balance sheet. Asset managers then face less distress as they don’t face the same regulation to readjust their balance sheet when market prices adjust and therefore can use their liquidity buffers in a different (wiser) way. See in detail: S. Callmani et al., (2017), Simulating Fire-Sales in a Banking and Shadow Banking System, ESRB Working Paper Nr. 46, June.

230

Capital requirements force banks to hold less risky assets (i.e. interbank claims). This leads to excess supply of interbanking claims and drives down the risk-free rate of return in that segment, pp. 12, 20.

231

See in detail: S. Callmani et al., (2017), Simulating Fire-Sales in a Banking and Shadow Banking System, ESRB Working Paper Nr. 46, June, pp. 5 ff. See also: S. Morris et al., (2017), Redemption Risk and Cash Hoarding, BIS Working Paper Nr. 608, via bis.org. Cash hoarding seems to be the rule rather than the exception and is more severe when the fund holds a larger amount of the illiquid assets.

232

FSMA, (2017), Report on Asset Management and Shadow Banking, Report, September, via fsma.be

233

FSMA, (2017), ibid., p. 4. Also see: M. Druant and S. Cappoen, (2017), Belgian Shadow Banking Sector with a Focus on OFIs. Paper for the IFC-NBB Workshop ‘Data needs and statistics compilation for macroprudential analysis’, May 18–19; E. Wymeersch, (2017), Shadow Banking and Systemic Risk, Working Paper 2017/1, Financial Law Institute, March.

234

IMF, (2018), Belgium: Financial System Stability Assessment, IMF Country Report, Nr. 18/67, March 6, p. 10; NBB, (2017), Financial Stability Report, pp. 35–38 (2.4 the shadow banking sector and portfolio management).

235

See in detail: B.A. Jones, (2016), Institutionalizing Countercyclical Investment: A Framework for Long-term Asset Owners, IMF Working paper Nr. 16/38, February.

236

S. Claessens and N. van Horen, (2015), The Impact of the Global Financial Crisis on Banking Globalization’, DNB Working Paper Nr. 459, January.

237

See, for example, S. Adrianova et al., (2015), Why Do African Banks Lend so Little?, Oxford Bulletin of Economics and Statistics, Vol. 77, Issue 3, pp. 339–359.

238

S. Claessens and N. van Horen, (2015), The Impact of the Global Financial Crisis on Banking Globalization, DNB Working Paper Nr. 459, January, p. 3.

239

And it’s not all bad: there is, for many emerging economies a positive relation identified between credit expansion and real GDP growth in those countries; see: M. Garcia-Escribano and F. Han, (2015), Credit Expansion in Emerging Markets: Propeller of Growth, IMF Working Paper Nr. WP/15/212, September. The type of credit determines to a large degree the impact on GDP and through which channel (investment or consumption).

240

P.A. Imam and K. Kpodar, (2015), Is Islamic Finance Good for Growth, IMF Working Paper Nr. WP/15/81; A. Barajas and A. Massara, (2015), Can Islamic Banking Increase Financial Inclusion?, IMF Working Paper Nr. WP/15/31; M. Farooq and S. Zaheer, (2015), Are Islamic Banks More Resilient During Financial Panics?, IMF Working Paper Nr. WP/15/41.

241

L. de Haan et al., (2015), Lenders on the Storm of Wholesale Funding Shocks: Saved by the Central Bank?, DNB Working Paper Nr. 456, January.

242

‘The Eurosystem has reacted to banks’ funding strains by various measures. Refinancing operations have been extended in terms of maturity, size and conditions. This enabled banks to obtain liquidity from the central bank at fixed rate at full allotment.’ Mooney, L. de Haan et al., (2015), ibid., p. 3.

243

L. de Haan et al., (2015), Lenders on the Storm of Wholesale Funding Shocks: Saved by the Central Bank?, DNB Working Paper Nr. 456, January, p. 2.

244

C. Bonner and P. Hilbers, (2015), Global Liquidity Regulation -Why Did It Take So Long?, DNB Working Paper Nr. 455, January.

245

T.F. Hellmann, et al. (2000), ‘Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?’ American Economic Review, Vol. 90, Issue 1, pp. 147–165.

246

R. Banerjee and M. Hio, (2014). The Impact of Liquidity Regulation on Bank Behaviour: Evidence from the UK. Mimeo.

247

U. Bindseil and J. Lamoot, (2011), The Basel III Framework for Liquidity Standards and Monetary Policy Implementation, SFB 649 Discussion Paper, 2011-041; C. Bonner, and S. Eijffinger, (2013), The Impact of Liquidity Regulation on Financial Intermediation, CEPR Discussion Paper, Nr. 9124. C. Bonner, et al., (2013), Banks’ Liquidity Buffers and the Role of Liquidity Regulation, DNB Working Paper Nr. 393.

248

L. De Haan, et al., (2013), Bank Liquidity, the Maturity Ladder, and Regulation. Journal of Banking and Finance, Vol. 37, Issue 10, pp. 3930–3950. M. Kowalik, (2013), Basel Liquidity Regulation: Was It Improved with the 2013 Revisions? Economic Review, QII, pp. 65–87.

249

S. Claessens, (2014), An Overview of Macroprudential Policy Tools, IMF Working Papers Nr. WP/14/214, p. 8–11, 21–23.

250

Or to put it more diplomatically: ‘the literature on macroprudential policy has looked at a wide range of possible tools without a primary instrument emerging. It has only recently been converging toward a common understanding of its perimeter and a common taxonomy of instruments’; see G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p. 3.

251

See for the current state of affairs and summary of the current ‘knowledge base’: G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September.

252

The question has been asked what the international and global spillovers are and will be of the unconventional monetary policy as we have witnessed in the US in recent years and more recently also in Europe. See: Q. Chen et al., (2015), Financial Crisis, US Unconventional Monetary Policy and International Spillovers, IMF Working Paper Nr. WP/15/85, April. They study the impact of the US quantitative easing (QE) on both the emerging and advanced economies. They focus on the effects of reductions in the US term and corporate spreads. First, US QE measures reducing the US corporate spread appear to be more important than lowering the US term spread. Second, US QE measures might have prevented episodes of prolonged recession and deflation in the advanced economies. Third, the estimated effects on the emerging economies have been diverse but often larger than those recorded in the US and other advanced economies. The heterogeneous effects from US QE measures indicate unevenly distributed benefits and costs. Obviously, although meticulous from an academic perspective, they contribute very little to our ability to apply these macroprudential tools in a more effective and chirurgical precise way.

253

C. Borio, et al., (2001), Procyclicality of the Financial System and Financial Stability: Issues and Policy Options. In Marrying the Macro- and Micro-Prudential Dimensions of Financial Stability. BIS Papers, Nr. 1, March, pp. 1–57. See for a more extensive analysis of the demarcation lines and interactions between the different policy fields: S. Claessens, (2014), An Overview of Macroprudential Policy Tools, IMF Working Paper Nr. WP/14/214, pp. 8–12. For more in general, see: D. Schoenmaker (ed.), (2014), Macro-prudentialism, VoxEU E-Book, London.

254

A. Crockett, A. (2000) Marrying the Micro- and Macro-Prudential Dimensions of Financial Stability. Remarks Before the Eleventh International Conference of Banking Supervisors. Bank for International Settlements. Basel, 20–21 September 2000.

255

G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p. 2.

256

IMF, (2011), Macroprudential Policy: An Organizing Framework. Prepared by the Monetary and Capital Markets Department.

257

Time-varying loan-to-value (LTV), loan-to-income (LTI) or debt-to-income (DTI) ratios belong to this category.

258

IMF, (2011), Macroprudential Policy: An Organizing Framework, Background Paper, Prepared by the Monetary and Capital Markets Department.

259

D. Schoenmaker and P. Wierts, (2011), Macroprudential Policy: The Need for a Coherent Policy Framework. DSF Policy Paper, Nr. 13.

260

See, for example, G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p.4, Table 1. Other categorizations are possible based on rule versus discretion, quantity versus price and those that are predominantly used in emerging economies. Galati and Moessner, (2014), ibid., p. 3 footnote 1 for literature references.

261

G. De Nicolò, et al., (2012), Externalities and Macroprudential Policy, IMF staff discussion note Nr. WP/12/05. S. Hanson, et al., (2011), A Macroprudential Approach to Financial Regulation, Journal of Economic Perspectives, Vol. 25, Issue 1, pp. 3–28.

262

See for a summary: G. De Nicolò, et al., (2012), ibid., p. 11.

263

That position of more focus on tax instruments and Pigovian instruments in particular can be found back in: S. Claessens, (2014), An Overview of Macroprudential Policy Tools, IMF Working Paper Nr. WP/14/214, pp. 13–15.

264

H. Borchgrevink et al., (2014), Macroprudential Regulation – What, Why and How?, Norges Bank Staff Memo Nr. 13, pp. 4–8.

265

See for a historical review of experiences with macroprudential tools: G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, pp. 6–7.

266

: G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p. 7. See for an overview of central banking experiences: Committee on the Global Financial System, (2010), Macroprudential instruments and frameworks: a stocktaking of issues and experiences. CGFS Papers Nr. 38, May; IMF, (2011), Macroprudential Policy: An Organizing Framework. Background Paper, Prepared by the Monetary and Capital Markets Department. IMF, (2011), Regional economic outlook Asia and the Pacific, April.

267

G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p. 8. See also J.W. Van den End, (2013), A Macroprudential Approach to Address Liquidity Risk with the Loan-to-Deposit Ratio, DNB Working Paper Nr. 372, March.

268

G. Galati, and R. Moessner, (2013), Macroprudential Policy – a Literature Review, Journal of Economic Surveys, Vol. 27, Nr. 5, pp. 846–878.

269

R. Portes, (2014), Macro-Prudential Policy and Monetary Policy, in Macroprudentialsm (ed. D. Schoenmaker), VoxEU, London, pp. 47–59.

270

See for an overview and evaluation of these studies and models: G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, pp. 9–17.

271

G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p. 8.

272

G. Galati and R. Moessner, (2014), What Do We Know About the Effects of Macroprudential Policy?, DNB Working Paper Nr. 440, September, p. 17.

273

See for a review: P. Kannan, et al., (2012), Monetary and Macroprudential Policy Rules in a Model with House Price Booms. The B.E. Journal of Macroeconomics, Vol. 12, Issue 1, Article 16 and P. Angelini, et al., (2012), Macroprudential, Microprudential and Monetary Policies: Conflicts, Complementarities and Trade-Offs. Bank of Italy Occasional Paper Nr. 140; J. Boeckx et al., (2015), Interaction Between Monetary and Macro-Prudential Policies, Economic Review, NBB, September, pp. 7–27.

274

W. Wagner, (2014), Unintended Consequences of Macro-Prudential Policies, in Macroprudentialism (ed. D. Schoenmaker), VoxEU, London, pp. 105–114.

275

C. Borio, (2014), Macroprudential Frameworks: (Too) Great Expectations, in Macroprudentialism (ed. D. Schoenmaker), VoxEU, London, pp. 29–46.

276

C. Borio, (2014), ibid., p. 40.

277

W. Wagner, (2014), ibid., p. 112.

278

D.G. Demekas, (2015), Designing Effective Macro-Prudential Stress Tests: Progress So Far and the Way Forward, IMF Working Paper Nr. WP/15/146.

279

Ibid., p. 21.

280

S. Claessens et al., (2014), Macro-Prudential Policies to Mitigate Financial System Vulnerabilities, IMF Working Paper Nr. WP/14/155.

281

S. Claessens et al., (2014), ibid., p. 19.

282

S. Claessens et al., (2014), ibid., pp. 19–20.

283

S. Claessens et al., (2014), ibid., p. 20.

284

S. Claessens et al., (2014), ibid., pp. 20, 12–18.

285

S. Claessens et al., (2014), ibid., p. 20.

286

S. Claessens et al., (2014), ibid., p. 21.

287

D. Longworth, (2012), Combatting the Dangers Lurking in the Shadows: The Macroprudential Regulation of Shadow Banking, C.D. Howe Institute, Commentary Nr. 361, p. 13. See further p. 19 for an overview of the suggested policies regarding the different shadow banking entities and activities.

288

ESRB, (2014), Flagship Report on Macro-Prudential Policy in the Banking Sector, Frankfurt, p. 5.

289

This leakage may occur, for example, via securitization or the creation of special purpose vehicles.

290

Disruptions in the shadow banking sector are expected to have spillover effects and transmit risk to the banking sector; see also ESRB, (2014), The ESRB Handbook on Operationalising Macro-Prudential Policy in the Banking Sector, Frankfurt, pp. 32–33, 84.

291

See for an analysis of the new Basel III requirements and the opportunities for ‘regulatory arbitrage’, M. Ojo, (2011), Financial Stability, New Macro Prudential Arrangements and Shadow Banking: Regulatory Arbitrage and Stringent Basel III Regulations, MPRA Working Paper Nr. 31,319, Munich.

292

See also ESRB, (2014), The ESRB Handbook on Operationalising Macro-Prudential Policy in the Banking Sector, Frankfurt, p. 167.

293

T. Adrian et al., (2014), Financial Stability Monitoring, NY Federal Reserve Bank of New York, Staff Reports, Nr. 601, pp. 29–31.

294

T. Adrian et al., (2014), ibid., p. 29.

295

See T. Adrian et al., (2014), ibid., p. 33. They indicate: ‘[f]irst, an expansion along these lines would require a new regulatory structure to prevent moral hazard, which can be expensive and difficult to implement effectively. Second, an expansion of regulations does not reduce the incentives for regulatory arbitrage, but just pushes it beyond the beyond the existing perimeter. Third, there is a limited understanding of the impact that such a fundamental change would have on the efficiency and dynamism of the financial system. At the same time, it seems clear that policies that promote only greater disclosure would not be sufficient to effectively limit the build-up of systemic risk,’

296

For example, N. Liang, (2015), Shadow Banking, Low Interest Rates, and Financial Stability, Financial Market Adaptation to Regulation and Monetary Policy, Stanford Graduate School of Business, Presentation March 22. See also A. Blundell-Wignall and C. Roulet, (2014), Macro-Prudential Policy, Bank Systemic Risk and Capital Controls, OECD Journal: Financial market Trends 2014, Volume 2013/2, Paris, pp. 1–22.

297

D.K. Tarullo, (2015), Advancing Macroprudential Policy Objectives, speech given at the Office of Financial Research and Financial Stability Oversight Council’s 4th Annual Conference on Evaluating Macroprudential Tools: Complementarities and Conflicts, Arlington, Virginia, January 30. See also D.K. Tarullo, (2013), Macroprudential Regulation, speech delivered at the Yale Law School Conference on Challenges in Global Financial Services, New Haven, Connecticut, September 20; D. Langworth and J. Weatherall, (2011), Macroprudential Policy and Financial Markets, Paper prepared for ‘The Economics and Econometrics of Recurring Financial Market Crises’, Waterloo, 3–4 October 2011.

298

M. Harris, et al., (2015), Macroprudential Bank Capital Regulation in a Competitive Financial System, Berkeley Working Paper, January 9.

299

See also but then from a regulatory point of view: K.N. Johnson, (2013), Macro-Prudential Regulation: A Sustainable Approach to Regulating Financial Markets, University of Illinois Law Review, Vol. 2013, Nr. 3, pp. 881–918. She also pays attention (besides the macroprudential regulation enacted) to the corporate governance mechanisms enacted. See also T. Bennani et al., (2014), Macro-Prudential Framework: Key Questions Applied to the French Case, Banque de France, Occasional Papers Nr. 9, Paris, February; P. Tucker, (2013), Banking Reform and Macroprudential Regulation: Implications for Banks’ Capital Structure and Credit Conditions, Speech given at the SUERF/Bank of Finland Conference, ‘Banking after regulatory reform – business as usual’, Helsinki, June 13.

300

D. Liebeg and A. Trachta, (2013), Macroprudential Policy: A Complementing Pillar in Prudential Supervision – The EU and Austrian Frameworks, Financial Stability Report Nr. 26, Austrian Central Bank, pp. 56–61.

301

S.L. Schwarcz, (2015), Banking and Financial Regulation, in the Oxford Handbook of Law and Economics, F. Parisi (ed.), Oxford University Press, Oxford.

302

A. Clark and A. large, (2011), Macroprudential Policy: Addressing the Things We Don’t Know, Group of Thirty, Occasional Paper Nr. 30, Washington D.C., pp. 25–28, 47–48.

303

A. Ganioğlu, (2014), Does Effectiveness of Macroprudential Policies on Banking Crisis Depend on Institutional Structure, Central Bank of the Republic of Turkey, Working Paper Nr. 14/19. Particularly important for emerging markets, see: B. Schmitz, (2013), Macroprudential Financial Market Regulation, Aims, Implementation, and Implications for Developing and Emerging Economies, Deutsches Institut für Entwicklungspolitik, Discussion Paper 20/2013, Bonn.

304

‘Moreover, a statistical default model estimated in a low securitization period breaks down in a high securitization period in a systematic manner: it underpredicts defaults among borrowers for whom soft information is more valuable. Regulations that rely on such models to assess default risk may therefore be undermined by the actions of market participants’; see U. Rajan, et al., (2010), The Failure of Models That Predict Failure: Distance, Incentives and Defaults, University of Michigan Working Paper.

305

M. Wilson, (2015), Taking the Shadow Banks out of the Shadows, Verbatim C.D. Howe Institute, The Sylvia Ostry Lecture, Presented to the C.D. Howe Institute, April 9.

306

See, for example, for Africa: C. Enoch et al., (2015), Pan-African Banks, Opportunities and Challenges for Cross-Border Oversight, African Department and Monetary and Capital Markets Department, IMF, April 30. Washington.

307

M. Nirei et al., (2015), Bank Capital Shock Propagation via Syndicated Interconnectedness, BIS Working Paper Nr. 484.

308

See for details on the syndicated market: G. Hale, et al., (2011), Global Banking Network and International Capital Flows, Mimeo, Federal Reserve Bank of San Francisco; V. Ivanshina and D. Scharfstein, (2010), Loan Syndication and Credit Cycles, American Economic Review, Vol. 100, Issue 2, pp. 57–61.

309

See specifically on the impact of portfolio concentration and the effects of a market or capital shock: A. Pavlova and R. Rigobon, (2008), The Role of Portfolio Constraints in the International Propagation of Shocks, Review of Economic Studies, Vol. 75, Issue 4, pp. 1215–1256.

310

N. Antonakakis, (2012), The Great Synchronization of International Trade Collapse, Economics Letters, Vol. 117, pp. 608–614.

311

See in detail: T. Adrian and H.S. Shin, (2014), Procyclical Leverage and Value-at-Risk, Review of Financial Studies, Vol. 27, Issue 2, pp. 373–403.

312

M. Nirei et al., (2015), Bank Capital Shock Propagation via Syndicated Interconnectedness, BIS Working Paper Nr. 484, p. 28.

313

M. Nirei et al., (2015), ibid., p. 28.

314

M. Nirei et al., (2015), ibid., pp. 28–29.

315

S. Agarwal, (2010), Distance and Private Information in Lending, Review of Financial Studies, Vol. 23, Issue 7, pp. 2757–2788. J.W. Bos, et al., (2013), The Evolution of the Global Corporate Loan Market: A Network Approach, Mimeo, Maastricht University; F. Caccioli, et al., (2014), Stability Analysis of Financial Contagion due to Overlapping Portfolios, Journal of Banking & Finance, Vol. 46, pp. 233–245.

316

L. Allen, et al., (2012), The Impact of Joint Participation on Liquidity in Equity and Syndicated Bank Loan Markets, Journal of Financial Intermediation, Vol. 21, Issue 1, pp. 50–78; S. Battiston, et al., (2012), Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk, Journal of Economic Dynamics and Control, Vol. 36, Issue 8, pp. 1121–1141; J. Cai, et al., (2011), Syndication, Interconnectedness, and Systemic Risk, NYU Working Papers FIN-11-040, NYU; S.A. Dennis and D. J. Mullineaux, (2000), Syndicated Loans, Journal of Financial Intermediation, Vol. 9, Issue 4, pp. 404–426.

317

P.E. Mistrulli, (2011), Assessing Financial Contagion in the Interbank Market: Maximum Entropy Versus Observed Interbank Lending Patterns, Journal of Banking & Finance, Vol. 35, Issue 5, pp. 1114–1127; E. van Wincoop, (2013), International Contagion Through Leveraged Financial Institutions, American Economic Journal: Macroeconomics, Vol. 5, Issue 3, pp. 152–189.

318

M.B. Devereux, and J. Yetman, (2010), Leverage Constraints and the International Transmission of Shocks, Journal of Money, Credit and Banking, Vol. 42, pp. 71–105; C.H. Furfine, (2003), Interbank Exposures: Quantifying the Risk of Contagion, Journal of Money, Credit and Banking, Vol. 35, Issue 1, pp. 111–128.

319

B. Gadanecz, (2011), Have Lenders Become Complacent in the Market for Syndicated Loans? Evidence from Covenants, BIS Quarterly Review; R.D. Haas and N. V. Horen, (2012), International Shock Transmission After the Lehman Brothers Collapse: Evidence from Syndicated Lending, American Economic Review, Vol. 102, pp. 231–237.

320

M. Nirei et al., (2015), ibid., p. 2.

321

M. Nirei et al., (2015), ibid., p. 2.

322

See: M. Levine, (2014), Companies Don’t Need Banks for Loans, BloombergView, December 4; C.L. Culp, (2013), Syndicated Leveraged Loans During and After the Crisis and the Role of the Shadow Banking System, Journal of Applied Corporate Finance, Vol. 25, pp. 63–85. The buoyant US leveraged loan market is an example of one of the ‘benefits of shadow markets and securitization namely, the role of non-bank investors in diversifying the risk of credit creation while at the same time improving the price discovery process in different markets. The recent history of the U.S. leveraged loan market demonstrates that shadow banking system participants play a critical role in meeting the total demand for such loans, and that the ebbs and flows from institutional leveraged loan markets are strongly connected with the health and integrity of the underlying leveraged bank loan market.’

323

N. Harrisson and T. Walsch, (2014), Shadow Banks Taking Market Share in US Loan Market, Reuters, October 16. T. Braithwaite et al., (2014), Shadow banks step into the lending Void, Financial Times, June 17.

324

S. Aramonte et al., (2014), Risk Taking and Low Longer-Term Interest Rates: Evidence from the US Syndicated Loan Market, Working Paper December 5.

325

McKinsey Global Institute (MGI), (2015), Debt and (Not Much) Deleveraging, February, pp. 55–74.

326

See also: Y. Altunbaş, et al., (2009), Large Debt Financing: Syndicated Loans Versus Corporate Bonds, The European Journal of Finance, Vol. 16, pp. 437–458; T. Berg, et al., (2014), Mind the Gap… The Syndicated Loan Pricing Puzzle Revisited, Working Paper; M. Bradley and M. R. Roberts, (2004), The Structure and Pricing of Debt Covenants, Working Paper; R. Gropp, et al., (2014), The Impact of Public Guarantees on Bank Risk-Taking: Evidence from a Natural Experiment, Review of Finance, Vol. 18, pp. 457–488; V. Ivashina and D. Scharfstein, (2010), Loan Syndication and Credit Cycles, American Economic Review, Vol. 100, pp. 57–61; H. Parthasarathy, 2007), Universal Banking Deregulation and Firms’ Choices of Lender and Equity Underwriter, Working Paper.

327

See also: C. Laux and U. Walz, (2009), Cross-Selling Lending and Underwriting: Scope Economies and Incentives. Review of Finance, Vol. 13, pp. 341–367; J. Lim, et al., (2014), Syndicated Loan Spreads and the Composition of the Syndicate, Journal of Financial Economics, Vol. 111, pp. 45–69; D. Nandy and Pei Shao, (2010), Institutional Investment in Syndicated Loans, Working Paper.

328

M. Grupp, (2015), Taking the Lead: When Non-Banks Arrange Syndicated Loans, SAFE Working Paper Nr. 100, Goethe University, Frankfurt am Main, p. 1, 18–21, 26–29. He further concludes: ‘[i]n terms of loan syndicate composition, non-banks syndicate less often than banks (and keep those loan on their books at least when information about the borrower is available (ed.)). If they syndicate, however, they prefer, to a higher degree than banks, participants that help them to reduce information asymmetries. Finally, non-banks charge 105 basis points more than banks, which is a mark-up of around 38% compared to an average bank spread of 274 basis points. This mark-up is a compensation for serving more opaque borrowers, for higher information asymmetries between lead arranger and participants and it is countercyclical as it decreases if lending competition is lower and vice versa.’

329

L.D. Wall, (2014), Stricter Microprudential Supervision Versus Macroprudential Supervision, Federal Reserve Bank of Atlanta Working Paper, August 14.

330

See for a few examples of that V. Constâncio, (2015), Financial Stability Risks, Monetary Policy and the Need for Macro-Prudential Policy, Speech by Vítor Constâncio, vice president of the ECB, Warwick Economics Summit, 13 February 2015; V. Constâncio, (2015), Financial Integration and Macro-Prudential Policy, Speech by V. Constâncio, vice president of the ECB, at the joint conference organized by the European Commission and the European Central Bank, European Financial Integration and Stability, 27 April 2015.

331

P. Alessandri et al., (2015), Tracking Banks’ Systemic Importance Before and After the Crisis, Bank of Italy Occasional Papers Nr. 259.

332

See in detail: P. Danisewicz et al., (2015), On a Tight Leash: Does Bank Organizational Structure Matter for Macro-Prudential Spillovers, Bank of England Working Paper Nr. 524, February, in particular pp. 11–15.

333

C. Monnet and D.R. Sanches, (2015), Private Money and Banking Regulation, Federal Reserve Bank of Philadelphia, Working Paper Nr. 15–19, April. Their central question is: can a private banking system provide a socially efficient quantity of money?

334

I have commented before on the unsatisfying nexus between law and economic models; See: L. Nijs, (2015), Neoliberalism 2.0: Organizing and Financing Globalizing Markets. A Pigovian Approach to 21st Century Markets, Palgrave Macmillan, London, Chapter 4.

335

A fractional reserve system is a banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. To put it differently, the system allows banks to create more loans to the market than they have deposits and so on to back them. This is done to expand the economy by freeing up capital that can be loaned out to other parties. It also makes the system inherently unstable as a sudden withdrawal of deposits or other funding resources.

336

D.R. Sanches, (2015), On the Welfare Properties of Fractional Reserve Banking, Federal Reserve Bank of Philadelphia Working Paper Nr. 15–20.

337

J.J. Wang, (2015), Distress Dispersion and Systemic Risk in Networks, Carnegie Mellon University Working Paper, March 30, pp. 20–24. See also: D. Acemoglu, et al. (2015), Systemic Risk in Endogenous Networks, Working Paper; D. Acemoglu, et al., (2015), Systemic Risk and Stability in Financial Networks, American Economic Review Vol. 105, pp. 564–608.

338

J.J. Wang, (2015), ibid., p. 42.

339

M. Farboodi, (2014), Intermediation and Voluntary Exposure to Counterparty Risk, Working Paper.

340

J.J. Wang, (2015), ibid., p. 42.

341

J.J. Wang, (2015), Distress Dispersion and Systemic Risk in Networks, Carnegie Mellon University Working Paper, March 30, pp. 25–27.

342

J.J. Wang, (2015), ibid., pp. 28–31.

343

J. C. Coates IV, (2015), Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications, Yale Law Journal Vol. 124, Issue 4 pp. 882–1011.

344

The aforementioned Coates and secondly E. A. Posner and E. G. Weyl, (2013), Benefit-Cost Analysis for Financial Regulation, American Economic Review, Vol. 103, Issue 3, pp. 393–397; E.A. Posner et al. (2014), Benefit-Cost Paradigms in Financial Regulation, Journal for Legal Studies, Vol. 43, Issue S2, pp. S1–S34. J.H. Cochrane, (2014), Challenges for Cost-Benefit Analysis of Financial Regulation, Journal of legal Studies, Vol. 42, pp. S63–105.

345

See for a response: E. A. Posner & E. G. Weyl, (2015), Cost-Benefit Analysis of Financial Regulations: A Response to Criticisms, Yale Law Journal Forum, Vol. 124, pp. 246–264.

346

E. Lee, (2014), The Shadow Banking System: Why It Will Hamper the Effectiveness of Basel III, University of Hong Kong Working Paper. See also: E. Lee, (2014), Basel III and Its New Capital Requirements, as Distinguished from Basel II, Vol. 131, Issue 1, The Banking Law Journal, pp. 27–69; E. Lee, (2013), Basel III: Post-Financial Crisis International Financial Regulatory Reform, Journal of International Banking Law and Regulation Vol. 28, Issue 11, pp. 433–447.

347

C-Y Chang, (2015), Interbank Repo, Reverse and Regulations: Roles on the Run, Wellington University Working Paper, in particular pp. 20–22.

348

That seems in line with previous analysis regarding this matter: G. Gorton, (2010), E-Coli, Repo Madness, and the Financial Crisis, Business Economics, Vol. 45 Issue 3, pp. 164–173; G. Gorton and A. Metrick (2012), Who Ran on Repo?, NBER Working Paper Nr. 18,455.

349

C-Y Chang, (2015), ibid., p. 23.

350

C-Y Chang, (2015), ibid., p. 23; See also in detail: J. Stein, (2014), Monetary Policy as Financial Stability Regulations, Quarterly Journal of Economics, Vol. 127, pp. 57–95.

351

H.S. Shin and K. Shin, (2011), Procyclicality and Monetary Aggregates, NBER Working Paper Nr. 16,836 and J.-H. Hahm et al., (2011), Non-Core bank Liabilities and Financial Vulnerabilities, paper presented at the Federal Reserve Board and JMCB Conference on ‘Regulation of Systemic Risk’, Washington, DC.

352

B.-K. Kim, (2013), Central, Traditional and Shadow Banking in the Multiple Deposit Creation Scheme, Bank of Korea, Nr. 2013-10, pp. 22.

353

B. Gaille, (2015), In Praise of Ex-Ante Regulation, Boston College Law School, Legal Studies Research Paper Series, Nr. 354, March 13, Vanderbilt Law Review, Vol. 68, pp.

354

S.L. Schwarcz, (2011), Keynote & Chapman Dialogue Address: Ex Ante Versus Ex Post Approaches to Financial Regulation, Chapman Law Review, Vol. 15, pp. 258–269.

355

S.L. Schwarcz, (2015), Regulating Financial Change: A Functional Approach, Minnesota Law Review, Vol. 100, pp. 1441–1494; See also C. K. Whitehead, (2010), Reframing Financial Regulation, Boston University Law Review, Vol. 100, Issue 1, pp. 1–50.

356

I. Anatawi and S.L. Schwarcz, (2013), Regulating Ex-Post: How Law Can Address the Inevitability of Financial Failure, Texas Law Review, Vol. 92, pp. 75–131.

357

See on the specifics of systemic risk in regulation: S. L. Schwarcz, (2008), Systemic Risk, Georgetown Law Journal, Vol. 97, Issue 1, pp. 193–249.

358

See for a review: I. Anatawi and S.L. Schwarcz, (2013), ibid., pp. 93–101.

359

See for a review of ex post strategies for financial regulation: I. Anatawi and S.L. Schwarcz, (2013), ibid., pp. 102–121.

360

B. Galle, (2015), In Praise of Ex-Ante Regulation, Boston College Law School, Legal Studies Research Paper Nr. 354.

361

Galle, (2015), ibid., p. 2.

362

See also: T. Edgar, (2014), Corrective Taxation, Leverage, and Compensation in a Bloated Financial Sector, 33 Virginia Tax Revenue, Vol. 22, Issue 393, pp. 414–422.

363

Galle, (2015), ibid., p. 6.

364

Galle, (2015), ibid., pp. 38–39.

365

I. Anatawi and S.L. Schwarcz, (2013), ibid., p. 128.

366

I. Anatawi and S.L. Schwarcz, (2013), ibid., p. 128.

367

I. Anatawi and S.L. Schwarcz, (2013), ibid., p. 130.

368

That covers the financial sector but also directly adjacent industry like insurance: See, for example, D. Schwarcz and S.L. Schwarcz, (2014), Regulating Systemic Risk in Insurance, Chicago Law Review, Vol. 81, pp. 1569–1640; also see M. Dungey et al., (2014), The Emergence of Systemically-Important Insurers, Working Paper, November 2.

369

See for an extensive evaluation: S.L. Schwarcz, (2014), Systemic Risk and the Financial Crisis: Protecting the Financial System as a ‘System’, Working Paper; see also: S.L. Schwarcz, (2012), Controlling Financial Chaos: The Power and Limits of Law, Wisconsin Law Review, pp. 815–833, and S.L. Schwarcz, (2013), On Regulating Shadows: Financial Regulation and Responsibility Failure, Washington and Lee Law Review, Vol. 70, pp. 1781 ff; D.S. Bieri, (2014), Financial Stability Rearticulated: Institutional Reform, Post-Crisis Governance, and the New Regulatory Landscape in the United States, Working Paper, August.

370

See in detail: N.V. Okeye, (2015), Behavioural Risks in Corporate Governance: Regulatory Intervention as a Risk Management Mechanism, Routledge, London.

371

S.L. Schwarcz, (2014), Excessive Corporate Risk-Taking and the Decline of Personal Blame, Emory Law Journal, Vol. 65, Nr. 2 (December).

372

See in detail: S.L. Schwarcz, (2013), Ring-Fencing, Southern California Law Review, Vol. 87, pp. 69–109.

373

See also: T.R. Hurd, (2015), Contagion! The Spread of Systemic Risk in Financial Networks, McMaster University Canada Working Paper, February 2.

374

See for an application of these principles and testing of exposures to the specifics of the shadow banking sector: S.L. Schwarcz, (2014), Regulating Shadow Banking, Review of Banking and Financial Law, 2011-212, Vol. 31, pp. 619–642. Schwarcz asks the question as to what the role is of the lawyers active in the shadow banking sector: L. Schwarcz, (2013), Lawyer in the Shadows: The Transactional Lawyer in a World Of Shadow Banking, American University Law Review, Vol. 63, Issue 1, pp. 157–172: ‘to what extent should transactional lawyers address the potential systemic consequences of their client’s actions? The legal system itself inadvertently enables or requires firms operating as shadow banks to engage in uniquely risky behavior, without protecting against the resulting systemically risky externalities. That finding, in turn, broadens the legal ethics inquiry to two issues: what duty should transactional lawyers have to try to improve the legal system to protect against those externalities, and what duty should transactional lawyers have to try to prevent those externalities, assuming the legal system is not improved.’

375

S.L. Schwarz, (2013), Regulating Shadows: Financial Regulation and Responsibility Failure, Washington and Lee Law Review, Vol. 70, Issue 3, pp. 1781–1825.

376

S.L. Schwarcz, (2014), The Governance Structure of Shadow Banking: Rethinking Assumptions about Limited Liability, Notre Dame Law Review, Vol. 90, Issue 1, pp. 1–30.

377

J. Caruana, (2015), The International Monetary and Financial System: Eliminating the Blind Spot, Panel remarks at the IMF conference ‘Rethinking macro policy III: progress or confusion?’, Washington, DC, 16 April 2015, pp. 1–2.

378

J. Caruana, (2015), ibid., pp. 2–3.

379

D.B. Choi et al., (2015), Watering a Lemon Tree: Heterogeneous Risk Taking and Monetary Policy Transmission, NY FED Staff Reports, Nr. 724, April.

380

D.B. Choi et al., (2015), ibid., pp. 27–28.

381

D. Rheinhardt and R. Sowersbutt, (2015), Regulatory Arbitrage in Action: Evidence from Banking Flows and Macroprudential Policy, Bank of England Staff Working Paper Nr. 546.

382

D. Rheinhardt and R. Sowersbutt, (2015), ibid., pp. 21–22.

383

A.G. Haldane, (2015), Multi-Polar Regulation, International Journal of Central Banking, Vol. 11, Nr. 3 (June), pp. 385–401.

384

The most visible constraints post-crisis are (1) liquidity regulation: a core funding ratio (the so-called net stable funding ratio) and a maturity mismatch ratio (the so-called liquidity coverage ratio), (2) the leverage ratio, (3) the capital surcharge to be levied on the world’s largest, most complex, most interconnected banking institutions and (4) the capital conservation and countercyclical capital buffers (pp. 388–391). Their prime intention is to reduce network externalities.

385

A.G. Haldane, (2015), ibid., pp. 391–396.

386

D. Acemoglu, et al., (2015), Systemic Risk and Stability in Financial Networks, American Economic Review, Vol. 105, Issue 2, pp. 564–608.

387

For example, due to the cumulative nature of moral hazard problems over the network, small changes in collateral liquidity may result in significant drops in the financial system’s intermediation capacity, which leads to a total credit freeze; M. di Maggio and A. Tahbaz-Salehi, (2015), Financial Intermediation Networks, March. They further demonstrate that the financial system’s intermediation capacity crucially depends not only on the quality of assets used as collateral, but also on how such assets are distributed among different intermediaries. See also: A. Zawadowski, (2013), Entangled Financial Systems, Review of Financial Studies, Vol. 26, pp. 1291–1323.

388

See on all three counts: G. Alfonso, et al., (2014), Do ‘Too-Big-to-Fail’ Banks Take on More Risk? Economic Policy Review (Federal Reserve Bank of New York), Vol. 20, Issue 2, pp. 41–58; E. Farhi and F. Tirole, (2012), Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts, American Economic Review Vol. 102, issue 1, pp. 60–93.

389

D. Duffie, (2013), Capital Requirements with Robust Risk Weights, Speech given at the Brookings Institution, Washington, DC, October 31.

390

A.G. Haldane, (2015), ibid., p. 388, and J. Tinbergen, (1952), On the Theory of Economic Policy, Amsterdam, North-Holland; confirmed in a contemporary context: F. Smets, (2014), Financial Stability and Monetary Policy: How Closely Interlinked? International Journal of Central Banking, Vol. 10, Issue 2, pp. 263–300.

391

S.G. Cecchetti, (2015), The Road to Financial Stability: Capital Regulation, Liquidity Regulation, and Resolution, International Journal for Central Banking, Vol. 11, Nr. 3 (June), pp. 127–139.

392

R. Sahay et al., (2015), Rethinking Financial Deepening: Stability and Growth in Emerging Markets, IMF Staff Discussion Note, SDN/15/08, May, p. 5; J. De Gregorio, and P. Guidotti, (1995), Financial Development and Economic Growth, World Development Vol. 23, Issue 3, pp. 433–448; J. Eugster, (2014), Nonlinear Marginal Effects of Finance on Growth, Unpublished, International Monetary Fund.

393

S.G. Cecchetti and E. Kharroubi, (2015), Why Does Financial Sector Growth Crowd Out Real Economic Growth? BIS Working Paper Nr. 490, Bank for International Settlements, Basel; N. Gennaioli, et al., (2012), Neglected Risks, Financial Innovation, and Financial Fragility, Journal of Financial Economics Vol. 104, Issue 3, pp. 452–468.

394

R. Sahay et al., (2015), ibid., p. 5. See also: L. Angeles, (2015), Credit Expansion and the Real Economy, Applied Economics Letters pp. 1– 9; J.-L. Arcand, et al., (2012), Too Much Finance?, IMF Working Paper WP/12/161, International Monetary Fund Washington, DC; A. Barajas, et al., (2013), (2013), The Finance and Growth Nexus Re-examined: Do All Countries Benefit Equally?” IMF Working Paper 13/130, International Monetary Fund, Washington.

395

See in detail: R. Sahay et al., (2015), ibid., pp. 15–23. R. Levine, (2005), Finance and Growth: Theory and Evidence, In Handbook of Economic Growth, (eds.) by Ph. Aghion et al., Elsevier, New York, pp. 865–934. R. Levine, et al., (2000), Finance and the Sources of Growth, Journal of Financial Economics, Vol. 58 (1/2), pp. 261–300; N. Loayza, and R. Ranciere, (2006), Financial Development, Financial Fragility, and Growth, Journal of Money, Credit and Banking Vol. 38, Issue 4, pp. 1051–1076.

396

R. Sahay et al., (2015), ibid., pp. 5 and 24–27.

397

R. Sahay et al., (2015), ibid., pp. 10–11. See also in depth on shadow banking in emerging economies: IMF, (2014), Shadow Banking around the Globe: How Large and How Risky? In Global Financial Stability Report, Washington, October.

398

R. Sahay et al., (2015), ibid., p. 30; see also: IMF, (2014), How Do Changes in the Investor Base and Financial Deepening Affect Emerging Market Economies? In Global Financial Stability Report, Washington, April; 2013. T. Philippon and A. Reshef, (2013), An International Look at the Growth of Modern Finance, Journal of Economic Perspectives Vol. 27, Issue 2, pp. 73–96.

399

Standard and Poor’s, (2013), Out of the Shadows: The Rise of Alternative Financing in Infrastructure, January, pp. 2–4.

400

Mainly through the NSFR, the liquidity standard introduced by Basel III.

401

See also: C. M. McNamara and A. Metrick, (2015), Basel III G: Shadow Banking and Project Finance, Case Study 2014-1G-V1, Yale Program on Financial Stability.

402

M. Grupp, (2015), On the Impact of Leveraged Buyouts on Bank Systemic Risk, SAFE Working Paper Nr. 101, Goethe University, Frankfurt am Main, April. See also: L. Allen, et al., (2012), Does Systemic Risk in the Financial Sector Predict Future Economic Downturns? Review of Financial Studies, Vol. 25, pp. 3000–3036. D. Anginer, (2014), How Does Competition affect Bank Systemic Risk? Journal of Financial Intermediation, Vol. 23, pp. 1–26. U. Axelson, et al., (2013), Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts, The Journal of Finance, Vol. 68, pp. 2223–2267; Th. Beck, and O. De Jonghe, (2013), Lending Concentration, Bank Performance and Systemic Risk: Exploring Cross-Country Variation, World Bank Policy Research Working Paper, WPS6604.

403

M. Grupp, (2015), pp. 9–13. See also: M. Billio, et al., (2012), Econometric Measures of Connectedness and Systemic Risk in the Finance and Insurance Sectors, Journal of Financial Economics, Vol. 104, pp. 535–559; M. Brunnermeier, et al., (2012), Banks’ Non-Interest Income and Systemic Risk, Working Paper; J. Cai, Jian, et al., (2014), Syndication, Interconnectedness, and Systemic Risk, Working Paper; N. Dass, and M. Massa, (2011), The Impact of a Strong Bank-Firm Relationship on the Borrowing Firm. Review of Financial Studies, Vol. 24, pp. 1204–1260.

404

See in detail: J. Lim, et al., (2014), Syndicated Loan Spreads and the Composition of the Syndicate, Journal of Financial Economics, Vol. 111, pp. 45–69; G. López-Espinosa, et al., (2012), Short-Term Wholesale Funding and Systemic Risk: A Global CoVaR Approach, Journal of Banking & Finance, Vol. 36, pp. 3150–3162; T. Tykvová, and M. Borell, (2012), Do Private Equity Owners Increase Risk of Financial Distress and Bankruptcy? Journal of Corporate Finance, Vol. 18, pp. 138–150.

405

See also: Adams, R.F. Zeno, and R. Gropp, (2014), Spillover Effects Among Financial Institutions: A State-Dependent Sensitivity Value-at-Risk Approach, Vol. 49, pp. 575–598; F. Allen and E. Carletti, (2013), What Is Systemic Risk? Journal of Money, Credit and Banking, Vol. 45, pp. 121–127; S. Bharath, et al., (2011), Lending Relationships and Loan Contract Terms, Review of Financial Studies, Vol. 24, pp. 1141–1203.

406

See in detail: P. Beaudry and A. Lahiri, (2009), Risk Allocation, Debt Fueled Expansion and Financial Crisis, NBER Working Paper Nr. 15,110, p. 2.

407

R.P. Buckley, (2015), The Changing Nature of Banking and Why It Matters, in Rethinking Global Finance and Its Regulation, (eds.) R. Buckley, et al., Cambridge University Press, Cambridge, pp. 14–15.

408

See for a review: R.P. Buckley, (2015), ibid., pp. 16–22.

409

S. Walby, (2013), Finance Versus Democracy? Theorizing Finance in Society, Work Employment and Society, Vol. 27, Nr. 3, pp. 489 ff.

410

R.P. Buckley, (2015), ibid., p. 23.

411

M. Behn et al., (2014), The Limits of Model-Based Regulation, SAFE Working Paper Nr. 75, Goethe University Frankfurt. Keep in mind that following the reform banks were allowed to choose between the model-based approach (referred to as the internal ratings-based approach, shortened to IRB) in which capital charges depend on internal risk estimates of the bank and a more traditional approach that does not rely on internal risk parameters (referred to as the standard approach, shortened to SA).

412

J.V. Duca, (2014), How Capital Regulation and Other Factors Drive the Role of Shadow Banking in Funding Short-Term Business Credit, Working Paper, mimeo.

413

Wang suggests to include ‘regulatory arbitrage’ as a risk measurement when determining the levels of regulatory capital required. When a risk measure is applied to calculate regulatory capital requirement, the magnitude of regulatory arbitrage is the amount of possible capital requirement reduction through splitting a financial risk into several fragments. Coherent risk measures by definition are free of regulatory arbitrage; dividing risks will not reduce the total capital requirement under a coherent risk measure. However, risk measures in practical use, such as the Value at Risk (VaR), are often not coherent and the magnitude of their regulatory arbitrage is then of significant importance. Wang developed a coherent mathematical model and illustrates (pp. 21–22) its application under each classification and for all classes of risk measures including distortion risk measures and convex risk measures; see R. Wang, (2015), Regulatory Arbitrage of Risk Measures, University of Waterloo Working Paper, July 3, mimeo.

414

J.V. Duca, (2014), ibid., 31.

415

See further: T. Adrian, and H. S. Shin, (2010), Liquidity and Leverage, Journal of Financial Intermediation, Vol. 19, pp. 418–437; T. Adrian and H. S. Shin, (2009), Money, Liquidity, and Monetary Policy, American Economic Review, Vol. 99, Issue 1, pp. 600–609; T. Adrian and H. S. Shin, (2009), The Shadow Banking System: Implications for Financial Regulation, Banque de France Financial Stability Review Vol. 13, pp. 1–10; S. Claessens, et al., (2012), Shadow Banking: Economics and Policy, IMF Staff Discussion Note Nr. SD/12/12; P. Jackson, (2013), Shadow Banking and New Lending Channels—Past and Future, in 50 Years of Money and Finance: Lessons and Challenges. Vienna: The European Money and Finance Forum, pp. 377–414; E.S. Rosengren, (2014), Our Financial Structures—Are They Prepared for Financial Stability?, Journal of Money, Credit, and Banking Vol. 46 (s1), pp. 143–56; A. Schleifer and R. W. Vishny, (2010), Unstable Banking, Journal of Financial Economics, Vol. 97, pp. 306–318.

416

J.V. Duca, (2014), ibid., 32.

417

M. Singh, (2012), ‘Puts’ in the Shadow, IMF Working Paper Nr. WP/12/229, p. 5.

418

See Singh, (2012), ibid., pp. 7–14.

419

See Singh, (2012), ibid., pp. 17–19; see also: M. Singh and P. Stella, (2012), Money and Collateral, IMF Working Paper Nr. WP/12/95, and M. Ricks, (2011), Regulating Money Creation After the Crisis, Harvard Law School, Working Paper. Singh refers to the creation of CCPs to reduce counterparty risk, the fact that MMFs still can offer NAV par funds and bailing out money-like collateral at subsidized haircuts, thereby referring to the US and European bailout programs that were initiated after the crisis (LTRO, etc.). They all are prone to ‘ambiguity’ if the government will step in and under what conditions.

420

M. Mazzucato and L.R. Wray, (2015), Financing the Capital Development of the Economy: A Keynes Schumpeter-Minsky Synthesis, Levy Economics Institute of Bard College, Working Paper Nr. 837, May.

421

J. Caruana, (2015), The International Monetary and Financial System: Eliminating the Blind Spot, Panel remarks at the IMF conference ‘Rethinking Macro Policy III: Progress or Confusion?’ Washington. DC, 16 April 2015, pp. 2–3.

422

See in detail: J. Caruana, (2015), ibid., pp. 3–4.

423

U. Bindseil and W.R. Nelson (Chair), (2015), Regulatory Change and Monetary Policy, Report submitted by a Working Group established by the Committee on the Global Financial System and the Markets Committee, CGFS Papers Nr. 54, May, p. iii.

424

U. Bindseil and W.R. Nelson (Chair), (2015), ibid., p. 1.

425

See for a distinct and detailed analysis: U. Bindseil and W.R. Nelson (Chair), (2015), ibid., pp. 12–21 & 22–32 & 33–39.

426

R. Vermeulen et al., (2015), Financial Stress Indices and Financial Crises, DNB Working Paper Nr. 469, March.

427

See for a complete overview of types and implications of the different crises: S. Claessens and M.A. Kose, (2013), Financial Crises: Explanations, Types and Implications, IMF Working Paper Nr. WP/13/28.

428

See for the literature re financial crises: I. Goldstein, (2013), Empirical Literature on Financial Crises: Fundamentals vs. Panic, Financial Crisis Review, pp. 523–534.

429

See: L. Alessi, et al., (2014), Central Bank Macroeconomic Forecasting During the Global Financial Crisis: The European Central Bank and Federal Reserve Bank of New York Experiences, Federal Reserve Bank of New York Staff Reports Nr. 680, July.

430

N. Gennaioli et al., (2014), Neglected Risk: The Psychology of Financial Crises, Working Paper, p. 1, also published as NBER paper Nr. 20875, January 2015.

431

J. Coval, et al., (2009), The Economics of Structured Finance, Journal of Economic Perspectives Vol. 23, pp. 3–26.

432

C. Foote, et al., (2012), Why Did So Many People Make So Many Ex-Post Bad Decisions? The Causes of the Foreclosure Crisis, Working paper, Federal Reserve Bank of Boston.

433

R. Greenwood, and A. Shleifer (2014), Expectations of Returns and Expected Returns, Review of Financial Studies Vol. 27, Issue 3, pp. 714–746.

434

N. Gennaioli et al., (2014), ibid., p. 2. See also: N. Gennaioli, et al., (2012), Neglected Risks, Financial Innovation and Financial Fragility, Journal of Financial Economics Vol. 104, Issue 3, pp. 452–468.

435

D. Kahneman and A. Tversky, (1972), Subjective Probability: A Judgment of Representativeness, Cognitive Psychology Vol. 3, Issue 3, pp. 430–454: When the investor assesses risk by representativeness, he overreacts to good news; N. Barberis, et al., (1998), A Model of Investor Sentiment, Journal of Financial Economics Vol. 49, Issue 3, pp. 307–343; P. Bordalo, et al., (2014), Stereotypes, NBER Working Paper.

436

See on the gender difference in this matter: F. D’Acunto, (2014), Identity, Overconfidence and Investment Decisions, Working Paper, November.

437

N. Gennaioli et al., (2014), ibid., p. 2. As a financial crisis tends to typically follow economic boom times, ‘the investor then puts too much probability weight on that scenario and neglects the risk of bad outcomes’. The expectations are elicited and they assess things ‘extrapolative’. Even bad news mixed with all the good news doesn’t change investor minds, which explains their ‘numb’ behavior. Bad news is seen as an aberration.

438

Gennaioli et al., (2014), ibid., p. 3.

439

Gennaioli et al., (2014), ibid., p. 7.

440

And a professor in finance at the Chicago Booth School of Business.

441

M. Wolf, (2015), Why Finance Is Too Much of a Good Thing, Financial Times, May 26.

442

N.C. Foley-Fisher et al., (2015), Self-Fulfilling Runs: Evidence from the U.S. Life Insurance Industry, Finance and Economics Discussion Series Nr. 2015-032, Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, DC.

443

J. Bryant, (1980), A Model of Reserves, Bank Runs, and Deposit Insurance, Journal of Banking & Finance, pp. 335–344.

444

D. W. Diamond and P.H. Dybvig, (1983), Bank Runs, Deposit Insurance, and Liquidity, Journal of Political Economy Vol. 91, Issue 3, 401–419.

445

N.C. Foley-Fisher et al., (2015), ibid., p. 2.

446

N.C. Foley-Fisher et al., (2015), ibid., p. 4.

447

N.C. Foley-Fisher et al., (2015), ibid., p. 5.

448

See on the distinction between regulation and supervision: D. Masciandaro and M. Quintyn, (2013), 8. The Evolution of Financial Supervision: The Continuing Search for the Holy Grail, SUERF 50th Anniversary Volume Chapters, pp. 263–318. F.S. Mishkin, (2001), Prudential Supervision: Why Is It Important and What Are the Issues? In Prudential Supervision: What Works and What Doesn’t, University of Chicago Press, Chicago, pp. 1–30.

449

See, for example, recently: T. Eisenbach et al., (2015), Supervising Large, Complex Financial Institutions: What Do Supervisors Do?, Federal Reserve Bank of New York Staff Reports, Nr. 729, May

450

L. H Meyer, (2000), The Challenges of Global Financial Institution Supervision, Speech by Mr. Laurence H. Meyer, Member of the Board of Governors of the US Federal Reserve System, at the Federal Financial Institutions Examination Council, International Banking Conference, held in Arlington, Virginia, on 31 May 2000 and more recently J.L. Yellen, (2015), Improving the Oversight of Large Financial Institutions, At the Citizens Budget Commission, New York, 3 March 2015. She indicates: ‘[t]o be effective, regulation and supervision must be independent of the entities subject to oversight. You may know or have heard the term “regulatory capture.” Regulatory capture is when a regulatory agency advances the interests of the industry it is supposed to oversee rather than the broader public interest it should represent.’ ‘Regulatory capture’ was first coined and thematically addressed by G. J. Stigler, (1971), The Theory of Economic Regulation, Bell Journal of Economics and Management Science, Vol. 2 (Spring), pp. 3–21; see also E. Dal Bó, (2006), Regulatory Capture: A Review, Oxford Review of Economic Policy, Vol. 22 (Summer), pp. 203–225.

451

Some, given the experiences of the behavior of the global financial markets in 2007/2008, refer to the globalized financial market as a ‘giant slush fund’.

452

See, for example, J. DeLisle, et al., (2014), Volatility as an Asset Class: Holding Vix in a Portfolio, Working Paper, December.

453

See: C. Wilkins, (2015), Liquid Markets for a Slid Economy, Remarks by Carolyn Wilkins Senior Deputy Governor of the Bank of Canada, Chambre de commerce du Montréal métropolitain, 5 May, Montréal, Quebec.

454

J. Brunsdun, (2015), Bank-Separation Talks Hit Snag in EU Parliament, Bloomberg, April 29.

455

Bankenverband, (2014), Shadow Banking, A Guide by the Association of German banks, January, Berlin; CFA Institute, (2015), Shadow Banking, Policy Frameworks and Investor Perspectives on Markets-Based Finance, April.

456

The most notable being: J.E. Stiglitz, (2015), Re-writing the Rules of the American Economy. An Agenda for Growth and Shares Prosperity, pp. 28–32 and 62–67. Its European Counterpart is Ambrosetti Club, (2015), Finance for Growth, The European House, Milan.

457

L. Elliott, (2015), Taxing Times: Banks Are the Golden Goose That Won’t Hiss Too Much, The Guardian, April 5.

458

F. Boldizzoni, (2013), On History and Policy: Time in the Age of Neoliberalism, MPIfG Discussion Paper, Nr. 13/6. And the comment of Streeck: W. Streeck, (2015), Comment on ‘On History and Policy: Time in the Age of Neoliberalism’, Journal of the Philosophy of History Vol. 9, pp. 33–40.

459

Including society as a system; see: Philip Stephens, (2014), Nothing Can Dent the Divine Right of Bankers, Financial Times, January 16.

460

A. Moreira and A. Savov, (2014), The Macroeconomics of Shadow Banking, Working Paper, mimeo; later on published in The Journal of Finance (2017), Vol 72, Issue 6, pp. 2381–2432.

461

The starting point was the green book issued in February 2015: see: EC, (2015), Green Paper, Building a Capital Markets Union, COM(2015) 63 final, February 18. See for an analysis and evaluation: N. Véron and G. B. Wolff, (2015), Capital Markets Union: A Vision for the Long-term, Bruegel Policy Contribution, Issue 2015/5, April.

462

O. Kaya, (2014), SME financing in the euro area. New solutions to an old problem, Deutsche Bank Research, October 18.

463

Industry-level analysis of the cost of debt funding is structurally lower in the US than in Europe.

464

G20, (2015), SME Debt Financing beyond Bank Lending: The Role of Securitization, Bonds and Private Placements, Working Paper; see also: I. K. Nassr and G. Wehinger, (2014), Non-Bank Debt Financing for SMEs: The Role of Securitisation, Private Placements and Bonds, OECD Journal: Financial Market Trends Vol. 2014/1, pp. 139–159.

465

W. Perraudin, (2014), High Quality Securitisation: An Empirical Analysis of the PCS Definition, Risk Control Limited, July 1.

466

Nevertheless, it seems that informational rent extraction is positively associated with collateral holdings by banks; see B. Xu et al., (2015), Do Banks Extract Informational Rents Through Collateral, BIS Working Paper Nr. 522, October.

467

Center for the Study of Financial Innovation, (2014), Securitisation and SME lending. A CSFI roundtable discussion with Richard Hopkin (AFME), Ramnik Ahuja (Bank of England), Hugh Savill (ABI), Monique Ebell (NIESR) and Andy Davis (Prospect), Held on Monday, 13 October 2014, p. 2.

468

AFME, (2014), High-Quality Securitisation for Europe. The Market at a Crossroads, June.

469

See in detail: C. Dannreuther, (2015), We Need a Democracy of Credit for SMEs. After the Lack of Demand in the EU Economy, the Key Problem Facing SMEs Is a Lack of Access to Finance, April.

470

G. Jackson, (2015), Europe’s Corporate Borrowers Look to Capital Market Union, Financial Times, May 27.

471

J. Shotter and C. Jones, (2015), ECB Warns of Risks Posed by Shadow Banking Sector, Financial Times, May 28.

472

ECB, (2015), Financial Stability Review, May, Frankfurt, pp. 12–14, 87–88, 98–100, 103–106, 126, 132.

473

See for an overview: ECB, (2015), ibid., p. 132.

474

Or ‘attempted to address’ is likely the better qualification.

475

F. Restoy, (2015), The Financial Sector and the Banking Union, Speech by Fernando Restoy, Deputy Governor of the Bank of Spain, at the Círculo Financiero, organized by La Caixa, Barcelona, 18 May 2015.

476

Ph. Baccetta et al., (2015), Self-Fulfilling Debt Crises: Can Monetary Policy Really Help, Working Paper January 19.

477

See also: M. Aguiar, et al., (2013), Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crisis, Working Paper, Harvard University; A. Camous, and R. Cooper, (2014), Monetary Policy and Debt Fragility, NBER Working Paper Nr. 20,650; D. Cohen, and S. Villemot, (2011), Endogenous Debt Crises, CEPR Discussion Paper Nr. 8270; G. Corsetti and L. Dedola, (2014), The Mystery of the Printing Press: Monetary Policy and Self-Fulfilling Debt Crises, Working Paper, Cambridge University; P. de Grauwe, (2011), The Governance of a Fragile Eurozone, CEPS Working Documents, CEPS, Brussels; P. de Grauwe and Juemei Ji, (2013), Self-Fulfilling Crises in the Eurozone: An Empirical Test, Journal of International Money and Finance Vol. 34, pp. 15–36; J. Hilscher, et al., (2014), Inflating Away the Public Debt? An Empirical Assessment, NBER Working Paper Nr. 20,339; G. Lorenzoni, and I. Werning, (2014), Slow Moving Debt Crises, Working Paper, Northwestern University; K. Sheedy, (2014), Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting, Brookings Papers on Economic Activity, Spring 2014.

478

N. Anderson et al., (2015), A European Capital Market Union: Implications for Growth and Stability, Financial Stability Paper, February 2015, London.

479

N. Anderson et al., (2015), ibid., p. 18.

480

T. Hale, (2015), Eurozone Securitisation Prospects Remain Slim, Financial Times, June 11.

481

T. Hale, (2015), New Regulatory Measures Anger European Securitisation Industry, Financial Times, May 17.

482

N. Cassolo and F. Koulisher, (2013), The Collateral Channel of Monetary Policy: Evidence from the European Central Bank, Working Paper, December. See also: V.V. Acharya and S. Steffen, (2013), The Greatest Carry Trade Ever? Understanding Eurozone Bank Risks, National Bureau of Economic Research Working Paper Series, Nr. 19,039; E. Farhi and J. Tirole, (2012), Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts, The American Economic Review, Vol. 102, pp. 60–93.

483

K. Knot, (2015), How Capital Markets Union Can Bolster Monetary Union, Speech by Mr. Klaas Knot, President of the Netherlands Bank, at the 47th International Capital Markets Association meeting and conference, Amsterdam, 4 June 2015, p. 2.

484

S. Langfield and M. Pagano, (2015), Bank Bias in Europe: Effects on Systemic Risk and Growth, ECB Working Paper Nr. 1797, Frankfurt, May.

485

S. Langfield and M. Pagano, (2015), ibid., pp. 3–4.

486

See for a weighting of the argument regarding bank-versus market-based financial systems, see: S. Langfield and M. Pagano, (2015), ibid., pp. 5–8.

487

S. Langfield and M. Pagano, (2015), ibid., p. 2.

488

The buildup of risk before financial crises and the sensitivity of economic activity to financial shocks is therefore expected to be larger in bank-based than in market-based structures.

489

See for details regarding these two core principles: S. Langfield and M. Pagano, (2015), ibid., pp. 8–14 (principle 1) and pp. 14–18 (principle 2).

490

The increase in systemic risk is particularly strong when real house prices drop by more than 10%, reflecting the importance of housing as collateral (p. 2).

491

The bank dominance in Europe is not an industry-wide problem but mostly one of large bank dominating the industry. See for an evaluation: S. Langfield and M. Pagano, (2015), ibid., pp. 18 ff. including the arguments why the industry has developed as such. Regulatory support is a dominant argument (see also: F.J. Lambert, et al., [2014}, ‘How Big Is the Implicit Subsidy for Banks Considered too Important to Fail?’ Chapter 3 in Global Financial Stability Report, International Monetary Fund, April). Other arguments for the specific bank dominance in Europe (since regulatory support is common around the world and therefore cannot account for the European dominance specifically) are the fact that more than elsewhere the ‘universal bank concept’ is dominant in Europe as well as the understanding that banks have played a more than critical role in the European integration efforts that occurred in recent decades and on the back of which they have grown disproportionately large. See for details on these arguments: M. Pagano, et al., (2014), Is Europe Overbanked?, Report Nr. 4 of the European Systemic Risk Board’s Advisory Scientific Committee; P. R. Lane, (2013), Capital Flows in the Euro Area, EU Commission Economic Papers Nr. 497; P. R. Lane, and P. McQuade, (2014), Domestic Credit Growth and International Capital Flows, Scandinavian Journal of Economics, Vol. 116, Issue 1, pp. 218–252. Banks have grown so large because they were politically endorsed as ‘national champions’ (N. Véron, (2013), Banking Nationalism and the European Crisis, Bruegel Policy Paper, Brussels). The national sovereign for a long time was dependent on them for financing and the board was considerably politically dominated.

492

Specifically they indicate ‘[u]seful steps towards this capital markets union would include the integration of stock trading platforms in Europe; a reduction of the fixed costs faced by small and medium firms in accessing capital markets; greater standardization of corporate bond issues and private placement transactions; and measures to improve the depth and quality of asset-backed securities markets’ (p. 2).

493

See in detail: S. Langfield and M. Pagano, (2015), ibid., pp. 22–28.

494

See: S. Alifanov, (2015), On the Dangers Inherent in a Fractional Reserve Banking System, The Student Economic Review Vol. XXIX, pp. 117–124.

495

A contrario, see: V.V. Chari and C. Phelan, (2014), On the Social Usefulness of Fractional Reserve Banking, Journal of Monetary Economics, Vol. 65, pp. 1–13.

496

P. Lowe, (2015), The Transformation in Maturity Transformation, Address by Philip Lowe, Deputy Governor of the Reserve Bank of Australia, to Thomson Reuters’ 3rd Australian Regulatory Summit, Sydney, 27 May 2015. He reports: ‘[t]he transformation of claims over fundamentally illiquid assets into claims that are highly liquid is one of the critical functions that the financial sector provides for the community. Without such transformation, it is difficult to see how modern economies would work. This transformation has been critical to the accumulation of physical capital in our societies as well as the operation of our modern payment systems’ (p. 1).

497

S. Fischer, (2015), The Importance of the Nonbank Financial Sector, Remarks by Stanley Fischer Vice Chairman Board of Governors of the Federal Reserve System at a conference on ‘Debt and Financial Stability—Regulatory Challenges’ sponsored by the Bundesbank and the German Ministry of Finance, Frankfurt, Germany, March 27.

498

See f.e. also S. Schwarcz, (2015), Banking and Financial Regulation, in The Oxford Handbook of Law and Economics, Francesco Parisi, (ed.), Oxford University Press, Oxford, pp. 19–21.

499

See, for example, A. Penalver, (2013) Managing Maturity Transformation Under Aggregate Uncertainty, Paris School of Economics Working Paper; A. Segura and J. Suarez (2013), Recursive Maturity Transformation, Working Paper September; S. Krieger, (2011), Shadow Maturity Transformation and Systemic Risk, Federal Reserve Bank of NY, March 8; T. Paligorova and J.A.C. Santos, (2014), Rollover Risk and the Maturity Transformation Function of Banks, Bank of Canada/Banque de Canada Working paper Nr. 2014/8; A. Segura and J. Suarez, (2014), How Excessive Is Bank’s Maturity Transformation, Working paper, November.

500

J.C. Williams, (2015), Macro-Prudential Policy in a Microprudential World, FRBSF Economic Letter Nr. 2015-18, June 1, pp. 4–5.

501

V. Constâncio, (2015), Monetary Policy and the European Recovery, Speech by Vítor Constâncio, Vice President of the European Central Bank, at the XXXI Reunión Círculo de Economía, Barcelona, 30 May 2015, p. 4.

502

See in detail on money creation: M. McLeay, et al. (2014), Money in the Modern Economy: An Introduction, Bank of England Quarterly Bulletin, Vol. 54, Issue 1, pp. 4–13, and M. McLeay, et al., (2014), Money Creation in the Modern Economy, Bank of England Quarterly Bulletin, Vol. 54, Issue 1, pp. 14–27; R. Werner, (2014), Can Banks Individually Create Money Out of Nothing? The Theories and the Empirical Evidence, International Review of Financial Analysis, Vol. 36, pp. 1–19; R. Werner, (2014), How Do Banks Create Money, and Why Can Other Firms Not Do the Same?, International Review of Financial Analysis, Vol. 36, pp. 71–77.

503

Z. Jakab and M. Kumhof, (2015), Banks Are Not Intermediaries of Loanable Funds—and Why This Matters, Bank of England Working Paper Nr, 529, May, revised in 2018. In the loan intermediation model, bank loans represent the intermediation of real savings, or loanable funds, between nonbank savers and nonbank borrowers. But in the real world, the key function of banks is the provision of financing, or the creation of new monetary purchasing power through loans, for a single agent that is both borrower and depositor. The bank therefore creates its own funding, deposits, in the act of lending, in a transaction that involves no intermediation whatsoever (p. ii).

504

Z. Jakab and M. Kumhof, (2015), ibid., pp. ii–iii. See also: T. Adrian and N. Boyarchenko, (2013), Intermediary Leverage Cycles and Financial Stability, Federal Reserve Bank of New York Staff Reports, Nr. 567; T. Adrian, et al., (2013), Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007 to 2009, NBER Macroeconomics Annual, Vol. 27, pp. 159–214; L. Christiano, et al., (2014), Risk Shocks, American Economic Review, Vol. 104, Issue 1, pp. 27–65; E. Chrétien and V. Lyonnet, (2014), Fire Sales and the Banking System, Working Paper, École Polytechnique, Paris; F. Lindner, (2013), Does Saving Increase the Supply of Credit? A Critique of Loanable Funds Theory, Working Paper, IMK; A. Martin and J. Ventura, (2012), Economic Growth with Bubbles, American Economic Review, Vol. 102, Issue 6, pp. 3033–3058.

505

R. Cooper and K. Nikolov, (2014), Government Debt and Banking Fragility: The Spreading of Strategic Uncertainty, Unpublished Working Paper; E. Farhi and J. Tirole, (2014), Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops, Unpublished Working Paper, Harvard University.

506

See: V.V. Acharya and S. Steffen, (2015), The Greatest Carry Trade Ever? Understanding Eurozone Bank Risks, Journal of Financial Economics Vol. 115, Issue 2, pp. 215–236; P. Augustin, et al., (2015), Corporate to Sovereign Risk Spillover. Unpublished Working Paper; L. Benzoni, et al., (2015), Modeling Credit Contagion via the Updating of Fragile Beliefs: An Investigation of the European Sovereign Crisis, Federal Reserve bank of Chicago Working Paper Nr. WP/2012-04 (also in The Review of Financial Studies, Vol. 28, Issue 7, pp. 1960–2008).

507

H.-Johannes Breckenfelder and Bernd Schwaab, (2015), The Bank-Sovereign Nexus Across Borders, Working Paper, May 21.

508

F. Eser and B. Schwaab, (2015), Evaluating the Impact of Unconventional Monetary Policy Measures: Empirical Evidence from the ECB’s Securities Markets Programme. Journal of Financial Economics, Elsevier, Vol. 119, Issue 1, pp. 147–167; M. Fratzscher and M. Rieth, (2015), Monetary Policy, Bank Bailouts and the Sovereign-Bank Risk Nexus in the Euro Area, DIW Discussion Paper Nr. 1448; A. Krishnamurthy, et al., (2014), ECB Policies Involving Government Bond Purchases: Impact and Channels, Working Paper; A. Leonello, (2014), Government Guarantees and the Two-Way Feedback Between Banking and Sovereign Debt Crises, Working Paper; A. Lucas, et al., (2014), Conditional Euro Area Sovereign Default Risk, Journal of Business and Economics Statistics Vol. 32, Issue 2, pp. 271–284.

509

G. di Iaso and Z. Pozsar, (2015), A Model of Shadow Banking: Crises, Central Banks and Regulation, Working Paper, May 18. They indicate that within the current financial infrastructure the ‘complex shadow banking model provides the equilibrium (when the demand for parking space from cash pools – as compared to the supply of sovereign bonds – and the demand for returns from entities with ALMs are high)’. This is caused by two structural dynamics: (1) the increasing demand of institutional cash pools for risk-free assets (sovereign bonds and shadow collateral) and (2) the proliferation of balance sheets with asset-liability mismatches (ALMs), like those of insurance companies and pension funds; these entities have liabilities in fixed nominal amount and, in a low-yield environment, seek to allocate funds to bankers which deliver leverage-enhanced returns.

510

G. di Iaso and Z. Pozsar, (2015), ibid., pp. 6–10.

511

G. di Iaso and Z. Pozsar, (2015), ibid., pp. 10–20.

512

That has material policy implications in particular for capital and liquidity regulation: G. di Iaso and Z. Pozsar, (2015), ibid., pp. 20–24. They indicate ‘a central bank focused on financial stability can fulfill that mandate actively managing its balance sheet by absorbing via reverse repo programs some of the demand for parking space from institutional cash pools. In the model, this type of policy intervention drives up the banks’ cost of the leverage sourced from institutional cash pools, and reduces incentives in pursing strategies which deliver high-leverage-enhanced returns in good times at the cost of massive deleveraging in the case of aggregate shocks’ (pp. 25–26).

513

G. di Iaso and Z. Pozsar, (2015), ibid., p. 25. See also: G. Di Iasio and F. Pierobon, (2013), Shadow Banking, Sovereign Risk and Bailout Moral Hazard, Bank of Italy (February).

514

G. di Iaso and Z. Pozsar, (2015), ibid., p. 25.

515

FSB, To G20 Finance Ministers and Central Bank Governors Financial Reforms – Progress on the Work Plan for the Antalya Summit, Basel, pp. 2–4.

516

Ø. Olsen, (2015), Integrating Financial Stability and Monetary Policy Analysis, Speech by Mr. Øystein Olsen, Governor of Norges Bank (Central Bank of Norway), at the Systemic Risk Centre, London School of Economics, London, 27 April 2015.

517

M. Čihák and H. Hesse, (2008), Islamic Banks and Financial Stability: An Empirical Analysis, IMF Working paper nr. WP/08/18. Specifically they conclude that ‘(i) small Islamic banks tend to be financially stronger than small commercial banks; (ii) large commercial banks tend to be financially stronger than large Islamic banks; and (iii) small Islamic banks tend to be financially stronger than large Islamic banks’. A contrario: A. López Mejía, et al., (2014), Regulation and Supervision of Islamic Banks, IMF Working Paper, WP/14/219. Their focus is more on the specific Islamic risk embedded in Islamic contracts: (1) shariah compliance risk, (2) equity investment risk, (3) rate of return risk, (4) displaced commercial risk and the fact that common risk seems to be more pronounced in Islamic banks—(1) credit risk, (2) operational risk, (3) liquidity risk and (4) transparency risk. Given the above, it doesn’t really nullify the benefits of Islamic banking as a system over the conventional model. Most of the argumentation has been done through the lens of a conventional banking model which implied their results. See H. Askari et al., (2010), The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future, Wiley & Sons (Asia) Pte. Ltd.

518

M.I. Tabash and R.S. Dhankar, (2014), The Impact of Global Financial Crisis on the Stability of Islamic Banks: An Empirical Evidence, Journal of Islamic Banking and Finance, Vol. 2, Nr. 1 (March), pp. 367–388.

519

A. Kammer, et al., (2015), Islamic Finance: Opportunities, Challenges, and Policy Options, IMF Staff Discussion Note Nr. SDN/15/05, April.

520

A contrario: K. Johnson, (2013), The Role of Islamic Banking in Economic Growth, CMC Senior Theses, Paper Nr. 642.

521

M.I. Tabash and R.S. Dhankar, (2014), Islamic Finance and Economic Growth: An Empirical Evidence from United Arab Emirates (UAE), Journal of Emerging Issues in Economics, Finance and Banking, Vol. 3, Issue 2, pp. 1069–1085; H. Furqani and R. Mulyany, (2009), Islamic Banking and Economic Growth: Empirical Evidence from Malaysia, Journal of Economic Cooperation and development, Vol. 30 Issue 2, pp. 59–74.

522

B.A. Ramsey and P. Sarlin, (2015), Ending Over-Lending: Assessing Systemic Risk with Debt to Cash Flow, ECB Working Paper Serie Nr. 1769, Frankfurt, March.

523

See also: M. Drehmann and K. Tsatsaronis, (2014), The Credit-to-GDP Gap and Countercyclical Capital Buffers: Questions and Answers, BIS Quarterly Review, March 2014; G. Farrell, (2013), Countercyclical Capital Buffers and Real-Time Credit-to-GDP Gap Estimates: a South African Perspective, Mimeo; F. Betz, et al., (2014), Predicting Distress in European Banks, Journal of Banking & Finance, Vol. 45, August, pp. 225–241.

524

M. Rick, (2012), Money and (Shadow) Banking: A Thought Experiment, Review of Banking and Financial Law, Vol. 31, p. 744.

525

These ‘private’ IOUs essentially became public obligations during the 2008 financial crisis.

526

M. Rick, (2012), ibid., p. 744.

527

See in how far sustainable contracting can help: B. Lomfeld, (2016), Sustainable Contracting: How Standard Terms Could Govern Markets, Reshaping Markets. Economic Governance, the Global Financial Crisis and Liberal Utopia, (eds. B. Lomfeld, A. Somma and P. Zumbansen) in Cambridge University Press, Cambridge, pp. 257–282.

528

See also S. Nagel, (2014), The Liquidity Premium of Near-Money Assets, Working Paper, September; see also: J. Bianchi and S. Bigio, (2013), Liquidity Management and Monetary Policy, Working Paper, University of Wisconsin and Columbia University; R. Robatto, (2013), Financial Crises and Systemic Bank Runs in a Dynamic Model of Banking, Working Paper, University of Chicago.

529

M. Rick, (2012), ibid., p. 746.

530

And the entities that issue those instruments would have to be subject to portfolio restrictions and capital requirements.

531

M. Rick, (2012), ibid., p. 747.

532

M. Rick, (2012), ibid., p. 748.

533

D. C. Furse, (2014), Taking the Long View: How Market-Based Finance can Support Stability, speech given by External Member of the Financial Policy Committee, Bank of England, March 28, p. 4.

534

D.C. Furse, (2014), ibid., p. 5.

535

I. K. Nasr and G. Wehinger, (2014), Unlocking SME Finance Through Market-Based Debt: Securitisation, Private Placements and Bonds, OECD Journal, Vol. 2014/2, pp. 89–190; R. Wardrop et al., (2015), Moving Mainstream. The European Alternative Finance Benchmarking Report, London, February; IOSCO, (2014), Market-Based Long-Term Financing Solutions for SMEs Infrastructure, September.

536

J. Boluw and P. Klemperer, (2013), Market-Based Bank Capital Regulation, Economics papers 2013-W12, University of Oxford.

537

J. Boluw and P. Klemperer, (2013), ibid., pp. 41–43.

538

J. Boluw and P. Klemperer, (2013), ibid., p. 43.

539

R. Levine, (2002), Bank-Based or Market-Based Financial Systems: Which Is Better?, NBER Working Paper Nr. 9138, also published in Journal of Financial Intermediation, Vol. 11, Issue 4, pp. 398–428.

540

R. Levine, (2002), ibid., pp. 2–3.

541

R. Levine, (2002), ibid., p. 23.

542

R. Levine, (2002), ibid., p. 23.

543

R. Levine, (2002), ibid., pp. 23–24.

544

F. Ferrante, (2015), A Model of Endogenous Loan Quality and the Collapse of the Shadow Banking System, FED Working Paper, March, later on published in American Economic Journal: Macroeconomics, Vol. 10 (2018), Issue 4, pp. 152–201.

545

L.J. Christiano, et al., (2014), Risk Shocks, American Economic Review, Vol. 104, Issue 1, pp. 27–65.

546

T.R.T. Ferreira, (2014), Financial Volatility and Economic Activity, Northwestern University Working Paper; M. Gertler and N. Kiyotaki, (2013), Banking, Liquidity and Bank Runs in an Infinite Horizon Economy, mimeo

547

ECB. (2013), Enhancing the Monitoring of Shadow Banking, ECB Monthly Bulletin, Frankfurt, February, pp. 89–99.

548

See about the relationship between monetary policy, financial conditions and financial stability: T. Adrian and N. Liang, (2014), Monetary Policy, Financial Conditions, and Financial Stability, FRB New York Staff Report, Nr. 690, September.

549

A. Agresti et al., (2013), Non-Bank Financial Intermediation in the Euro Area: Current Challenges for Harmonized Statistics, Bank and Bank Systems, Vol. 8, issue 4, pp. 62–66.

550

L.R. Wray, et al., (2015), Reforming the Fed’s Policy Response in the Era of Shadow Banking, April 2015, Levy Economics Institute of Bard College, p. 7.

551

L.R. Wray, et al., (2015), ibid., pp. 16–17.

552

T.G. Moe, (2015), Shadow Banking and the Policy Challenges Facing Central Banks, in Reforming the Fed’s Policy Response in the Era of Shadow Banking, Working Paper, April 2015, p. 103, also published in Journal of Financial Perspectives, Vol. 3, Nr. 2, pp. 31–42.

553

T.G. Moe, (2015), ibid., p. 100.

554

T.G. Moe, (2015), ibid., p. 100.

555

Moe, (2015), ibid., p. 104.

556

The concept was introduced in: C. Borio and P. Disyatat, (2011), Global Imbalances and the Financial Crisis: Link or No Link? BIS Working Papers Nr. 346, Bank for International Settlements. May.

557

This ‘self-reinforcing interaction between risk appetite and liquidity is not yet sufficiently appreciated’; B. Coeuré, (2012), Global Liquidity and Risk Appetite: A Re-interpretation of the Recent Crises, Speech at the BIS-ECB Workshop ‘Global Liquidity and Its International Repercussions’, Frankfurt am Main, February 6.

558

See Moe, (2015), ibid., p. 106.

559

See Moe, (2015), ibid., pp. 106–112.

560

M. Fourcade et al., (2014), The Superiority of Economists, Maxpo Discussion Paper Nr. 14/3.

561

M. Fourcade et al., (2014), ibid., p. 23.

562

M. Fourcade et al., (2014), ibid., p. 23. See also: J. Jung and F. Dobbin, (2012), Finance and Institutional Investors, In K. K. Cetina and A. Preda (eds.), The Oxford Handbook of the Sociology of Finance, Oxford University Press, Oxford, pp. 52–74.

563

See for an excellent overview on the origins of ordoliberalism: D.J. Gerber, (1994), Constitutionalizing the Economy: German Neo-Liberalism, Competition Law and the ‘New’ Europe, American Journal of Comparative Law, 1994, Vol. 42, pp. 25–84.

564

D. Marsh, et al., (2006), Globalization and the State, in C. Hay, M. Lister and D. Marsh (eds.), The State. Theories and Issues, Palgrave Macmillan, Hampshire and New York, p. 177.

565

C. Cutler, (2008), Toward a Radical Political Economy Critique of Transnational Economic Law, in: S. Marks (ed.), International Law on the Left: Re-examining Marxist Legacies, Cambridge University Press, Cambridge, p. 201.

566

C. Peters, (2014), On the Legitimacy of International Tax Law, IBFD Doctoral Series Nr. 31, Amsterdam, p. 44.

567

M. Carney, (2014), Taking Shadow banking Out of the Shadows to Create Sustainable Market-Based Finance, Financial Times, June 16.

568

Smaller probabilities don’t say anything about the damage that occurs when that reduced probability, despite everything, manifests itself.

569

My apologies for the intentional oxymoron.

570

IIF, (2012), Shadow Banking: A Forward Looking Framework for Effective Policy, Preface, June.

571

Record of Meeting, (2015), Federal Advisory Council and Board of Governors, February 6, p. 7.

572

Record of Meeting, (2015), Federal Advisory Council and Board of Governors, February 6, p. 17.

573

FSB, (2014), Transforming Shadow Banking into Resilient Market-Based Financing. An Overview of Progress and a Roadmap for 2015, Basel, November 14.

574

FSB, (2014), ibid., p. 2.

575

See, for example, J.N. Gordon and C.M. Gandia, (2014), Money Market Funds Run Risks: Will Floating Net Asset Value Fix the Problem?, Columbia Business Law Review, Nr. 2, pp. 313–371. They find that ‘the stable/accumulating distinction explains none of the cross-sectional variation in the run rate among these funds (i.e. between a fixed NAV and a Variable NAV (ed.)). Instead, two other variables are explanatory: ‘yield which we take as a proxy for the fund’s portfolio risk, and whether the fund’s sponsor is an investment bank, which we take as proxy for sponsor capacity to support the fund’.

576

S. Agarwal et al., (2014), Inconsistent Regulators: Evidence from Banking, Quarterly Journal of Economics, pp. 889–938. They claim that is ‘due to differences in their institutional design and incentives’.

577

BCBS, (2011), The Joint Forum Report on Asset Securitisation Incentives, Basel, July.

578

For example, Kumar demonstrates that ‘firms use securitization facilities to access the commercial paper market at a time when they find direct access to investment grade debt prohibitive’ and that ‘firms using securitization are larger, have more account receivables, have fewer growth opportunities and have a credit rating along the investment grade/speculative grade boundary’; see in detail: N. Kumar, (2013), The Role of Lender Relationship in Receivable Securitization, University of Chicago, Booth School of Business Working Paper, May 2.

579

Kumar, (2013), ibid.

580

FSB, (2014), Strengthening Oversight and Regulation of Shadow Banking Regulatory framework for haircuts on non-centrally cleared securities financing transactions, Basel, October 14, Annex 4, pp. 27–29.

581

A poster child example is the exemption of derivatives and repos from the normal insolvency/bankruptcy cash flow waterfall distribution of claims under US regulation. These repos, ‘which are equivalent to very short-term (often one-day) secured loans, are exempt from core bankruptcy rules such as the automatic stay that enjoins debt collection, rules against pre-bankruptcy fraudulent transfers, and rules against eve-of-bankruptcy preferential payment to favored creditors over other creditors’; see E. Morrison et al., (2014), Rolling Back the Repo Safe Harbors, John M. Olin Center for Law, Economics and Business, Harvard Business Lawyer Discussion Paper Nr. 793, August 18, also published in Business Lawyer, Vol. 69, Issue 4, pp. 1015–1047. They advance and indicate that ‘While these exemptions can be justified for United States Treasury securities and similarly liquid obligations backed by the full faith and credit of the United States government, they are not justified for mortgage-backed securities and other securities that could prove illiquid or unable to fetch their expected long-run value in a panic. The exemptions from baseline bankruptcy rules facilitate this kind of panic selling and, according to many expert observers, characterized and exacerbated the financial crisis.’

582

G. Afonso, et al., (2014), Do ‘Too-Big-to-Fail’ Banks Take On More Risk, Federal Reserve Bank of NY, Economic Policy Review, December, pp. 41–58; see also: M. Brandão Marques, et al., (2013), International Evidence on Government Support and Risk Taking in the Banking Sector, Mimeo.

583

E. Brewer and J. Jagtiani, (2007), How Much Would Banks Be Willing to Pay to Become ‘Too-Big-to-Fail’ and to Capture Other Benefits?, Mimeo.

584

D. Baker and T. McArthur, (2009), The Value of the ‘Too Big to Fail’ Big Bank Subsidy, CEPR Reports and Issue Briefs Nr. 36; Z. Li, et al., (2011), Quantifying the Value of Implicit Government Guarantees for Large Financial Institutions, Moody’s Analytics Quantitative Research Group, January; J. Santos, (2014), Evidence from the Bond Market on Banks’ ‘Too-Big-To-Fail’ Subsidy, Federal Reserve Bank of New York Economic Policy Review 20. Nr. 3 (December), pp. 29–39; K. Ueda and B. Weder di Mauro, (2012), Quantifying Structural Subsidy Values for Systemically Important Financial Institutions, Mimeo.

585

See in detail: EBA, (2015), Overview of the Potential Implications of Regulatory Measures for Banks’ Business Models, EBA Report, London, February 9.

586

BCBS, (2014), Criteria for Identifying Simple, Transparent and Comparable Securitisations, Consultative Document, December 11, pp. 8–9 and annex pp. 12–19; see also: EBA, (2014), EBA Discussion Paper on Simple Standard and Transparent Securitisations. Response to the Commission’s call for advice of December 2013 related to the merits of, and the potential ways of, promoting a safe and stable securitization market, EBA/DP/2014/02, October 14.

587

M.L. Fein, (2013), The Shadow Banking Charade, Working Paper, February 13, in particular pp. 5–11.

588

M.L. Fein, (2013), ibid., p. 6.

589

M.L. Fein, (2013), ibid., p. 7.

590

G. Gorton, (2010), Questions and Answers About the Financial Crisis, prepared for the US Financial Crisis Inquiry Commission, Feb. 20, 2010, p. 2.

591

S. Ben Hadj, (2014), Financial Institutions Externalities and Systemic Risk: Tales of Tails Symmetry, Working paper, November, mimeo.

592

Op. cit. at M.L. Fein, (2013), ibid., p. 9.

593

M.L. Fein, (2013), ibid., p. 11.

594

M.L. Fein, (2013), ibid., p. 12–19 & 23–24.

595

A.W. Lo, (2015), The Gordon Gekko Effect: The Role of Culture in the Financial Industry, Working Paper, June 7.

596

S. Ben Hadj, (2014), ibid., p. 2.

597

S. Ben Hadj, (2014), ibid., p. 3.

598

D. Bisias, et al., (2012), A Survey of Systemic Risk Analytics, Office of Financial Research, US Department of Treasury, January.

599

A. Capponi and M. Larsson, (2014), Price Contagion Through Balance Sheet Linkages, Working Paper, March 1; see also C. Chen, et al., (2014), Asset Price-Based Contagion Models for Systemic Risk, Working Paper, mimeo.

600

M. Chinazzi et al., (2015), Defuse the Bomb: Rewiring Interbank Networks, Working Paper, June 3; see also: M. Chinazzi and G. Fagiolo, (2015), Systemic Risk, Contagion, and Financial Networks: A Survey, Working Paper, June 4.

601

P. Gai, and S. Kapadia, (2010), Contagion in Financial Networks, Proceedings of the Royal Society A: Mathematical, Physical and Engineering Science, Vol. 466, pp. 2401–2423. And later on: P. Gai, et al., (2011), Complexity, Concentration and Contagion, Journal of Monetary Economics, Vol. 58, pp. 453–470.

602

See extensively: M. Chinazzi et al., (2015), ibid., pp. 19–25. The findings are in line and build upon: M. Elliott, et al., (2014), Financial Networks and Contagion, American Economic Review, Vol. 104, pp. 3115–3153; F. Caccioli, et al., (2012), Heterogeneity, Correlations and Financial Contagion, Advances in Complex Systems, Vol. 15; F. Caccioli, et al., (2014), Stability Analysis of Financial Contagion due to Overlapping Portfolios, Journal of Banking & Finance, Vol. 46, pp. 233–245; T. Roukny, (2013), Default Cascades in Complex Networks: Topology and Systemic Risk, Scientific Reports.

603

J.M. Conley and C.A. Williams, (2016), Fixing Finance 2.0 in Reshaping Markets. Economic Governance, the Global Financial Crisis and Liberal Utopia, (eds. B. Lomfeld, A. Somma and P. Zumbansen) in Cambridge University Press, Cambridge, 208–228.

604

See for a Europe-specific view on the topic: P. Abbassi et al., (2014), Cross-Border Liquidity, Relationships and Monetary Policy: Evidence from the Euro Area Interbank Crisis, Bundesbank Discussion Paper Nr. 45/2014 Frankfurt.

605

See also in more detail: D. Acemoglu, et al. (2013), Systemic Risk and Stability in Financial Networks, NBER Working Paper Nr. 18,727; H. Amini, et al., (2012), Stress Testing the Resilience of Financial Networks, International Journal of Theoretical and Applied Finance, 15; F. Blasques, et al., (2015), A Dynamic Network Model of the Unsecured Interbank Lending Market, BIS Working Paper Nr. 491, Basel; R. Cont, et al., (2013), Network Structure and Systemic Risk in Banking Systems, in Handbook on Systemic Risk, (eds.) by J.-P. Fouque, and J.A. Langsam, Cambridge University Press, Cambridge; M. Elliott, et al., (2014), Financial Networks and Contagion, American Economic Review, Vol. 104, pp. 3115–3153; P. Glasserman and H. P. Young, (2015), How Likely Is Contagion in Financial Networks? Journal of Banking & Finance, Vol. 50, pp. 383–399.

606

See in detail: N.C. Foley-Fisher, et al., (2015), Self-Fulfilling Runs: Evidence from the U.S. Life Insurance Industry, Finance and Economics Discussion Series 2015-032, Board of Governors of the Federal Reserve System, Washington; see also: D. Alberts et al., (2013), The Use of Captives and Special Purpose Vehicles Shadow Insurance or Legitimate Financing? De-Mystifying the Life Reserve Financing Debate.

607

See on the concept of shadow banking creating ‘claims’ seen by investor as ‘money-like claims’: A. Sunderam, (2015), Shadow Banking and Money-Like Claims, Review of Financial Studies, Vol. 28, Issue 4, pp. 939–977.

608

BCBS, (2015), Interest Rate Risk in the Banking Book, Consultative Document, Basel, June.

609

T.H. Trőger, (2014), How Special Are They? – Targeting Systemic Risk by Regulating Shadow Banking, Working Paper, Goethe University, Frankfurt am Main, House of Finance, Frankfurt am Main, October 5. Later on published in: Reshaping Markets. Economic Governance, the Global Financial Crisis and Liberal Utopia, (eds. B. Lomfeld, A. Somma and P. Zumbansen) in Cambridge University Press, 2016, Cambridge, pp. 185–207.

610

S.L. Schwarcz, (2016), Regulating Financial Change: A Functional Approach, Minnesota Law Review, Vol. 100, Issue 4, pp. 1441–1494.

611

T.H. Trőger, (2014), ibid., p. 3.

612

See, for example, J. Black, et al., (2007), Making a Success of Principles-Based Regulation, Law and Financial Markets Review, Vol. 1, Issue 3, pp. 191–206, J. Black, (2011), The Rise, Fall and Fate of Principles Based Regulation, Law Reform and Financial Markets, Vol. 3, pp. 26–32.

613

S. L. Schwarcz, (2009), The ‘Principles’ Paradox, European Business Organization Law Review, Vol. 10, June, pp. 175–184.

614

T.H. Trőger, (2014), ibid., p. 5.

615

T.H. Trőger, (2014), ibid., pp. 14–15.

616

T.H. Trőger, (2014), ibid., p. 9.

617

T.H. Trőger, (2014), ibid., p. 11.

618

T.H. Trőger, (2014), ibid., p. 11.

619

T.H. Trőger, (2014), ibid., pp. 15–17.

620

T.H. Trőger, (2014), ibid., p. 17; see also: E. Posner and E. G. Weyl, (2013), An FDA for Financial Innovation: Applying the Insurable Interest Doctrine to 21st Century Financial Markets, Northwestern Law Review, Vol. 107, pp. 1307–1358. Regulatory-capital arbitrage is defined by the Basel Committee as ‘the ability of banks to arbitrage their regulatory capital requirement and exploit divergences between true economic risk and risk measured under the [Basel Capital] Accord’. See how regulatory arbitrage contributed to commercial real estate bubbles and CMBS issuance boom and busts: J. Duca and D. C. Ling, (2015) The Other (Commercial) Real Estate Boom and Bust: The Effects of Risk Premia and Regulatory Capital Arbitrage, Federal Reserve Bank of Dallas, Working Paper Nr. 1504.

621

T.H. Trőger, (2014), ibid., pp. 18–19.

622

T.H. Trőger, (2014), ibid., p. 19.

623

A. Turner, (2013), Credit, Money and Leverage: What Wicksell, Hayek and Fisher Knew and Modern Macroeconomics Forgot, Stockholm School of Economics Conference on: ‘Towards a Sustainable Financial System’, Stockholm, September 12.

624

A. Turner, (2013), ibid., pp. 32–33.

625

A. Turner, (2013), ibid., p. 34. We are very remote from that position. Turner points in the analysis at the fact that many, if not all, economics textbooks still are deeply embedded in a number of financial economic myths: (1) first, that banks in sequence ‘raise deposits’ from savers and then ‘make loan’ to borrowers, ignoring their potential to create purchasing power ex nihilo, (2) that banks primarily lend money to firms/entrepreneurs to fund investment projects, allocating funds between alternative uses, largely ignoring the other potential functions and impacts of bank lending, (3) third, that the ‘demand for money’ (i.e. ‘for transactions money’) is a crucial issue. These books are often also silent on the role of banks as creators of money and the important impact they have on aggregate balance sheets and the leverage embedded (p. 31).

626

G. Di Iasio and Z. Poszar, (2015), A Model of Shadow Banking: Crisis, Central Banks and Regulation, Working Paper, May 18, mimeo.

627

To be precise: ‘[w]holesale funding is not only something that dealers/banks use to fund their own securities inventories/portfolios, but it is largely passed on through banks’ matched repo books to less regulated/supervised portfolio managers, such as leveraged hedge and bond funds. Leveraged funds use securities financing transactions and other cash-absorbing investment strategies to generate excess (leverage-enhanced) returns over a benchmark. The returns of these so-called alternative investment strategies satisfy the reach for yield of entities, like pension funds and insurance companies, which have accumulated asset-liability mismatches (ALMs). These entities have liabilities in fixed nominal amount and the returns of their traditional asset portfolios, dominated by sovereign bonds and other safe assets, have been suffering in a low yield environment. As a response, they increase allocations (i.e. funds to be managed) to leveraged funds: the greater the reach for yield from entities with ALMs, the greater the need for leverage from leveraged funds, the higher the demand for dealers’ balance sheet capacity, the greater the demand of dealers to raise funding for their matched books, the larger the volume of repos (and derivatives) absorbing the cash provided by institutional cash pools. In a nutshell, this is the modern financial ecosystem’ (pp. 24–25).

628

They assume that the liquidity properties of the shadow collateral in different states of the world are a banker’s’ choice. This choice characterizes the type of shadow banking system that emerges in equilibrium. In the terminology of our model, bankers’ decision is between (i) high leverage/output at the cost of large exposure to aggregate shocks (complex shadow banking) versus (ii) lower leverage/output and insurance against aggregate shocks (simple shadow banking). They show that the choice is largely affected by the financial ecosystem: when the demand for parking space from cash pools and the reach for yield from entities with liabilities in fixed, nominal amount (asset-liability mismatches) are high, complex shadow banking is the competitive equilibrium outcome and the economy is prone to massive deleveraging in the case of aggregate shocks (p. 25).

629

Di Iasio and Z. Poszar, (2015), ibid., p. 25.

630

Di Iasio and Z. Poszar, (2015), ibid., pp. 25–26.

631

T. Davig and R.S. Gürkaynak, (2015), Is Optimal Policy Always Optimal, International Journal of Central Banking, September, Vol. 11S1, pp. 353–384, and see the discussion: A. Orphanides, (2015), Discussion of ‘Is Optimal Monetary Policy Always Optimal?’, International Journal of Central Banking, September, Vol. 11S1, pp. 385–393.

632

Lawrence Schembri, (2015), Building trust, not walls – the case for cross-border financial integration, Remarks by Lawrence Schembri, Deputy Governor of the Bank of Canada, to the Windsor–Essex Regional Chamber of Commerce, Windsor, Ontario, 25 June 2015, p. 2.

633

D.O. Beltram et al., (2015), Un-Networking: The Evolution of Networks in the Federal Fund Market, Finance and Economics Discussion Series 2015-055, Washington, Board of Governors of the Federal Reserve System.

634

See in detail: A. Lucas et al., (2015), Modeling Financial Sector Joint Tail Rik in the Euro Area, ECB Working Paper Series, Nr. 1837, August 2015, Frankfurt.

635

M. van Oordt and C. Zhou, (2015), Systemic Risk of European Banks: Regulators and Markets, DNB Working Paper Nr. 478, July, p. 17.

636

M. Woodford, (2010), Financial Intermediation and Macroeconomic Analysis, Journal of Economic Perspectives, Vol. 24, Issue 4, pp. 29.

637

B. Nelson, G. Pinter and K. Theodoridis, (2015), Do Contractionary Monetary Policy Shocks Expand Shadow Banking? Bank of England Working Paper Nr. 521, Bank of England, January.

638

F. Mazelis, (2015), The Role of Shadow Banking in the Monetary Transmission Mechanism and the Business Cycle, Humboldt University Berlin Working Paper, July, mimeo. Since banks create credit endogenously, funding supply is not a constraint on bank lending. Instead, their choice of lending depends on the productivity in the economy. Banks’ response to shocks therefore more readily resembles the balance sheet channel of monetary policy transmission. Shadow banks have to raise funds in the form of deposits first to act as intermediaries. Their behavior is therefore dependent on the supply of funding and corresponds more accurately to the lending channel (p. 20).

639

Mazelis, (2015), ibid., p. 17. He raises the question: whether central bank policy reacts optimally to real and nominal shocks if it does not take the presence of shadow banks into account?

640

C. Monnett and D.R. Sanches, (2015), Private Money and Banking Regulation, Federal Reserve Bank of Philadelphia, Working Paper Nr. 15-19, April, also published in Journal of Money, Credit and banking, Vol. 47, Issue 6, pp. 1031–1062.

641

See also L. Nijs, (2015), Neoliberalism 2.0, Regulating and Financing Globalizing Markets, Palgrave, Basingstoke, chapters 4 ff.

642

Monnett and Sanchez, (2015), ibid., p. 2.

643

Monnett and Sanchez, (2015), ibid., pp. 33–34.

644

D.R. Sanches, (2015), On the Inherent Instability of Private Money, Federal Reserve Bank of Philadelphia, Working Paper Nr. 15-18, April.

645

D.R. Sanches, (2015), ibid., p. 32.

646

See for an analysis of the counterparty risk as a key vulnerability in a complex and global financial infrastructure: BIS, (2015), BIS Quarterly Review: International Banking and Financial Market Developments, September, p. 61.

647

S. Kucinskas, (2015), Liquidity Creation Without Banks, DNB Working Paper, Nr. 482, August 17, p. 23.

648

R. Horváth et al., (2012), Bank Capital and Liquidity Creation. Granger-Causality Evidence, Working Paper Nr. 1497, November.

649

A. Admati, and M. Hellwig, (2014), The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It, Princeton University Press, Princeton, NJ; L.J. Kotlikoff, (2010), Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking, John Wiley & Sons New Jersey; J.H. Cochrane, (2013), Stopping Bank Crises Before They Start. The Wall Street Journal, 23 June and (2014), Toward a Run-Free Financial System, Working Paper, University of Chicago. M. Wolf, (2014), Strip Private Banks of Their Power to Create Money, Financial Times, 24 April.

650

D.W. Diamond and P.H. Dybvig, (1983), Bank Runs, Deposit Insurance, and Liquidity, Journal of Political Economy, Vol. 91, Issue 3, pp. 401–419.

651

D. K. Tarullo, (2015), Capital Regulation Across Financial Intermediaries, Speech by Mr. Daniel K Tarullo, Member of the Board of Governors of the Federal Reserve System, at the Bank of France Conference ‘Financial Regulation – Stability Versus Uniformity; A Focus on Non-bank Actors’, Paris, 28 September 2015, pp. 3–4.

Ibid., p. 4.

Ibid., p. 5.

Ibid., p. 5.

See, for example, B. Munyan, (2015), Regulatory Arbitrage in Repo Markets, OFR Working Paper, October 29.

656

Ibid., p. 8.

657

D.J. Elliott, (2015), Market Liquidity: A Primer, Economic Studies at Brookings Paper, The Brookings Institution, Washington.

658

See extensively: IMF, (2015), Global Financial Stability Report, Chapter Two: Market Liquidity-Resilient or Fleeting, October, pp. 53–56.

659

F. Duarte and T. M. Eisenbach, (2015), Fire-Sale Spillovers and Systemic Risk, FRB of New York Staff Report Nr. 645, Federal Reserve Bank of New York. R. Bookstaber and M. Paddrik, (2015), An Agent-Based Model for Crisis Liquidity Dynamics, OFR Working Paper Nr. 15-18, September 16.

660

IMF, (2015), ibid., pp. 49–114.

661

662

See extensively with literature references: IMF, (2015), ibid., p. 55.

663

See IMF, (2015), ibid., pp. 58–60.

664

IMF, (2015), ibid., p. 49.

665

IMF, (2015), ibid., pp. 66–67.

666

IMF, (2015), ibid., pp. 60–64; also see: D. Duffie, (2012), Market Making Under the Proposed Volcker Rule, Working Paper Nr. 106, Rock Center for Corporate Governance at Stanford University, Palo Alto, California.

667

J. Christensen, and J. Gillan, (2015), Does Quantitative Easing Affect Market Liquidity?, Federal Reserve Bank of San Francisco Working Paper Nr. 26, San Francisco.

668

IMF, (2015), ibid., p. 65.

669

M. Eden and B. Kay, (2015), Safe Assets as Commodity Money, OFR Working Paper Nr. 15-23, November 25.

670

See extensively: J. Cunliffe, (2015), Market Liquidity and Market-Based Financing, Speech given by Sir Jon Cunliffe, Deputy Governor, Deputy Governor Financial Stability, Member of the Monetary Policy Committee, Member of the Financial Policy Committee and Member of the Prudential Regulation Authority Board British Bankers’ Association International Banking Conference, London, Thursday 22 October 2015, pp. 4–6.

671

J. Cunliffe, (2015), ibid., p. 6. See for a number of examples and applications pp. 6–7.

672

B. Groschulski and Y. Zhang, (2015), Optimal Liquidity Regulation with Shadow Banking, The Federal Reserve Bank of Richmond, Working paper Nr. 15-12. They indicate: ‘[d]uring expansions, i.e., when the return on illiquid assets is high, the threat of investors flocking out to shadow banking pins down optimal policy rates. These rates do not respond to business cycle fluctuations as long as the economy stays out of recession. In recessions, when the return on illiquid assets is low, optimal liquidity regulation policy becomes sensitive to the business cycle: both policy rates are reduced, with deeper discounts given in deeper recessions. In addition, when high aggregate demand for liquidity is anticipated, the IOR rate is reduced and, unless the shadow banking constraint binds, the tax rate on illiquid assets is increased.’

673

N. Anderson et al., (2015), The Resilience of Financial Market Liquidity, Bank of England Financial Stability Paper Nr. 34, October 2015, p. 3.

674

M. Hertrich, (2015), Does Credit Risk Impact Liquidity Risk? Evidence from Credit Default Swap Markets, International Journal of Applied Economics, Vol. 12, Issue 2, September, pp. 1–46.

675

Liquidity regulation (through the implementation of the LCR) has led to a repricing of liabilities to reflect their new treatment under LCR and on the asset side it has led to an increase of T-bonds by banks; see: G. Debelle, (2015), Some Effects of the New Liquidity Regime, Speech by Guy Debelle, Assistant Governor (Financial Markets) of the Reserve Bank of Australia, at the 28th Australasian Finance and Banking Conference, Sydney, 16 December 2015, p. 8.

676

See in detail: BCBS, (2014), Basel III Leverage Ratio Framework and Disclosure Requirements, Working Paper, January. There are some fine differences between the definition of the leverage ratio between the Basel III framework and the capital regulation in the US; see EBA, (2014), Report on Impact of Differences in Leverage Ratio Definitions, Leverage Ratio Exposure Measure Under Basel III and the CRR, March 4.

677

I. Kiema and E. Jokivuolle, (2014), Does a Leverage Ratio Requirement Increase Bank Stability?, ECB Working Paper Nr. 1676, May.

678

Ibid., p. 1. Also see ECB, (2015), Financial Stability Review, November, pp. 1–13.

679

T. Adrian et al., (2015), The Cyclicality of Leverage, Federal Reserve Bank of New York Staff Reports, Nr. 743, October. They conclude: ‘[b]anking organizations manage payout and leverage in order to achieve a scale of operation that is best captured by its book equity. The long-run leverage of the bank is then built on the trend book equity. In the short-run, however, the bank’s total assets can fluctuate considerably depending on market conditions, especially on those same forces that determine the book-to-market ratio of the bank’ (pp. 13–14).

680

M. Brei and L. Gambacorta, (2014), The Leverage Ratio Over the Cycle, BIS Working Paper Nr. 471, November. See regarding the leverage issue on novel lending platforms in emerging markets: CGAP, (2015), Inclusive Finance and Shadow Banking: Worlds Apart or Worlds Converging, Washington, September.

681

M. Carlson et al., (2015), Why Do We Need Both Liquidity Regulations and a Lender of Last Resort? A Perspective from Federal Reserve Lending During the 2007–09 U.S. Financial Crisis, Finance and Economics Discussion Series Nr. 2015-011, Board of Governors of the Federal Reserve System, Washington.

682

BCBS, (2015), What Do New Form of Finance Mean for EM Central Banks, BIS Paper Nr. 83, November.

683

M. Brooke et al., (2015), Measuring the Macro-Economic Costs and Benefits of Higher UK Bank Capital Requirements, Bank of England Financial Stability Paper Nr. 35, December. This paper uses a framework that measures and compares the macroeconomic costs and benefits of higher bank capital requirements. The economic benefits derive from the reduction in the likelihood and costs of financial crises. The economic costs are mainly related to the possibility that they might lead to higher bank lending rates which dampen investment activity and, in turn, potential output.

684

J. Huang, (2016), Banking and Shadow Banking, Princeton University Working Paper, December 1, mimeo (also published in Journal of Economic Theory, Elsevier, Vol. 178(C), pp. 124–152).

685

J. Huang, (2016), ibid., p. 2.

686

J. Huang, (2016), ibid., p. 3. Huang’s model is based on M. Brunnermeier and Y. Sannikov, (2014), A Macroeconomic Model with a Financial Sector, The American Economic Review, Vol. 104, pp. 379–421.

687

To make it even more complicated, there are three types of leverage: (1) ‘balance sheet’, (2) economic leverage and (3) embedded, respectively, based on balance sheet concepts, market-dependent future cash flows, and market risk. Avgouleas argues, ‘[b]alance sheet leverage is the most recognized form as it is the most visible. It measures the ratio at which the value of a firm’s assets exceeds its equity base. Banks typically leverage themselves by borrowing to acquire more assets, with the aim of increasing their return on equity. Economic leverage means that a bank is exposed to a change in the value of a position by an amount that exceeds what the bank paid for it. Finally, embedded leverage refers to holding a position that is itself leveraged. There is no single measure that can capture all three dimensions of leverage simultaneously’; see E. Avgouleas, (2015), Bank leverage Ratios and Financial Stability: A Micro- and Macroprudential Perspective, Levy Economics Institute Working Paper Nr. 849, October, p. 2.

688

See for a discussion of the different leverage concepts within the context of new financial regulation: E. Avgouleas, (2015), ibid., pp. 30–34.

689

E. Avgouleas, (2015), ibid., p. 35.

690

A.R. Admati et al., (2015), The Leverage Ratchet Effect, Princeton University Working Paper, mimeo, March 19.

691

Q.-A. Vo, (2015), Liquidity Management in Banking: What Is the Role of Leverage?, Swiss Finance Institute, Research Paper Nr. 15-51.

692

B. Stellinga, (2015), Europese Financiële Regulering Voor en Na de Crisis, WRR Paper Nr. 15; conclusions pp. 83–86.

693

I. Kaminska, (2015), Fintech and Banking Risk; Cognitive Dissonance de Semaine, Financial Times, FT Alphaville, November 12.

694

Quoted in I. Kaminska, (2015), ibid.

695

Quoted in I. Kaminska, (2015), ibid. A beautiful narrative of Mazzucato in the article reflects the current conundrum: ‘[n]ational income and product accounting up until the 1960s treated the whole financial sector almost like it treated social security payments, as transfer of existing wealth. For good reasons finance started to be counted into GDP measures and the net interest payments was the way to do it because otherwise the fees had already been included, and you would think that given this massive amount of financial innovation in financial intermediation the percentage of GDP of these net interest payments would have reduced, right? Because the reason why commercial banks were all of a sudden included in GDP was due to their service of financial intermediation. That percentage has not decreased.’ A good example of that is the involvement of (shadow) banking in real estate finance; see extensively: A. Antoniades, (2015), Commercial Bank Failures During the Great Recession: The Real (Estate) Story, BIS Working Paper Nr. 530, November 23.

696

G. Demos et al., (2015), Birth or Burst of Financial Bubbles: Which Is Easier to Diagnose?, Swiss Finance Institute Research Paper Nr. 15-57.

697

S. Fisher, (2015), Financial Stability and Shadow Banks – what we don’t know could hurt us, Speech by Stanley Fischer, Vice Chair of the Board of Governors of the Federal Reserve System, at the ‘Financial Stability: Policy Analysis and Data Needs’ 2015 Financial Stability Conference, sponsored by the Federal Reserve Bank of Cleveland and the Office of Financial Research, Washington, DC, 3 December 2015, pp. 1–2.

698

Ibid., p. 2.

699

Although there is some concern about certain parts of the market, for example, lower broker-dealer activity and the impact on bond market liquidity.

700

S. Fisher, (2015), ibid., p. 4. Also: S. Fischer, (2015), ‘The Importance of the Nonbank Financial Sector’, speech delivered at the Bundesbank conference ‘Debt and Financial Stability–Regulatory Challenges’, Frankfurt, Germany, March 27, and S. Fisher, (2015), ‘Nonbank Financial Intermediation, Financial Stability, and the Road Forward’, speech delivered at ‘Central Banking in the Shadows: Monetary Policy and Financial Stability Postcrisis’, 20th Annual Financial Markets Conference sponsored by the Federal Reserve Bank of Atlanta, Stone Mountain, Ga., March 30.

701

Fisher provides a nice example, ‘[a]n illustration of the possible interaction between better data and better policies is the potential role of margins in securities financing transactions. The more stringent regulation of the banking sector may push short-term financing activities to less regulated entities. To limit such regulatory arbitrage, the Federal Reserve will be developing regulations that would establish minimum margins for securities financing transactions on a market-wide basis. The margins would apply to all market participants, thereby mitigating the risks associated with regulation along institutional lines’ (p. 5).

702

See for a good overview: D. Bisias, et al., (2012), A Survey of Systemic Risk Analytics, OFR Working Paper Nr 1, Washington: US Department of the Treasury, Office of Financial Research, January; G. Kara, et al., (2015), Taxonomy of Studies on Interconnectedness, FEDS Notes. Washington: Board of Governors of the Federal Reserve System, July 31.

703

Reference has already been made to the relevant literature in the Pigovian chapter and wider throughout the book. Here it can be limitedly referred to: (1) D. Acemoglu, (2015), Systemic Risk and Stability in Financial Networks, American Economic Review, vol. 105 (February), pp. 564–608; (2) F. Allen, et al., (2012), Asset Commonality, Debt Maturity and Systemic Risk, Journal of Financial Economics, Vol. 104 (June), pp. 519–534; (3) R. Caballero, et al., (2013), Fire Sales in a Model of Complexity, Journal of Finance, Vol. 68 (December), pp. 2549–2587; (4) F. Duarte, and T. Eisenbach, (2015), Fire-Sale Spillovers and Systemic Risk, Federal Reserve Bank of New York Staff Reports Nr. 645, Federal Reserve Bank of New York, February; (5) G. Hale, et al., (2014), Crisis Transmission in the Global Banking Network, Working Paper, December, mimeo; and (6) G. Kara, et al., (2015), Taxonomy of Studies on Interconnectedness, FEDS Notes, Washington: Board of Governors of the Federal Reserve System, July 31.

704

A. Turner, (2015), Between Debt and the Devil: Money, Credit, and Fixing Global Finance, Princeton University Press, Princeton, NJ. See for a full evaluation that come with the rise of financialization of the economy and society at large: The Rise of Finance: Causes and Consequences of Financialization, Socio-Economic Review, Vol. 13, Issue, July 2015.

705

D. Fiashi et al., (2014), The Interrupted Power Law and the Size of Shadow Banking, PLoS ONE 9(4): e94237. doi:https://doi.org/10.1371/journal.pone.0094237

706

However, there are more aspects defining the shape of shadow banking: regulatory arbitrage, technology lowering barriers to entry, demographics and a favorable macro environment. See: High Meadow Institute, (2016), The Shadow Banking Sector & Alternative Financing Driven by Technology, Industry Snapshot and Forecast, Working Paper, February; G. Buchak et al., (2018), Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks, Journal of Financial Economics, Vol. 130, Issue 3, pp. 453–483. Fintech firms accounted for more than a third of shadow bank loan originations by 2019. Fintech firms have advantages in corresponding interest rates. To isolate the role of technology, in the decline of traditional banking, Buchak et al. ‘focus on technology differences between shadow banks, holding the regulatory differences between different lenders fixed. More importantly, the online origination technology appears to allow fintech lenders to originate loans with greater convenience for their borrowers.’ How much of shadow banking and fintech growth is regulation driven and how much is due to better technology? Answer: 70/30. Regulatory arbitrage seems to be the dominant force with shadow banks now controlling the riskiest lending segment and are the largest issuer of guarantees in lightly regulated markets. Technology plays a role but doesn’t democratize credit access nor does it reduce the cost of credit. It merely focuses on refinancing already creditworthy borrowers at a high price. See also: J. Frost et al. (2019), BigTech and the Changing Structure of Financial Intermediation, BIS Working Papers Nr. 779, April 8. To be published in 2020 in Economic Policy. They conclude that differences in the development of FinTech credit reflect differences in income and financial market structure. The higher a country’s income and the less competitive its banking system, the larger is the FinTech credit volume. BigTech credit benefits even more from these factors. Looking at credit scoring shows that credit models using machine learning and data from the e-commerce platform are better at predicting losses than traditional credit bureau ratings. BigTech lenders have an information advantage in credit assessment relative to a traditional credit bureau. A. Fuster et al., (2018), The Role of Technology in Mortgage Lending, FRB of NY Staff Report nr. 836, February, also published in The Review of Financial Studies, Vol. 32 (2019), Issue 5, pp. 1854–1899.

707

M. Behn et al., (2016), The Limits of Model-Based Regulation, ECB Working Paper Series Nr. 1928, July.

708

They did so by comparing following positions. Since Basel II banks can choose between the model-based approach (known as IRB ‘internal-ratings-based approach’) in which capital charges depend on internal risk estimates of the bank and a more traditional approach that does not rely on internal risk parameters (referred to as the standard approach, known as SA) (p. 2 & pp. 16 ff.). S. Tuuli, (2019), Model-Based Regulation and Firms’ Access to Finance, Bank of Finland Research Discussion Paper Nr. 4, Helsinki. Rule discusses insurance models and the growing importance of model risk management. He describes some recent findings from the Prudential Regulation Authority (PRA)’s work to guard against weakening over time of capital requirements calculated from internal models—the so-called model drift. D. Rule, (2019), Model use and misuse—speech by David Rule, given at the Association for British Insurer’s Prudential Regulation Seminar 2019, May 14.

709

They conclude that ‘the introduction of Basel II-type, model-based capital regulation affected the validity of banks’ internal risk estimates. We find that for the same firm in the same year, both reported PDs and risk-weights are significantly lower, while estimation biases and loan losses are significantly higher for loans under the new regulatory approach’ (p. 32).

710

M. Rubio, (2018), Shadow Banking, Macroprudential Regulation and Financial Stability, in Shadow Banking: Financial Intermediation beyond Banks (Ed. Esa Jokivuolle), SUERF Conference Proceedings 2018/1, Larcier, pp. 112–118.

711

It remains to be seen if and how ‘regulatory sandboxes’ can help in tackling this problem. Sandbox is a mechanism for developing regulation that keeps up with the fast pace of innovation. A regulatory sandbox is a regulatory approach, typically summarized in writing and publishing, which allows live, time-bound testing of innovations under a regulator’s oversight. Novel financial products, technologies and business models can be tested under a set of rules, supervision requirements and appropriate safeguards. A sandbox creates a conducive and contained space where incumbents and challengers experiment with innovations at the edge or even outside of the existing regulatory framework. A regulatory sandbox brings the cost of innovation down, reduces barriers to entry and allows regulators to collect important insights before deciding if further regulatory action is necessary. A successful test may result in several outcomes, including full-fledged or tailored authorization of the innovation, changes in regulation or a cease-and-desist order. See: UNGSA, (2018), Briefing on Regulatory Sandboxes, via ungsa.org

712

See R. Ghandi, (2016), Financial Stability – Issues and Concerns: Are We Barking up All Right Trees, Inaugural speech at the 6th Annual Great Lakes – Union Bank Financial Conference, Great Lakes Institute of Management, Chennai, February 5 (via bis.org). D. Kohn, (2017), Regulating for Financial Stability: the Essentials, Speech given by Donald Kohn, Robert S Kerr Senior Fellow, Brookings and External Member of the Financial Policy Committee, Bank of England at the Wharton School of the University of Pennsylvania April 7. Kohn argues, in my understanding correctly, to extend the toolkit to create stability with tools that allow to counter strong procyclicality in real estate and mortgage markets (pp. 6 ff.) and back-up liquidity facilities adapted to the diverse intermediation channels of the twenty-first century (pp. 7 ff.).

713

See P. Praet, (2016), The European Central Bank and Its Role as Lender of Last Resort During the Crisis, Speech by Peter Praet, (2016), Member of the Executive Board of the European Central Bank, at ‘The Lender of Last Resort: An International Perspective’, a conference sponsored by the Committee on Capital Markets Regulation, Washington, DC, February 10; M. Dobbler et al., (2016), The Lender of Last Resort Function After the Global Financial Crisis, IMF Working Paper Nr. WP/16/10, January, pp. 11–25 (pp. 26–35 for a garden variety of operational challenges and outstanding issues). Also see M. Anson et al., (2017), The Bank of England as Lender of Last Resort: New Historical Evidence from Daily Transactional Data, Bank of England Working Staff Working Paper Nr. 691, November 10. And in more general terms: FCA, (2016), Market-Based Finance: Its Contribution and Emerging Issues, Occasional Paper Nr. 18, May. Regarding the impact of principle versus rule-based mechanism in monetary policy, see: J.A. Dorn, (2017), Monetary Policy in an Uncertain World: The case for Rules, CATO Working Paper Nr. 47, August 16.

714

Idiosyncratic support refers to the uncertainty about whether the central bank will provide support, by the imposition of punitive financial and nonfinancial penalties on management and shareholders and by strictly enforced frameworks for enhanced regulatory oversight and prompt corrective action; ibid., p. 7.

715

See in the implications of collateral quality and credit quality under growing balance sheet conditions: D. Gatarek and J. Jablecki, (2014), Estimating the Risk of Joint Defaults: An Application to Collateralized Lending Operations, NBP Working Paper Nr. 181.

716

M. Shafik, (2016), Small Is Beautiful but Big Is Necessary, Speech given at the Bloomberg Markets Most Influential Summit, September 28, who argues in favor.

717

A. Haldane et al., (2017), Rethinking Financial Stability, Speech given at the ‘Rethinking Macroeconomic Policy IV’ Conference, Washington, DC, Peterson Institute for International Economics, 12 October, p. 3. In extensor: D. Aikman et al., (2018), Rethinking Financial Stability, Bank of England Staff Working Paper Nr. 712, February 28. They find that additional insights gained since the start of the reforms paint an ambiguous picture on whether the current level of bank capital should be higher or lower. Additionally, they present new evidence that a combination of different regulatory metrics can achieve better outcomes in terms of financial stability than reliance on individual constraints in isolation. They further discuss in depth several recurring themes of the regulatory framework, such as the appropriate degree of discretion versus rules, the setting of macroprudential objectives and the choice of policy instruments.

718

D. Strauss, (2018), Andy Haldane Calls for Corporate Governance reform, FT, September 28. The FSB has also been concerned with the issues which it coins ‘misconduct in financial institutions’. See in extensor: FSB, (2018), Strengthening Governance Frameworks to Mitigate Misconduct Risk: A Toolkit for Firms and Supervisors, April. After industry and shareholder concerns, the idea has now been pushed out to 2020. J. Heltman, (2018), FED to Delay New Big-Bank Capital Measure Until 2020, American Banker, November 9, americanbanker.com

719

Also A. Gerety, (2017), Clarifying the Shadow Banking Debate: Application and Policy Implications, Institute for International Economic Law Issue Brief 01/2017. One of the conclusions is that the analysis of shadow banking is a necessary part, but only a part, of the work required to understand and monitor the risks and frailties in an evolving financial system.

720

Did capital regulation do its work, and what about Basel III, how did we handle the too-big-to-fail aspect. Many options drift around but nobody is a very convinced about their opinions on this matter. See, for example, D. Nouy, (2017), Safer than Ever Before? An Assessment of the Impact of Regulation on Banks’ Resilience Eight Years On, Banque de France Financial Stability Review Nr. 12, April, pp. 23–32; D.J. Elliott and E. Balta, (2017), Measuring the Impact of Basel III, Banque de France Financial Stability Review Nr. 12, April, pp. 33–44; S.J.A. de-Ramon et al., (2017), An Overview of the UK Banking Sector Since the Basel Accords: Insights from a New Regulatory Database, Bank of England Working Paper Nr. 652, March. Greenwood et al. provide some perspective on the essential qualities of capital regulation: (1) first, whenever possible, multiple constraints on the minimum level of equity capital should be consolidated into a single constraint; (2) second, the best way to deal with the inevitable gaming of any set of ex ante capital rules is not to propose further rules, but rather to allow the regulator sufficient flexibility to address unforeseen contingencies ex post; (3) third, though a regulatory framework that relies primarily on minimum capital ratios is appropriate for normal times, such a framework is inadequate in the wake of a large negative shock to the system. See: R. Greenwood et al., (2017), Strengthening and Streamlining Bank Capital Regulation, Brookings Paper on Economic Activity, Fall 2017, pp. 479–565; L.B. Boulifa and D.R. Khouaja, (2016), Could Basel III Capital and Liquidity Requirements Avoid Bank Failure, The International Journal of Business and Finance Research, Vol. 10, Nr. 4, pp. 63–71. The latter focus on the newly introduced LCR and NSFR. Their results show a mixed bag and small banks and off-balance sheet activities continue to be a concern.

721

S. Meredith, (2018), The Global Financial Crisis Has Inspired Little Meaningful Reform, says WEF founder, September 14, cnbc.com. He also refers to the global debt levels when indicating ‘[w]e should not forget that the global debt today is substantially higher than it [was] at the beginning of the financial crisis’.

722

Martin Wolf looks at the rent-extracting economy and the vested interest: M. Wolf, (2018), Why So Little Has Changed Since the Financial Crash, Financial Times, September 3; Mario Draghi, despite all efforts so far, urges harder policing of the USD 49 trillion shadow banking market. Regulators have forced banks to become more resilient in the last decade, but the ‘next step will be to ensure that equally strong regulation and supervision’ is applied to shadow banking: N. Comfort, (2018), ECB’s Draghi Seeks Tougher Policing of $49 Trillion Shadow Banks, Bloomberg September 13 (bloomberg.com). This should be read in conjunction with the analysis which can be found in ECB, (2017), Report on Financial Structures, October, in particular pp. 59 ff.

723

See the BIS data sets (bis.org) for updates on outstanding debt, but as it stands the level of global debt is well above 250% of global GDP. For some analysis and reflection on the current state of affairs regarding (both public and private) debt management and their role of financial crises: IMF, (2016), Debt: Use It Wisely, Fiscal Monitor, October, Washington, DC.

724

McKinsey Global Institute, (2015), Debt and (Not Much), Deleveraging, February. H.S. Shin, (2017), Leverage in the Small and in the Large, Panel remarks at IMF Annual Meeting seminar on systemic risk and macroprudential stress testing, Washington, DC, October 10.

725

Every financial stability report issued in recent years regardless of the country reports house price dynamics and global debt levels as the most dominant themes in terms of stability issues.

726

A. Turner, (2018), After the Crisis, the Banks Are Safer, But Debt Is a Danger, Financial Times, September 11.

727

M. Vandevelde et al., (2018), The Story of a House: How Private Equity Swooped in After the Subprime Crisis, Financial Times, September 5.

728

G. Tett, (2018), Has the Banking Culture Really Changed, Financial Times, September 3.

729

H. Ellyatt, (2018), The Financial System Still Looks Vulnerable Despite Post-Lehman Banking Rules, Experts Say, CNBC, September 10, cnbc.com

730

James Bullard, president of the Federal Reserve Bank of St. Louis in C. Jeffery, (2018), Next Financial Crisis ‘Will Be Brewing’ in Shadow Banking, August 17, centralbanking.com; R. Miller, (2018), Bernanke, Geithner, Paulson Voice Some Concern About Next Crisis, July 18, bloomberg.com. Others feel very concerned about the outcome of ten years of new regulation and policies: G. Tett, (2018), Five Surprising Outcomes of the 2008 Financial Crisis: (1) debt has increased; (2) banks have become bigger, (3) US banks rule; (4) shadow banking has increased; (5) no banker has been jailed; (6) the left has lost.

731

Because of the need for a climate change-fueled switch: N. Ahmed, (2018), Scientists Warn the UN of Capitalism’s Imminent Demise, motherboard.vice.com, August 27. Also P. Collier, (2018), The Future of Capitalism, Allen Lane, Bristol. The question of what has gone wrong centers on the disappearing ‘reciprocal obligation’, the mutual obligation on which fruitful social arrangement depends. This besides the economic factors at work such as globalization, urbanization and tax erosion.

732

See regarding the topic of legal protection of central banks (for their (in)actions) and their balancing act between independence and accountability: A. Khan, (2018), Legal Protection: Liability and Immunity Arrangements of Central Banks and Financial Supervisors, IMF Working Paper Nr. WP/18/176, August. Also earlier: A. Khan, (2017), Central Bank Legal Frameworks in the Aftermath of the Global Financial Crisis, IMF Working Paper Nr. WP/17/101 and A. Khan, (2016), Central Bank Governance and the Role of Nonfinancial Risk Management, IMF Working Paper Nr. WP/16/34.

733

M. Sandbu, (2018), The Devastating Cost of Central Banks’ Caution, Financial Times, August 7. Monetary trust and the politics of central bank legitimacy are intrinsically related but that relationship is also full of paradoxes: ‘while a central bank’s legitimacy hinges on it being perceived as acting in line with the dominant folk theory of money, this theory accords poorly with how money actually works. How central banks cope with this ambiguity depends on the monetary situation.’ See in detail: B. Braun, (2016), Speaking to the People? Money, Trust, and Central Bank Legitimacy in the Age of Quantitative Easing, MPIfG Discussion Paper 16/12, Max-Planck-Institut für Gesellschaftsforschung, Köln, October; also see: C. Borio, (2019), On Money, Debt, Trust and Central Banking, BIS Working Paper Nr. 763, January 11, via bis.org. Borio highlights that trust is the foundation of a well-functioning monetary system. The distinction between money and credit, both underpinned by trust, is overdone. He further indicates that a demand-determined, elastic supply of credit is essential for the system to operate at all and to set interest rates. But in the longer run, too elastic a supply can undermine monetary and financial stability. The notion that the monetary base, rather than the interest rate, is the system’s ultimate anchor is incorrect.

734

C. Ban et al., (2016), Grey Matter in Shadow Banking: International Organizations and Expert Strategies in Global Financial Governance, Review of International Political Economy, Vol. 23, Nr. 6, pp. 1001–1033. Experts secured control over how issues in shadow banking regulation are treated is the baseline in their message. To be precise, ‘The evidence suggests that IO (international organizations ed.) experts embedded a bland reformism opposed to both strong and “light touch” regulation at the core of the emerging regulatory regime. Technocrats reinforced each other’s expertise, excluded some potential competitors (legal scholars), coopted others (select Fed and elite academic economists), and deployed measurement, mandate, and status strategies to assert issue control.’ When it comes to shadow banking, they add ‘academic economists’ influence came from their credibility as arbitrageurs between several professional fields rather than their intellectual output’. Please observe the very interesting literature list pp. 1028 ff.

735

C. Ban et al., (2016), ibid., pp. 1025–1026.

736

T. Lou, (2014), Into the Shadows: Banking and the Prudential Regulation of Litigation Funders, Macquarie Law Journal, Vol. 14, pp. 73–96. Lou argues that litigation funding is a form of shadow banking.

737

The fact that European banks have been the main providers of capital during the melt-up toward the financial crisis starting in 2007 has often been neglected or assumed it were the savings-heavy Asian economies. It is however well understood that aging societies tend to always develop an excess supply of capital. See, for example, B. Noeth and R. Sengupta, (2012), Global European Banks and the Financial Crisis, Federal Reserve Bank of St. Louis Review, November/December 2012, Vol. 94, Issue 6, pp. 457–479. They argue ‘that the role of funding costs and a “liberal” regulatory regime that allowed for an unprecedented expansion of the balance sheets of European banks was no less important’ in deciphering the elements that led to the financial crisis. In a broader context this has now been reconfirmed for both individuals and corporates, that is, a broad-based trend in rising gross saving and net lending of nonfinancial corporates across major industrialized countries (though most pronounced in countries with persistent current account surpluses). Dao and Maggi confirm that ‘this trend holds consistently across major industries, and is concentrated among large firms, driven by rising profitability, lower financing costs, and reduced tax rates. At the same time, higher gross corporate saving have not supported a commensurate increase in fixed capital investment, but instead led to a build-up of liquid financial assets (cash). The determinants of corporate cash holding and saving are also broad-based across countries, with the growth in assets of large firms, R&D intensity, and lower effective tax rates accounting for most of the increase.’ See in detail: M.C. Dao and C. Maggi, (2018), The Rise in Corporate Saving and Cash Holding in Advanced Economies: Aggregate and Firm Level Trends, IMF Working Paper Nr. WP/18/262, November.

738

In recent times, it was resurfaced that behavioral elements are more relevant to financial supervision and regulation. Khan distinguishes three categories in that space: (1) behavioral effects of norms (social, legal and market), (2) behavior of others (internalization, identification and compliance) and (3) psychological biases. Both individual and group behaviors are relevant. See A. Khan, (2018), A Behavioral Approach to Financial Supervision, Regulation, and Central Banking, IMF Working Paper Nr. 18/178, August, in particular pp. 29 ff. Innovation can escape any rule provided there is sufficient time, but a banker is always looking for the boundaries in which the law loses focus and no longer is trustworthy. Khan signals, ‘More comprehensive financial regulation and supervision could consider the different norm contexts, how individual behavior is shaped by behavior of others, and behavioral biases. This could allow regulation and supervision to more comprehensively address individual decision-making and its risks to the financial sector’ (p. 29). Further analysis and deep thinking are required into the following fields: (1) incorporating behavioral expertise into the selection and application of supervisory interventions; (2) examining the behavioral impact of supervision itself; and (3) the links between behavioral elements and systemic risk (p. 51). This topic deserves way more attention than I (can) provide it with here. See Khan’s literature list (pp. 52–56) for inspiration. Reflexivity is the idea that investors’ biased beliefs affect market outcomes and that market outcomes in turn affect investors’ beliefs. Investors form beliefs about firms’ creditworthiness, in part, by extrapolating past default rates. Investor beliefs influence firms’ actual creditworthiness because firms that can refinance maturing debt on favorable terms are less likely to default in the short run—even if fundamentals do not justify investors’ generosity. Greenwood et al.’s model is able to match many features of credit booms and busts, including the imperfect synchronization of credit cycles with the real economy, the negative relationship between past credit growth and the future return on risky bonds, and ‘calm before the storm’ periods in which firm fundamentals have deteriorated but the credit market has not yet turned. See in detail: R. Greenwood et al., (2019), Reflexivity in Credit Markets, NBER Working Paper Nr. 25,747, April. Regarding the relationship between publicly available information (to be precise data that is open to interpretation and exhibits randomness, as this gives the persuader ‘wiggle room’ to highlight false patterns and persuasion): J. Schwarzstein and A. Sunderam, (2019), Using Models to Persuade, HBS Working Paper, May 16, mimeo.

739

Z. Iscenko et al., (2016), Economics for Effective Regulation, FCA Occasional Paper Nr. 13, March.

740

That is the case, for example, in Italy where shadow banks and traditional banks are subject to mirroring rules. See in detail: C. Gola et al., (2017), Shadow Banking out of the Shadows: Non-Bank Intermediation and the Italian Regulatory Framework, Bank of Italy Occasional Papers Series Nr. 372, February. What stays undiscussed is the impact of our earlier discussion that creating a level playing field in regulatory terms comes with unnecessary and disproportionate economic consequences. Regulatory drifting has its impact on economic parameters. You might contain shadow banking risk quite efficiently (p. 38). Marginal cost and benefits of additional regulation should be balanced to avoid suboptimal functioning of the market. Containing demand in Italia could also be the consequence of the preference of firms to use banks loan rather than market-based instruments.

741

The whole issue of tax competition, offshore-onshore deserves its own (set of) monograph(s). See: J. Garcia-Bernardo et al., (2017), Uncovering Offshore Financial Centers: Conduits and Sinks in the Global Corporate Ownership Network, Scientific Reports, nature.com, July 24, pp. 1–10.

742

See for a write-up: T. Adrian et al., (2017), Macroprudential Policy: A Case Study from a Tabletop Exercise, FRBNY Economic Policy Review, February, pp. 1–30. See for a schematic overview of the findings table 3 p. 20.

743

G. Ordoñez, (2018), Sustainable Shadow Banking, American Economic Journal: Macroeconomics, Vol. 10, Issue 1, pp. 33–56.

744

Analysis of those demand and supply relations teaches us that ‘[d]uring non-crisis years, bank flows are well explained by a common global factor and a local demand factor. But during times of crisis flows are affected by idiosyncratic supply shocks to a borrower country’s creditor banks.’ See: M. Amiti et al., (2017), Supply- and Demand-Side Factors in Global Banking, Federal Reserve Bank of New York Staff Reports, Nr. 818, June.

745

S. Avdjiev et al., (2017), The Shifting Drivers of Global Liquidity, Federal Reserve Bank of New York Staff Reports, Nr. 819, June, also published as NBER Working Paper Nr. 23565, and revised in October 2019.

746

See also: E. Cerutti, et al., (2017), Global Liquidity and Drivers of Cross-Border Bank Flows, Economic Policy, Vol. 32, Issue 89, pp. 81–125.

747

There are many different ways in which banks can be categorized. The EBA, not too long ago, proposed a standardized classification of business models of the EU banks. The proposed approach to classification combines both a qualitative and a quantitative component. The qualitative component is based on an expert knowledge of the supervisory authority, which is confirmed or challenged by quantitative indicators. Their findings are that banks’ classification through this mixed approach allows better and more granular identification of banks’ business models than the clustering methodology. They maintain the four traditional models: universal, retail-oriented, corporate-oriented and other specialized business models. See in detail: M. Cernov and T. Urbano, (2018), Identification of EU Bank Business Models. A Novel Approach to Classifying Banks in the EU Regulatory Framework, EBA Staff Paper report, Nr, 2, June, via eba.europe.org

748

T. Cordella et al., (2017), Government Guarantees, Transparency and Bank Risk-Taking, World Bank Policy Research Working Paper Nr. 7971, February.

749

This leads alternatively to banks rescuing their SIVs (in the financial crisis), although they had no contractual obligation to do so. This is known as step-in risk. Segura clarifies that behavior: ‘I show that this outcome may arise as the equilibrium of a signaling game between banks and their debt investors when a negative shock affects the correlated asset returns of a fraction of banks and their sponsored vehicles. A rescue is interpreted as a good signal and reduces the refinancing costs of the sponsoring bank. If banks leverage is high or the negative shock is sizeable enough, the equilibrium is a pooling one in which all banks rescue.’ See: A. Segura, (2017), Why Did Sponsor Banks Rescue Their SIVs, Bank of Italy Working Paper Nr. 1100, February, Milan.

750

How the capital position of potential buyers of assets affects the decision to purchase and the value of the transaction themselves breaks down in two questions. This relates to the amount of funding available as a function of their equity capital and the demand for assets is a function of the total funds available to financial intermediaries.

751

See: S. Das, (2017), The Effect of Leverage on Asset Sales Between Financial Institutions, IMF Working Paper Nr. WP/17/200, August.

752

J. Crawford, (2017), Lesson Unlearned? Regulatory Reform and Financial Stability in the Trump Administration, Columbia Law Review, Vol. 117, Issue 4, pp. 127–143.

753

Also see D. Żochowski et al., (2019), Cross-Border Effects of Prudential Regulation: Evidence from the Euro Area, ECB Working Paper Nr. 2285, May 23.

754

P. Paech, (2017), Repo and Derivative Portfolios. Between Insolvency Law and Regulation, LSE Working Paper Nr. 13/2017. What is particularly nice is the comparison that peach draws between the US and European regulatory model. Also see: P. Paech, (2016), The Value of Insolvency Safe Harbours, Oxford Journal of Legal Studies, Vol. 36, Issue 4, pp. 855–884; S.L. Schwarcz, (2018), Securitization Ten Years After the Financial Crisis: An Overview, Review of Banking and Financial Law, Vol. 37, pp. 757–769.

755

See in detail: M. Saldías, (2017), The Non-Linear Interaction Between Monetary Policy and Financial Stress, IMF Working Paper Nr. WP/17/184, August. The paper observes that ‘monetary policy and stressed financial conditions have a nonlinear relationship. The findings suggest that the effects of monetary policy shocks on output are stronger when the financial system is sound.’ A stressed financial sector impairs the transmission mechanism which casts serious doubt about the effect of an expansionary monetary policy under those regimes and that it could very well be that the effect would be not too effective to stabilize output. It forces to rethink conceptually countercyclical policies under different scenarios of financial conditions and all types of ‘lean against the wind’ policies to address financial vulnerabilities. Saldías highlights that ‘direct effect of a monetary policy shock on financial conditions is considerably larger when the financial system is under stress. This suggests that expansionary monetary policy can really “get into the cracks” and help rebuild resilience of the financial system when it is needed. However, a tightening of monetary of the same magnitude is less effective in containing vulnerabilities in normal times.’

756

See in detail: CGFS, (2018), Structural Changes in Banking after the Crisis, CGFS Papers Nr. 60, January. The CGFS draws four major conclusions from the shifts and changes identified: (1) post-crisis, a stronger banking sector has resumed the supply of intermediation services to the real economy, albeit with some changes in the balance of activities; (2) longer-term profitability challenges require the attention of banks and supervisors, as they may signal risk-taking incentives and over-capacity; (3) consolidation and preservation of gains in bank resilience require ongoing surveillance, risk management and a systemic perspective; and (4) enhanced surveillance of systemic risk is required by developing more granular data sets and using and sharing data more intensely and wisely.

757

Although they haven’t suffered from negative interest rates as banks experience losses in interest income (due to negative interest rates) that are almost exactly offset by savings on deposit expenses and gains in non-interest income, including capital gains on securities and fees. In detail: J.A. Lopez et al., (2018), Why Have Negative Nominal Interest Rates Had Such a Small Effect on Bank Performance? Cross Country Evidence, NBER Working Paper Nr. 25,004, September.

758

The risk-taking channel has moved to the shadow banking sector. Wischnewsky and Neuenkirch document a risk-taking channel of monetary policy transmission in the euro area that works through an increase in shadow banks’ total asset growth and their risk asset ratio. Conventional monetary policy shocks create a portfolio reallocation effect toward riskier assets which is pronounced, whereas for unconventional monetary policy shocks they detect stronger evidence for a general expansion of assets. See: A. Wischnewsky and M. Neuenkirch, (2018), Shadow Banks and the Risk-Taking Channel of Monetary Policy Transmission in the Euro Area, CESifo Working Paper Nr. 7118, June 26.

759

A. Mika and T. Zumer, (2017), Indebtedness in the EU: A Drag or a Catalyst for Growth? ECB Working Paper Nr. 2118, December 21. They find evidence of a positive long-run relationship between private sector indebtedness and economic growth, and a negative relationship between public debt and long-run growth across EU countries. However, the more immediate impact of private sector debt on growth is found to be negative, and positive for the public sector debt. They find no conclusive evidence for a common debt threshold within EU countries, neither for the private nor for the public sector.

760

Discussed and well documented. See recently: M. Harris et al., (2014), Higher Capital Requirements, Safer Banks? Macroprudential Regulation in a Competitive Financial System, Working Paper University of Chicago, mimeo; G. Ordoñez, (2018), Sustainable Shadow Banking, American Economic Journal: Macroeconomics, Vol. 10, Issue 1, pp. 33–56; G. Plantin, (2015), Shadow Banking and Bank Capital Regulation, Review of Financial Studies, Vol. 28, Issue 1, pp. 146–175. For example, see the supplementary leverage ratio (SLR). The SLR rule may present their latest arbitrage opportunity. Enacted after the crisis to prevent another leverage buildup, the rule caps leverage at the very largest US banks. While the leverage rule is simpler than risk-based capital requirements because it requires equal capital against assets with unequal risk, bankers can arbitrage by shedding safer assets and/or adding riskier ones. An earlier leverage rule imposed in 1981 invited the same arbitrage. D.B. Choi et al. find more compelling evidence of leverage rule arbitrage around the new rule. They find higher-risk (risk-weighted) asset shares and security yields at SLR banks relative to the control (the next largest set of banks) after the SLR was finalized in 2014. The effects tend to be larger at more leverage rule–constrained banks. While this arbitrage might have, perversely, increased overall bank risk, they find no evidence that it did. In detail: D.B. Choi et al., (2018), Bank Leverage Limits and Regulatory Arbitrage: New Evidence on a Recurring Question, FRB of NY Staff Report, Nr. 856, November.

761

I ignore the international dimensions here for a moment.

762

Solvency and liquidity risk can be understood in a very similar fashion. But here the distinction is that ‘solvency risk’ is the risk of fundamental insolvency after holding assets to maturity, and ‘liquidity risk’, which refers to the prospect of bankruptcy due to withdrawals before assets reach maturity.

763

The story regarding interest rates deserves two volumes itself. Many elements have contributed to the changes in the natural interest rate as we observed it (i.e. the interest rate consistent with output at its potential and constant inflation). In general terms, globalization and the associated change in market power in the goods and labor markets can be a significant driver of global real interest rates. See: J.M. Natal and N. Stoffels, (2019), Globalization, Market Power and the Natural Interest Rate, IMF Working Paper Nr. WP/19/95, May. Also and in a broader context: IMF, (2019), Chapter 2: The Rise of Corporate Market Power and Its Macroeconomics effects, in World Economic Outlook April 2019, Washington, DC.

764

Liquidating (often) illiquid assets will lead to expected losses for depositors. Illiquid banks (holding lots of illiquid assets) are vulnerable to self-fulfilling runs.

765

See in extenso the excellent work of A. Ari et al., (2017), Shadow Banking and Market Discipline on Traditional Banks, IMF Working Paper Nr. WP/17/285, December, pp. 5–6. I will refer this paragraph extensively to this work to facilitate research efforts.

766

V. Asriyan et al. (2019), Collateral Booms and Information Depletion, ECB Working Paper Nr. 226, April 16.

767

The aforementioned but in this context neglected deposit insurance mechanism does exactly that. It also eliminates liquidity risk but replaces bank discipline by bank regulation. A combination of the two items could work: it would stabilize the traditional banking sector, diminish the fire sale risk but would grow the shadow banking sector, whereby the positives outweigh the negatives (growth of the SB market), yielding a positive financial stability outlook (ibid. pp. 5–6).

768

Or migrates from information-insensitive to information-sensitive. See recently: A. Moreira and A. Savov, (2017), The Macro-Economics of Shadow Banking, The Journal of Finance, Vol. 72, Issue 6, pp. 2381–2432.

769

The exchange point or zone between shadow banks and traditional banks has become an area of interest. See, for example, L.A. Gornicka, (2016), Banks and Shadow Banks: Competitors or Complements? Journal of Financial Intermediation, Vol. 27, pp. 118–131. Within that exchange zone, traditional banks provide implicit guarantees to shadow banks in order to gain access to off-balance sheet exposure, or share a pool of liquidity among them (traditional banks can hold more illiquid, higher-yielding assets with higher returns without all the downsides, especially when they also enjoy insurance despot guarantees).

770

Ibid. Ari et al. p. 7.

771

R. Palan and D. Wigan, (2017), The Economy of Deferral and Displacement: Finance, Shadow Banking and Fiscal Arbitrage, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 202–216.

772

Ibid. Ari et al., pp. 8–12.

773

Bailouts could be efficient not only ex post (after the debt has been issued) but also ex ante (before the issuance of the debt). Although anticipated bailouts create the typical moral hazard problem leading countries to issue more debt, this may be correct for the under issuance of public debt that would result from the lack of cross-country policy coordination. See in detail: M. Azzimonti and V. Quadrini, (2018), International Spillovers and ‘Ex-ante’ Efficient Bailout, NBER Working Paper Nr. 25,011, September.

774

Ibid. Ari et al., pp. 37–40

775

Market agents respond to complexity regardless of whether that is regulatory complexity, market complexity or the complexity of the corporate structure of large multinational corporations. See regarding the nature of international financial integration and the role of complexity: P.R. Lane and G. Milesi-Ferretti, (2017), International Financial Integration in the Aftermath of the Global Financial Crisis, IMF Working Paper Nr. WP/17/115, May. Regulatory complexity stems from both demand and supply side assets: supply-side factors include developments in the financial system and crisis-generated policymaking, which may increase regulatory complexity, including through the institutional architecture underpinning it. Demand-side factors include the self-interest of regulated entities (p. 2). See in detail G. Prasanna et al., (2019), Regulatory Complexity and the Quest for Robust Regulation, ESRB Report of the Advisory Scientific Committee, Nr. 8, June. They produce seven principles to design robust legislation (pp. 3–4, 32–40). They report that excessively complex regulations contribute to increased systemic risk in several ways: the illusion of well-designed systems that can be played; it misses contingencies; an over-fitted model misses the ‘unknown unknowns’; complexity makes responses convoluted; and it fosters regulatory arbitrage. Too simple regulation misses the mark and fails to address misaligned incentives, informational asymmetries and externalities. Financial regulation is robust when it stands even when confronted with hard-to-predict developments and innovations. The expert panels detail the aforementioned seven principles around the concept of system robustness and regulatory robustness: ‘[s]ystem robustness refers to the capacity of a system to maintain its core functions in the face of unexpected perturbations or disturbances. Regulatory robustness entails being able to cope with a variety of failure-inducing circumstances and behaviors, while not trying to offer the best-tailored response to each specific phenomenon’ (p. 3).

776

F. Allen et al., (2018), The Interplay Among Financial Regulations, Resilience, and Growth, Federal Reserve Bank of Philadelphia, Working Paper Nr. 18-09, February.

777

It was argued before that the lowering of corporate taxes (combined with higher profitability and lower funding costs) has led to more corporate cash savings and hoarding behavior but not to the well-anticipated capital and R&D investments. Dao and Maggi reported recently and extensively that higher gross corporate savings have not supported a commensurate increase in fixed capital investment, but instead led to a buildup of liquid financial assets (cash). See: M.C. Dao and C. Maggi, (2018), The Rise in Corporate Saving and Cash Holding in Advanced Economies: Aggregate and Firm Level Trends, IMF Working Paper Nr. WP/18/262, November. Also see: K. Adler et al., (2019), Corporate Cash Holding and Innovation in the Era of Globalization, IMF Working Paper, WP/19/17; R. Armenter and V. Hnatkovska, (2017), Taxes and Capital Structure: Understanding Firms Savings, Journal of Monetary Economics, Vol. 87, pp. 13–33; J. Azar, et al., (2016), Can Changes in the Cost of Carry Explain the Dynamics of Corporate Cash Holdings? Review of Financial Studies, Vol. 29, Issue 8, pp. 2194–2240; P. Bacchetta and K. Benhima, (2015), The Demand for Liquid Assets, Corporate Saving, and International Capital Flows. Journal of the European Economic Association, Vol., 13, Issue 6, pp. 1101–1135; P. Chen, et al., (2017), The Global Rise of Corporate Saving, Journal of Monetary Economics, Elsevier, Vol. 89(C), pp. 20–24; M. Dao, et al., (2019), The Granularity of Corporate Saving, IMF Working Paper WP/; J. Graham and M.T. Leary, (2017), The Evolution of Corporate Cash, NBER Working Paper Nr. 23,767; J. Gruber and S.B. Kamin, (2016), The Corporate Saving Glut and Falloff of Investment Spending in OECD Economies. IMF Economic Review, Vol. 64, Issue 4, pp. 777–799. G. Gutiérrez and T. Philippon, (2017), Investment-Less Growth: An Empirical Investigation, Brookings Papers on Economic Activity Nr. 22,897; E. Lyandres and B. Palazzo, (2016), Cash Holdings, Competition, and Innovation, Journal of Financial and Quantitative Analysis, Vol. 51, Issue 6, pp. 1823–1861.

778

Ibid. Ari et al., pp. 40–41.

779

S. Gissler and B. Narajabad, (2019), Supply of Private Safe Assets: Interplay of Shadow and Traditional Banks, Working Paper, December, mimeo.

780

To manage their interest rate risk, they changed the terms of their lending: the new loans had a shorter maturity and reset the interest rate at a high frequency, that is, they decreased the frequency of interest rate resets of their loans to depository institutions. Also see: I. Drechsler, et al., (2018), Banking on Deposits: Maturity Transformation Without Interest Rate Risk, NBER Working Papers Nr. 24,582, National Bureau of Economic Research, Inc. and P. Hoffmann et al., (2018), Who Bears Interest Rate Risk?, ECB Working Paper Nr. 2176, September. The latter find limited interest rate risk—on aggregate—in the European banking sector. Interesting however is the different (three) measurements of interest rate risk: ‘[f]irst, a net-worth sensitivity measures the effects of a hypothetical increase in interest rates of one basis point on the net present value of assets minus that of liabilities. Second, we compute the projected change in the net interest margin at a one-year horizon resulting from the same increase in interest rates. Finally, we use time-series information on banks’ net interest margin to compute its sensitivity with respect to changes in short-term interest rates (3-month Euribor)’ (p. 2). But the critical point here is that their findings somewhat deviate from other reported analysis including the one by Drechsler et al. (pp. 4, 7, 11–12, 15), although some differences exist in the way the studies are set up and which might help to explain some of the differential in the findings. They comment: ‘[w]hile some theoretical models highlight the redistributive effects of monetary policy between banks and the non-financial sector, our results show that these effects may be quantitatively less important than previously thought. Instead, our results highlight potential re-distributive effects within the banking sector. We estimate these to be 40% larger than those between banks and the non-financial sector’ (p. 2). Also: M.K. Brunnermeier, and Y. Koby, (2018), The “Reversal Interest Rate”: An Effective Lower Bound on Monetary Policy, March 29, Mimeo; S. Di Tella and P. Kurlat, (2018), Why Are Banks Exposed to Monetary Policy, NBER Working Paper Nr. 24,076, November; I. Drechsler et al., (2017), The Deposit Channel of Monetary Policy, Quarterly Journal of Economics, Vol. 132, pp. 1819–1876; W.B. English et al., (2018), Interest Rate Risk and Bank Equity Valuations, Journal of Monetary Economics, Elsevier, Vol. 98(C), pp. 80–97; F. Ippolito et al., (2018), The Transmission of Monetary Policy Through Bank Lending: The Floating Rate Channel, Journal of Monetary Economics, Vol. 95, pp. 49–71; D. Kirti, (2017), Why Do Bank-Dependent Firms Bear Interest-rate Risk, Working Paper, mimeo.

781

S. Gissler and B. Narajabad, (2018), Ibid. p. 18.

782

An interesting question was asked whether financial stability is a matter of macroprudential or monetary policy. See: D. Aikman et al., (2018), Targeting Financial Stability: Macroprudential or Monetary Policy? Bank of England Staff Working Paper Nr. 734, June 8. Deploying the countercyclical capital buffer (CCyB) improves outcomes significantly relative to when interest rates are the only instrument. The instruments are typically substitutes, with monetary policy loosening when the CCyB tightens. Also A. Ferrero et al., (2018), Concerted Efforts? Monetary Policy and Macro-Prudential Tools, Bank of England Staff Working Papers Nr. 727, May 25.

783

Markets have a short memory, and reengage with products that were at the root cause of previous crises. See, for example, J. Rennison, (2019), Investors Flock Back to Credit Product Blamed in Financial Crisis, Financial Times May 2. In this case synthetic CDOs. Also: C. M. Reinhart, (2018), The Biggest Emerging Market Debt Problem in America, December 20, via project-syndicate.org. She points out the intrinsic risks that exist in the corporate collateralized loan obligations. See also: K. Haunss, (2018), European CLO Market Hits Post-Crisis High, Reuters, November 21, via reuters.com. It has led the FSB to open a formal inquiry into leveraged loans indicating that the segment could pose a threat to financial stability. See in detail: S. Flemming, (2019), Global Regulators Launch Inquiry into Leveraged Loans, FT, March 7. See also the FSB, (2019), Global Monitoring Report on Non-Bank Financial Intermediation 2018, February 4, Case study 2: Recent developments in leveraged loan markets and the role of NBFIs, pp. 73–78. Leveraged loans are loans provided to nonfinancial corporates that typically have high levels of indebtedness, below-investment grade credit ratings or a spread at issuance higher than a certain threshold. The market is estimated to be around USD 1.4 trillion, but is very likely larger due to syndication projects, and the fact that most contracts are private. While restrictions on the use of collateral, issuance of new debt, payments to shareholders, asset sales and affiliate transactions is widespread, clauses that weaken these restrictions are almost as common and economically large. In detail: V. Ivanshina and B. Vallee, (2018), Weak Credit Covenant, Working Paper, May 28, mimeo. Securitizations are also on their way up both in the US and, according to the latest charts, in Europe. For example, DNB, (2019), Uitstaande Nederlandse securitisaties nemen voor het eerst sinds 2007 weer toe, Statistisch Nieuwsbericht, March 15, via dnb.nl. Or what about the first ‘reverse mortgage securitization’ created by Waterfall Asset Management. M. Adams, (2018), Hedge Fund Claims First Reverse Mortgage Securitization, October 31, via globalcapital.com. In a reverse mortgage, a homeowner borrows against a portion of the equity value in their home. These borrowers make no repayments until a repayment event occurs (the sale of the property after the last surviving borrower died). The loan doesn’t amortize and the interests accrue. Probability of default is focusing here on the borrower mortality or morbidity rather than the repayment capacity. Or a landmark securitization by landinvest, a company which makes property loans over the internet. See: T. Hale, (2019), What a Debut Securitisation Tells Us About Fintech, FT Alphaville, June 10.

784

For example, Goldberg and Meehl document that comparing 2007 with 2017 large US bank holding companies (BHCs) remain very complex, with some declines along organizational and geographical complexity dimensions. The numbers of legal entities within some large BHCs have fallen. By contrast, the multiple industries spanned by legal entities within the BHCs have shifted more than they have declined, especially within the financial sector. Nonfinancial entities within US BHCs still tilt heavily toward real estate–related businesses and span numerous other industries. Fewer large BHCs have global affiliates, and the geographic span of the most complex has declined. Favorable tax treatment locations still attract a significant share of the foreign bank and nonbank entities, while fewer legal entities are present in informationally opaque locations. In detail, see: L. Goldberg and A. Meehl, (2019), Complexity in U.S. Banks, FRB of NY Staff Report Nr. 880, February. For other examples how the nature, sources and perception of systemic risk changes over time: S. Antill and A. Sarkar, (2018), Is Size Everything, FRB of NY Staff Reports Nr. 864, August. Also: M.D. Flood et al., (2017), The Complexity of Bank Holding Companies: A Topological Approach, NBER Working Paper Nr. 23,755, August.

785

D. Basak and Y. Zhao, (2018), Does Financial Tranquility Call for Stringent Regulation, IMF Working Paper Nr. WP/18/123, May.

786

Ibid., p. 5. Their model allows investors to choose between a safe or risky asset. They are aware of the fact that a systemic risk crisis might occur. The investors do not know the extent to which the risky asset exposes the financial sector to this systemic crisis risk, but they can learn about it from the financial system’s history of performance. The longer the period of tranquility, the higher the level of risk taking is. The complacency trap means to risk buildup and is inherent to confidence associated with stable financial markets. A revision of that position only occurs once the crisis kicks in. This adjustment only occurs in the first phase of a crisis. In the following phases of a crisis, investors rebuild risk and invest even in assets that lead to the ongoing crisis. Despite the simplicity of the model designed by Basak and Zhao, it shows remarkable resemblance with reality where investors were willing to return to toxic products relative short after the first phase of the 2007 crisis (2007–2009). For example, subprime became bespoke and the show continued.

787

See for details: Ibid., pp. 11–18.

788

Ibid., 18–22. Also: S. Poledna and S. Thurner, (2016), Elimination of Systemic Risk in Financial Networks by Means of a Systemic Risk Transaction Tax, Quantitative Finance, Vol. 16, Issue 10, pp. 1599–1613.

789

More complete models of a crisis mode exist, but struggle to untangle the individual dynamics of the highlighted multivariable dynamics. See, for example, B. Biais et al., (2015), Dynamics of Innovation and Risk, Review of Financial Studies, Vol. 28, Issue 5, pp. 1353–1380; M. Gertler and N. Kiyotaki, (2015), Banking, Liquidity, and Bank Runs in An Infinite Horizon Economy, American Economic Review, Vol. 105, Issue 7, pp. 2011–2043.

790

D. Kirti, (2018), Lending Standards and Output Growth, IMF Working Paper Nr. WP/18/23.

791

In terms of systemic risk, much of the undefined risk sits in the rest category ‘investment funds’, which is a potpourri of vehicles not meeting formal regulatory qualifications but therefore also stay largely unsupervised. See also: E. Bengtsson, (2017), Investment Funds, Shadow Banking and Systemic Risk, in (eds. A. Nesvetailova) Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 163–178. Also in a broader context, see: A. Bouveret, (2017), The Shadow Banking System During the Financial Crisis of 2007–08: A Comparison of the US and the EU, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 107–121.

792

The inability for now to properly bring those dynamics together shows up in the fact that literature on countercyclical macroprudential policy and regulation, learning and moral hazard and ineffective risk taking from an externalities point of view tend to evolve in silos. See for an overview D. Basak and Y. Zhao, (2018), Does Financial Tranquility Call for Stringent Regulation, IMF Working Paper Nr. WP/18/123, May, pp. 8–11. P. Bolton et al., (2016), Cream-Skimming in Financial Markets. Journal of Finance, Vol. 71, Issue 2, pp. 709–736; J. Danielsson et al., (2016), Learning from History: Volatility and Financial Crises, Federal Reserve Board Finance and Economics Discussion Series Nr. 2016-093, October; M. Basurto and R. Espinoza, (2017), Consistent Measures of Systemic Risk, SRC Discussion Paper Nr. 74, October; G. Jiménez et al., (2017), Macroprudential Policy, Countercyclical Bank Capital Buffers and Credit Supply: Evidence from the Spanish Dynamic Provisioning Experiments, Journal of Political Economy, Vol. 125, Issue 6, pp. 2126–2177; M.E. Kahou and A. Lehar, (2017), Macroprudential Policy: A Review, Journal of Financial Stability, Vol. 29, pp. 92–105; A.R. Ghosh et al., (2017), Taming the Tide of Capital Flows—A Policy Guide, MIT Press, Cambridge, MA.

793

S. Naceur et al., (2019), Taming Financial Development to Reduce Crises, IMF Working Paper Nr. WP/19/94, April.

794

The question will always be asked how far should capital requirements be raised in order to ensure a strong and resilient banking system without imposing undue costs on the real economy. Capital requirement increases make banks safer and are beneficial in the long run but also entail transition costs because their imposition reduces credit supply and aggregate demand on impact. For example, see in detail: C. Mendicino et al., (2019), Bank Capital in the Short and the Long Run, ECB Working Paper Nr. 2286, May 24.

795

See the recommendations and analysis of the IMF, (2018), Bali Fintech Agenda, IMF Policy Paper, October, pp. 4–5; G. Buchak, et al. (2017), Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks, Chicago Booth Working Paper, May, mimeo. See regarding the impact of online platform providing or facilitating credit (USD 284 billion in 2017) and the implications it brings: FSB, (2019), Global Monitoring Report on Non-Bank Financial Intermediation 2018, February 4, Case study 1: FinTech Credit: Data, classification and policies, pp. 68–72. Some points of attention are as follows: (1) business models vary materially across jurisdictions (P2P, matching, notarized platforms, crowdfunding, marketplace lending, etc.); (2) data collection stays opaque despite licensing; (3) categorization remains difficult and can vary from deposit-taking corporations, OFIs or auxiliary financial activities and (4) prudent regulation is variably applicable often based on domestic technical criteria. Also see BCBS, (2018), Sound Practices: Implications of Fintech Developments for Banks and Bank Supervisors, February. S. Claessens, et al. (2018), FinTech Credit Markets Around the World: Size, Drivers and Policy Issues, BIS Quarterly Review, September, pp. 29–49; CGFS/FSB, (2017), FinTech credit: Market Structure, Business Models and Financial Stability Implications, May; T. Philippon, (2017), The FinTech Opportunity, BIS Working Paper Nr. 655, August 7, via bis.org; A. Meyer et al., (2017), Fintech: Is This Time Different? A Framework for Assessing Risks and Opportunities for Central Banks, Bank of Canada Staff Discussion Paper Nr. 10, July.

796

Also, the dynamics of regulatory arbitrage change with fintech, crowdfunding, and so on. See in detail: D.M. Ahern, (2018), Regulatory Arbitrage in a FinTech World: Devising an Optimal EU Regulatory Response to Crowdlending European Banking Institute Working Paper Series Nr. 24, March. Also see: Y. Googoolye, (2019), The Need to Adapt Regulatory and Supervisory Structures to Changing Technologies and Business Models, Speech at the 15th Meeting of the FSB Regional Consultative Group for Sub-Saharan Africa, Port Louis, 2 May 2019, via bis.org. The operative word when it comes to online platforms is ‘trust’. There is a wide variety of papers dealing with the issue. For example, C. van der Cruijsen et al., (2018), Trust in Other People and the Usage of Peer Platform Markets, DNB Working Paper Nr. 608, October 1.

797

See also the FSB report that considers the financial stability, regulatory and governance implications of the use of decentralized financial technologies such as those involving distributed ledgers and online peer-to-peer, or user-matching, platforms. The report focuses on technologies that may reduce or eliminate the need for intermediaries or centralized processes that have traditionally been involved in the provision of financial services. Such decentralization generally takes one of three broad forms: the decentralization of decision-making, risk taking and record-keeping. There are already examples emerging of decentralization in payments and settlement, capital markets, trade finance and lending. The report notes that the application of decentralized financial technologies—and the more decentralized financial system to which they may give rise—could benefit financial stability in some ways. At the same time, the use of decentralized technologies may entail risks to financial stability. These include the emergence of concentrations in the ownership and operation of key infrastructure and technology, as well as a possible greater degree of procyclicality in decentralized risk taking. A more decentralized financial system may reinforce the importance of an activity-based approach to regulation, particularly where it delivers financial services that are difficult to link to specific entities and/or jurisdictions. Certain technologies may also challenge the technology-neutral approach to regulation taken by some authorities. See in extenso: FSB, (2019), Decentralized Financial Technologies, June 6.

798

FSB, (2019), Report on Crypto-Assets, Work Underway, Regulatory Approaches and Potential Gaps, May 31. Also see: R. Auer and S. Claessens, (2018), Regulating Cryptocurrencies: Assessing Market Reactions, in BIS Quarterly Review Q3, September, pp. 51–65; R. Auer, (2019), Beyond the Doomsday Economics of ‘Proof-of-Work’ in Cryptocurrencies, BIS Working Paper Nr. 765, January 21. Also: ECB, (2019), Crypto-Assets: Implications for Financial Stability, Monetary Policy, and Payments and Market Infrastructures, ECB Crypto-Asset Task Force, ECB Occasional Paper Nr. 223, May 17. Also: J. Danielsson, (2018), Cryptocurrencies: Financial Stability and Fairness, LSE Systemic Risk Centre Discussion Paper Nr. 87, November and J. Danielsson, (2018), Cryptocurrencies: Policy, Economics and Fairness, LSE Systemic Risk Centre Discussion Paper Nr. 86, November.

799

S. Naceur et al., (2019), ibid., pp. 3,19.

800

See also: E. Cerutti et al., (2018), The Growing Footprint of EME Banks in the International Banking System, in BIS Quarterly Review pp. 27–38.

801

Also see: C. Mathonnat and A. Minea, (2018), Financial Development and the Occurrence of Banking Crises, Journal of Banking & Finance, Vol. 96, pp. 344–354.

802

EBA, (2019), The EBA 2019 Work Programme, via eba.europe.org. It also deserved special attention in the latest EBA annual report. See EBA, (2019), EBA Annual Report 2018, May, pp. 86–90. However, it wasn’t linked (directly) to the functioning and operations of shadow banking which in itself is remarkable.

803

EBA, (2019), ibid., pp. 9–10.

804

R. Ophèle and J. D’Hoir, (2018), Moving Beyond the Shadow Banking Concept, Banque de France, Financial Stability Review Nr. 22 April, pp. 145–154, and D. Domanski, (2018), Achieving the G20 Goal of Resilient Market-Based Finance, Banque de France, Financial Stability Review Nr. 22 April, pp. 155–165. For those who would like to explore and ponder a bit further regarding the road traveled in terms of regulation and supervision, trends in market-based finance, new forms of credit intermediation, and so on, I can recommend the full report of the Banque de France on Non-Bank Finance: Trends and Challenges, Financial Stability Review, Nr. 22 April, via banque-france.fr

805

In fact, and increasingly, financial regulation has adopted processes that are inconsistent with adherence to the rule of law. Relying on flawed regulatory processes—especially those related to the use of ‘guidance’, which avoids transparency, accountability and predictability, and thereby increases regulatory risk—has resulted in poor execution of regulatory responsibilities, unnecessary regulatory costs and opportunities for politicized mischief, claims Calomiris. He analysis a number of positions where this allegedly is the case. See C. Calomiris, (2017), Restoring the Rule of Law in Financial Regulation, CATO Working Paper Nr. 48, September 13.

806

See also FSB, (2018), Crypto-Asset Markets: Potential Channels for Future Financial Stability Implications, October 10, via fsb.org. This report sets out the analysis behind the FSB’s proactive assessment of the potential implications of crypto-assets for financial stability. The FSB’s report includes an assessment of the primary risks present in crypto-assets and their markets, such as low liquidity, the use of leverage, market risks from volatility and operational risks. Based on these features, crypto-assets lack the key attributes of sovereign currencies and do not serve as a common means of payment, a stable store of value or a mainstream unit of account. No direct material risk is identified coming from crypto-assets, but potential emerging risks need to be followed accurately. The FSB lays the framework as to how it will monitor crypto-asset markets. See: FSB, (2018), Crypto-Assets: Report to the G20 on work by the FSB and standard-setting bodies, July 16. The IOSCO also opens a consulting on the matter: IOSCO, (2019), Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms, Consultation Report, CR2/1019, May. The first demonstrates the current relevant frameworks (pp. 6–9), to whom are provided considerations in the following areas: access to trading platforms; safeguarding traded assets; support of platform operations; internal conflicts of interest; operational platform issues; detecting and dealing with market abuse; price discovery; safeguarding the resilience; integrity and reliability of critical systems; cybersecurity; clearing and settlement.

807

FSB, (2018), Potential Channels for Future Stability Implications, October 10, via fsb.org

808

See in detail: FSB, (2018), ibid., pp. 5–8.

809

And if there is, it is a sort of financialized corporate governance. See in detail for that discussion: A.R. Admati, (2017), A Skeptical View of Financialized Corporate Governance, Journal of Economic Perspectives, Vol. 31, Issue 3, pp. 131–150. See also: D. Domanski, (2019), Corporate Governance: A Building Block for Financial Resilience, Remarks at the G20/OECD Seminar on Corporate Governance: Corporate Governance in Today’s Capital Markets on 8 June in Fukuoka, via fsb.org. The EBA concluded that crypto-asset activities do not fall within the scope of EU banking, payments and electronic money law, and risks exist for consumers that are not addressed at the EU level. Crypto-asset activities may also give rise to other risks, including money laundering. EBA, (2019), Report with Advice for the European Commission on Crypto-Assets, EBA Report, January 9, via eba.europe.eu

810

D. Domanski, (2019), Cyber Security: Finding Responses to Global Threats, G7 2019 Conference: Cybersecurity: Coordinating efforts to protect the financial sector in the global economy Banque de France, Paris, 10 May 2019. Also see: IOSCO, (2019), Cyber Task Force, Final Report, IOSCO Report FR09/2019, June 18.

811

See in detail: FSB, (2018), ibid., pp. 8–12.

812

See in detail: FSB, (2018), ibid., pp. 12–16.

813

For an evaluation of what happened in the last decade. E. Avgouleas and C. Goodhart, (2019), Bank Resolution 10 Years from the Global Financial Crisis: A Systematic Reappraisal School of European Political Economy, LUISS 7/2019, May 31.

814

For example, S. Morris, et al. (2017), Redemption Risk and Cash Hoarding by Asset Managers, Journal of Monetary Economics, Vol. 89, pp. 71–87.

815

See in detail: EBA, (2018), EBA Report on the Prudential Risks and Opportunities Arising for Institutions from Fintech, July 3. The analysis includes positions such as biometric authentication, robo-advisory, big data and machine learning implications, DLT and smart contract aspects, outsourcing to public cloud and the use of mobile wallets. Also see: G. Buchak, et al. (2017), Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks, Chicago Booth Working Paper, mimeo. S. Gu et al. conclude that the machine learning repertoire, including generalized linear models, dimension reduction, boosted regression trees, random forests and neural networks, offers an improved description of expected return behavior relative to traditional forecasting methods (measuring asset risk premia). In detail: S. Gu et al., (2018), Empirical Asset Pricing via Machine Learning, NBER Working Paper Nr. 25,398, December; C. Chakraborty and A. Joseph, (2017), Machine Learning at Central Banks, Bank of England Staff Working Papers Nr. 674, September 1; J. Proudman, (2019), Managing Machines: The Governance of Artificial Intelligence, Given at FCA Conference on Governance in Banking, London, June 4; P.R. Milgrom and S. Tadelis, (2018), How Artificial Intelligence and Machine Learning Can Impact Market Design, NBER Working Paper Nr. 24,282, February. Shin is somewhat more positive about the potential for big tech to create financial inclusion. They do create a challenge in terms of trade-offs between financial stability, competition and data protection. H.S. Shin, (2019), Big Tech in Finance: Opportunities and Risks, chapter three, BIS Annual Economic Report, June 30, via bis.org; IMF/WBG, (2019), Fintech; The Experience so far, June 27; A. Fatás (eds.), (2019), The Economics of Fintech and Digital Currencies, CEPR Press, March 5, via voxeu.org

816

See in detail: Ph. Paech, (2017), The Governance of Blockchain Financial Networks, Modern Law Review, Vol. 80 Issue 6, pp. 1073–1110. Blockchain can then be defined as a new Internet-based way of recording entitlements and enforcing rights (smart contracts). Paech constructs a vision of how financial regulation and private law should set the boundaries of this new technology in order to protect market participants and societies at large. Also see: E. Avgouleas and A. Kiayias, (2019), The Promise of Blockchain Technology for Global Securities and Derivatives Markets: The New Financial Ecosystem and the ‘Holy Grail’ of Systemic Risk Containment, European Business Organization Law Review, Vol. 10, Issue 1, March, pp. 81–110. It took only a few hours after Libra, the Facebook-initiated stablecoin was communicated mid-June 2019 before parallels were drawn between the Libra and the construction of a new shadow banking market. It was German EP member Markus Ferber who tabled the idea (without further details), via blockcrypto.com, 18 June 2019. See also M. Casey et al., (2018), The Impact of Blockchain Technology on Finance: A Catalyst for Change, CEPR Press, July 16, via voxeu.org

817

Also see: V. Sushko and G. Turner, (2018), The Implications of Passive Investing for Securities Markets, BIS Quarterly Review, March, pp. 113–131; V. Sushko and G. Turner, (2018), What Risks Do Exchange-Traded Funds Pose?, Bank of France, Financial Stability Review Nr. 22, April, pp. 133–144; Z. Da and S. Shive (2018), Exchange Traded Funds and Asset Return Correlations, European Financial Management, Vol. 24, Nr. 1, pp. 136–168. Also see K. Anadu, (2018), The Shift from Active to Passive Investing: Potential Risks to Financial Stability?, Finance and Economics Discussion Series 2018-060. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2018.060. The latter ask themselves four questions: (1) effects on investment funds’ liquidity transformation and redemption risks; (2) passive strategies that amplify market volatility; (3) increases in asset management industry concentration; and (4) the effects on valuations, volatility and co-movement of assets that are included in indexes. They conclude that overall the shift from active to passive investment strategies appears to be increasing some types of risk while diminishing others: The shift has probably reduced liquidity transformation risks, although some passive strategies amplify market volatility, and passive-fund growth is increasing asset-management industry concentration. We find mixed evidence that passive investing is contributing to the co-movement of assets.

818

D. Zetzsche et al., (2019), The Future of Data-Driven Finance and RegTech: Lessons from EU Big Bang II, IBA Working Paper Nr. 35, April. Markets move based on news and narratives. In recent times, big data and algorithms determine sentiment and the narrative in financial markets. Nyman et al. wondered what that means for systemic risk assessments. They conclude that changes in the emotional content in market narratives are highly correlated across data sources. They show clearly the formation (and subsequent collapse) of very high levels of sentiment—high excitement relative to anxiety—prior to the global financial crisis. Their model and approach can lead to some intuitive and useful representations of financial market sentiment. A novel methodology was developed to measure consensus in the distribution of narratives. This metric can potentially be used to measure homogenization in the financial system. See R. Nyman et al., (2018), News and Narratives in Financial Systems: Exploiting Big Data for Systemic Risk Assessment, Bank of England Staff Working Paper Nr. 704, January. The idea is to get closer to gauging ex ante financial stability and systemic risks and events. Also see: S. Chassang et al. (2019), Data Driven Regulation: Theory and Application to Missing Bids, NBER Working Paper Nr. 25,654, March. Fraiberger et al. conclude that media sentiment robustly predicts daily returns in both advanced and emerging markets, even after controlling for known determinants of stock prices. But not all news sentiment is alike. A local (country-specific) increase in news optimism (pessimism) predicts a small and transitory increase (decrease) in local returns. By contrast, changes in global news sentiment have a larger impact on equity returns around the world, which does not reverse in the short run. Media sentiment affects mainly foreign—rather than local—investors: although local news optimism attracts international equity flows for a few days, global news optimism generates a permanent foreign equity inflow. See in detail: S.P. Fraiberger et al., (2018), Media Sentiment and International Asset Prices, NBER Working Paper Nr. 25,353, December; B. Broadbent, (2019), Investment and Uncertainty: The Value of Waiting for News, Speech given by Ben Broadbent, Deputy Governor Monetary Policy, Imperial College Business School, London, 20 May; M.J. Lee, (2018), Uncertain Booms and Fragility, FRB of NY Staff Reports Nr. 861, July.

819

FSB, (2019), FSB Report on Market Fragmentation, June 4, via fsb.org. There is no commonly agreed definition of ‘market fragmentation’ (see IOSCO report infra in this note pp. 6 ff. for a variety of definitions). The term is generally used to refer to markets that fragment either geographically or by type of product or participant. This paper only discusses fragmentation along geographical lines. Market fragmentation can manifest itself in a number of ways. One symptom may be a limited presence of foreign providers of financial services within a given jurisdiction. Another may be a reduction in cross-border capital flows and/or the existence of multiple prices for the same or economically similar financial assets across different jurisdictions or markets. A further symptom may be the segregation of levels of capital and liquidity within local markets that go beyond those commensurate with local risks, or a reduction in the availability of financial services for end-users (p. 4). See also the extensive literature list: pp. 20–26 and a number of interesting case studies: Annexes C & D: pp. 37–44. The supervisory and regulatory restrictions of extra-jurisdictional application exist and are known (pp. 5–13). The suggested solutions are still in terms of its constituting arguments, operational mechanics and broadband applicability: developing international standards, intensified cross-border sharing of information, and comparability and mutual recognition of regulatory regimes (pp. 14–18). Also to be read in conjunction with IOSCO, (2019), Market Fragmentation & Cross-Border Regulation, Report, Nr. FR07/2019, June. See for a set of interesting case studies, appendix A, pp. 28–52. There is also the concern of regulatory arbitrage working through the analysis.

820

See, for example, IMF, (2018), Global Financial Stability Report, October, Chapter 2, Regulatory Reform 10 Years after the Global Financial Crisis: Looking Back, Looking Forward, pp. 55–81. See also the FSB’s Cyberlexicon with a handy overview of the most important cyber-area-related concepts. See FSB, (2018), Cyber Lexicon, November 12, via fsb.org

821

A new type of Treasury bill that Italy wants to introduce in its drama to fight off the EC’s neoliberal agenda when it comes to budget management and sovereign debt. Mini-BOT (mini Bill of Treasury) small denomination bonds issued to help speed up its settling of debts. In essence, however, it is nothing more than an accounting trick. Giugliano explains, ‘the government simply pays its obligations through another form of debt. The innocent argument for their introduction is that they should make it easier for companies to cash in their arrears, providing a liquidity boost for Italian business.’ See: F. Giugliano, (2019), Italy Scary Parallel Currency Threat, June, via Bloomberg.com

822

See, for example, IMF, (2018), Global Financial Stability Report, October, Chapter 1, A Decade After the Global Financial Crisis: Are We Safer, pp. 1–53.

823

See a contrario: F. Villeroy de Galhau, (2018), Between ‘Shadow’ Banking and an Angelic Vision of the Market: Towards a Balanced Development of Non-Bank Finance, Banque de France, Financial Stability Review, Nr. 22, April, pp. 7–10.

824

R. Irani et al., (2018), The Rise of Shadow Banking: Evidence from Capital Regulation, ‘The Rise of Shadow Banking: Evidence from Capital Regulation, Finance and Economics’ Discussion Series Nr. 2018-039. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2018.039, who demonstrate the association between bank regulatory capital and credit reallocation toward nonbanks in the US market for syndicated corporate loans. Their research sits in a wider net of literature documenting the implication of recent banking regulation. They show how undercapitalized banks reallocate credit to nonbanks, and these effects are pronounced among loans with higher capital requirements and at times when bank capital is scarce. This is achieved by secondary market trading activity, that is, by selling loan shares in the years following origination. Low-capital banks are also most likely to sell distressed loans, which have higher-risk weights for capital requirements (pp. 2–4). There is limited empirical evidence on the relation between bank capital and shadow banking, and precisely how a greater presence of shadow banks might exacerbate or propagate risks in the financial system. See also: M. Bruche, et al. (2018), Pipeline Risk in Leveraged Loan Syndication, Working Paper, Federal Reserve Board; D. Martinez-Miera and R. Repullo, (2018), Markets, Banks and Shadow Banks. Working Paper, CEMFI; J. Toporowski, (2017), Why Overcapitalization Drives Banks into the Shadows, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 181.

825

D. Gabor, (2017), Shadow Connections: On Hierarchies of Collateral in Shadow Banking, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 143–162.

826

G. B. Gorton, (2019), The Regulation of Private Money, NBER Working Paper Nr. 25,891, May.

827

The concept of ‘information insensitivity’ in debt markets has earlier been discussed at large; Bengt Holstrom, (2015), Understanding the Role of Debt in the Financial System, BIS Working Paper Nr. 479, January, and T.V. Dang et al., (2015), The Information Sensitivity of a Security, Working Paper, March, mimeo.

828

See in extenso: T.V. Dang et al., (2017), Banks as Secret Keepers, American Economic Review, Vol. 107, Issue 4, pp. 1005–1029. Also: T. Jackson and L.J. Kotlikoff, (2018), Banks as Potentially Crooked Secret-Keepers, NBER Working Paper Nr. 24,751, July, Revised.

829

D. Martinez-Miera and R. Repullo, (2019), Markets, Banks and Shadow Banks, ECB Working Paper Nr. 2234, February. Also see: J. Beguenau and T. Landvoigt, (2017), Financial Regulation in a Quantitative Model of the Modern Banking System, mimeo; E. Fahri and J. Tirole, (2017), Shadow Banking and the Four Pillars of Traditional Financial Intermediation, NBER Working Paper Nr. 23,920.

830

V. Vanasco, (2017), The Downside of Asset Screening for Market Liquidity, Journal of Finance, Vol. 72, pp. 1937–1981.

831

Risk-based requirements can be found mainly in Basel II and Basel III standards. See for the modeling dynamics: D. Martinez-Miera and R. Repullo, (2019), ibid., pp. 18–21 (flat) and pp. 21–24 (risk sensitive).

832

D. Martinez-Miera and R. Repullo, (2019), ibid., pp. 5–7, on how the regulation is structured and affects the financial infrastructure.

833

D. Martinez-Miera and R. Repullo, (2019), ibid., pp. 24–33.

834

In detail on deposit insurance: D. Martinez-Miera and R. Repullo, (2019), ibid., pp. 36–38 Appendix A.

835

D. Martinez-Miera and R. Repullo, (2019), ibid., pp. 11–18 in detail for the model and results.

836

D. Martinez-Miera and R. Repullo, (2019), ibid., p. 34.

837

One can wonder if a paradigm shift isn’t required also within the context of regulation and how regulation needs to deal with a variety of variables and constantly changing objectives. Zetzsche et al. analyze possible new regulatory approaches, ranging from doing nothing (which spans from being permissive to highly restrictive, depending on context), cautious permissiveness (on a case-by-case basis, or through special charters), structured experimentalism (such as sandboxes or piloting), and development of specific new regulatory frameworks. A new regulatory approach, which incorporates these rebalanced or rebalancing objectives is coined ‘smart regulation’. See in detail: D. Zeitzsche, (2017), Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation, EBI Working Paper Series, Nr. 11, August; T. Adrian, (2018), Shadow Banking and Market-Based Finance, in Shadow Banking: Financial Intermediation Beyond Banks (Ed. Esa Jokivuolle), SUERF Conference Proceedings 2018/1, Larcier, pp. 14–37.

838

M. Harris, et al. (2017), Higher Capital Requirements, Safer Banks? Macroprudential Regulation in a Competitive Financial System, Wharton School Working Paper, mimeo; R. Irani, et al. (2018), The Rise of Shadow Banking: Evidence from Capital Regulation, CEPR Discussion Paper No. 12913; G. Ordoñez, (2018), Sustainable Shadow Banking, American Economic Journal: Macroeconomics, Vol. 10, pp. 33–56.

839

SME financing stays a sensitive topic, especially since evidence that the more stringent risk-based capital requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at those banks that were least capitalized ex ante relative to other banks. These effects are not homogeneous across jurisdictions, and they are generally found to be temporary. The evaluation also provides some evidence for a reallocation of bank lending toward more creditworthy firms after the introduction of reforms, but this effect is not specific to SMEs. See the public consultation started by the FSB on 9 June 2019. FSB, (2019), Evaluation of the effects of financial regulatory reforms on small and medium-sized enterprise (SME) financing: Consultation report, June 9, via fsb.org. Also see: R. Sébastien and S. Frédérique, (2017), SMEs’ Financing: Divergence Across Euro Area Countries? Banque de France Working Paper Nr. 654, December 12. Three external financing sources, bank loans, credit line/overdraft and trade credit, are analyzed. They find substantial differences between countries in the SMEs’ use of the three financing sources. In particular, the cross-country differences related to SMEs’ use of bank loans have significantly increased over the period 2010–2014. This divergence is not related to a global increase in the volatility of this use between countries. Instead, it has been driven by a sharper increase (resp. decrease) in the countries where SMEs’ use was initially higher (resp. lower). The results suggest that indicators about banking concentration are good candidates to explain the cross-country divergence of SMEs’ use of bank loans.

840

E. Farhi and J. Tirole, (2017), Shadow Banking and the Four Pillars of Traditional Financial Intermediation, NBER Working Paper Nr. 23,930, October.

841

How one organizes supervision—how we define the allocation of supervisory powers to different policy institutions—can have implications for policy conduct and for the economic and financial environment in which these policies are implemented. See for an analysis, also regarding (de)centralization: M. Ampudia et al., (2019), The Architecture of Supervision, ECB Working Paper Nr. 2287, May 27. Also see: A. Maddaloni and A. Scopelliti, (2019), Rules and Discretion(s) in the Prudential Regulation and Supervision: Evidence from EU Bank in the Run-up to the Crisis, ECB Working Paper Nr. 2284, May 22.

842

E. Farhi and J. Tirole, (2017), ibid., p. 38. Also see: P. Feve, et al. (2017) Financial Regulation and Shadow Banking: A Small-Scale DSGE Perspective, TSE Working Paper Nr. 17-829; J. Beguenau and T. Landvoigt (2017), Financial Regulation in a Quantitative Model of the Modern Banking System, Stanford University Working Paper, mimeo.

843

J. Kregel, (2010), Is This the Minsky Moment for Reform of Financial Regulation? Levy Economics Institute Working Paper Nr. 586, February. To be read together with J. Kregel, (2018), Preventing the Last Crisis, Minsky’s Forgotten Lessons Ten Years After Lehman Levy Economics Institute Policy Note Nr. 2018/5, November.

844

D. Graeber, (2018), The ‘Yellow Vests’ Show How Much the Ground Moves Under Our Feet, Critical Legal Thinking, December 9, via criticallegalthinking.com

845

J. Kregel, (2019), Democratizing Money, Levy Economics Institute Working Paper Nr. 928, May.

846

A. Barajas et al. (2018), A Decade After Lehman, the Financial System Is Safer. Now We Must Avoid Reform Fatigue, IMFBlog, October 3, via blogs.imf.org

847

G. Tett, (2018), European Banks Still Have Post-Crisis Repairs to Do, FT, July 19. Also see: BIS, (2018), Annual Economic Report, June, via bis.org, pp. 43–47. See also: S. Ingves, (2018), Basel III: Are We Done Now? Keynote speech by Stefan Ingves, Chairman of the Basel Committee on Banking Supervision, at the Institute for Law and Finance conference on ‘Basel III: Are we done now?’, Goethe University, Frankfurt am Main, 29 January, via bis.org, p. 3. Full, timely and consistent implementation: more than just words, and p. 4 Enhancing financial stability: an ongoing journey.

848

The EBA seems to somewhat agree with that view, although in more hidden terms. At least this is the impression I got when cruising through the Basel reform impact report. See in detail: EBA, (2018), 2018 Basel III Monitoring Exercise Report, October 4, via eva.europe.eu

849

EBA, (2018), EBA Report on Liquidity Measures Under Article 509(1) of the CRR, October 4, via eba.europe.eu

850

L. Culp and A. Neves, (2018), Shadow Banking, Risk Transfer and Financial Stability, Journal of Applied Corporate Finance, Vol. 29, Issue 4, pp. 45–64.

851

Dynamic stochastic general equilibrium (DSGE) models. See in detail: J. Fernández-Villaverde, (2009), The Econometrics of DSGE Models, NBER Working Paper Nr. 14,677, January; A. Gulan, (2018), Paradise Lost? A Brief History of DSGE Macroeconomics, Bank of Finland Research Discussion Papers, Nr. 22, Helsinki. R. Deb et al., (2018), Evaluating Strategic Forecasters, American Economic Review, Vol. 108, Nr. 10, October, pp. 3057–3103; H.F. Sonnenschein, (2018), Chicago and the Origins of Modern General Equilibrium, Journal of Political Economy, Vol. 125, Nr. 6, December, pp. 1728–1736; J. Breitung and M. Knüppel, (2018), How Far Can We Forecast? Statistical Tests of the Predictive Content, Deutsche Bundesbank Discussion Paper Nr. 7, April 25.

852

J. E. Stiglitz, (2018), Where Modern Macro-Economics Went Wrong, Oxford Review of Economic Policy, Vol. 34, Issue 1–2, Spring-Summer, pp. 70–106; C.-W. Chiu et al., (2018), A New Approach for Detecting Shifts in Forecast Accuracy, Bank of England Staff Working Paper Nr. 721, April 13; T. Nakata and T. Sunakawa, (2019), Credible Forward Guidance, Finance and Economics Discussion Series 2019-037. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2019.037; J.R. Campbell et al., (2019), The Limits of Forward Guidance, FRB of Chicago Working Paper Nr. 3, March 20; M. Ehrmann et al., (2019), Can More Public Information Raise Uncertainty? The International Evidence of Forward Guidance, ECB Working Paper Nr. 2263, April 15.

853

Liberal democracies operate with a majority that is always temporary. Any dominance or victory is temporary. In many ways, this idea seems more theoretical than actual. See: M. Wolf, (2018), Saving Liberal Democracy from the Extremes, FT, September 25. In line with that and how permanent networks seek rent capture: R. Haselmann et al., (2018), Rent Seeking in Elite Networks, The Journal of Political Economy, Vol. 126, Nr. 4, August, pp. 1638–1690.

854

See, for example, B. Braun, (2018), Central Banking and the Infrastructural Power of Finance: The case of ECB Support for Repo and Securitization Markets, Socio-Economic Review, February 20, online: https://doi.org/10.1093/ser/mwy008; T. Walter and L. Wansleben, (2019), How Central Bankers Learned to Love Financialization: The Fed, the Bank and the Enlisting of Unfettered Markets in the Conduct of Monetary Policy, Socio-Economic Review, March 21, online: https://doi.org/10.1093/ser/mwz011, both in preprint

855

J. de Loecker and J. Eeckhaut, (2017), The Rise of Market Power and the Macro-Economic Implications, NBER Working Paper Nr. 23,687, August.

856

See in detail: O.C. Valencia and A.O. Bolaños, (2018), Bank Capital Buffers Around the World: Cyclical Pattern and the Effect of Market Power, Journal of Financial Stability, Vol. 38, October, pp. 119–131; J. R. LaBrosse et al., (2018), ‘Multinational Banking’: Capturing the Benefits and Avoiding the Pitfalls, Journal of banking Regulation, Vol. 19, January pp. 1–3.

857

M. Wolf, (2017), Central Banks Alone Cannot Deliver Stable Finance, FT, October 24. Wolf indicates, ‘It has to be possible for the financial system to cope with changes in asset prices without blowing up the world economy. This should not need saying.’ True, but so far we haven’t moved an inch closer in achieving that objective. Partly because both regulation and policy are two very imperfect tools to achieve that objective. But, as a starter financial excess and leverage should be curbed. That is within the remit of both regulation and macroprudential policies. Banks ultimately remain far too undercapitalized for comfort, the same M. Wolf highlights. See FT 21 September 2017. Since then leverage position has only aggravated.

858

Also: R. Guttman, (2017), The Transformation of Banking, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 25–39; E. Engelen, (2017), How Shadow Banking Became Non-Finance: The Conjectural Power of Economic Ideas, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 40–54; T. Grung Moe, (2017), Shadow Banking and the Challenges for Central Banks, in (eds. A. Nesvetailova), Shadow Banking: Scope, Origins and Theories, Routledge, Abingdon UK, pp. 217–237.

859

See also: M. Renner and A. Leidinger, (2016), Credit Contracts and the Political Economy of Debt in Reshaping Markets. Economic Governance, the Global Financial Crisis and Liberal Utopia, (eds. B. Lomfeld, A. Somma and P. Zumbansen) in Cambridge University Press, Cambridge, pp. 133–158.

860

Koddenbrock argues, ‘[a]s a social structure and process, it makes moneymaking through capital permeate all our societies. As a public-private partnership between the state, rentiers, banks, and taxpayers that has existed since the foundation of the Bank of England in 1694, it binds these actors together in shifting relations of dependence. In today’s financial capitalism, what counts as money and how far moneyness stretches into the realms of financial innovation has been the core object of struggle in the public-private partnership of money.’ See in detail the excellent paper: K. Koddenbrock, (2017), What Money Does: An Inquiry into the Backbone of Capitalist Political Economy, MPIfG Discussion Paper Nr. 17/9, Max-Planck-Institut für Gesellschaftsforschung, Köln. Also see: L. Baccaro and J. Pontusson, (2018), Comparative Political Economy and Varieties of Macroeconomics. MPIfG Discussion Paper Nr. 18/10, Max-Planck-Institut für Gesellschaftsforschung, Köln. Regarding the role of money creation by shadow banks, see: J. Michell, (2017), Do Shadow Banks Create Money? ‘Financialization’ and the Monetary Circuit, Metroeconomica, Vol. 68, Issue 2, pp. 354–377.

861

L. Elsässer et al., (2018), Government of the People, by the Elite, for the Rich: Unequal Responsiveness in an Unlikely Case, MPIfG Discussion Paper Nr. 18/5, Max-Planck-Institut für Gesellschaftsforschung, Köln.

862

L. Baccaro and C. Howell, (2017), Unhinged: Industrial Relations Liberalization and Capitalist Instability, MPIfG Discussion Paper Nr. 17/19, Max-Planck-Institut für Gesellschaftsforschung, Köln; P.-R. Agénor et al., (2018), The Effects of Prudential Regulation, Financial Development and Financial Openness on Economic Growth, BIS Working Paper Nr. 752, October 5, via bis.org. Besides the fact that the latter provide analytical overview of the various channels through which prudential regulation can affect economic growth, they show that growth may be promoted by prudential policies that seek to mitigate financial risks to the economy. At the same time, financial openness tends to reduce the growth benefits of these policies. This may reflect either greater opportunities to borrow abroad or increased scope for cross-border leakages in regulation. Also see: F. Manaresi and N. Pierri, (2018), Credit Supply and Productivity Growth, BIS Working Paper Nr. 711, March 28, via bis.org. Literature has shown that credit supply helps firms purchase inputs, most notably capital, thus allowing them to increase production. They (Manaresi and Pieri) extend this research by showing that credit affects firm productivity beyond the estimated scale effect. These credit contractions have a negative and persistent effect on firm productivity. Positive credit supply shocks have a much more limited positive impact, implying that credit volatility may be bad for productivity growth. The estimated impact is found to result from several productivity enhancing activities. These include R&D, patenting, adoption of IT, improved management practices and propensity to export.

863

See in detail most recently: R. McCauley, (2018), The 2008 Crisis: Transpacific or Transatlantic, in BIS Quarterly Review Q4, pp. 39–58.

864

See for further guidance: BIS (2018): The Rise of Leveraged Loans: A Risky Resurgence?, BIS Quarterly Review, September, pp. 10–12; Bank of England, (2018), Financial Stability Report, Issue Nr. 44. November, pp. 42–48; ECB (2018): Financial Stability Review, May, pp. 74 ff.; ECB (2018): Financial Stability Review, November, pp. 10, 47–48, 54–55; Federal Reserve Board of Governors, (2018), Financial Stability Report. November, pp. 11–12, 18–19, 28–29; Fitch Ratings, (2016), European Leveraged Loan Funds, October; IOSCO, (2018), Leverage, Consultation Paper, CR08/2018, regarding leverage used in investment funds and the analysis of critical metrics of leverage (pp. 5–18) and the actual risk analysis at fund level (pp. 19–20); Moody’s (2018), High Corporate Leverage Signals Future Credit Stress Even as the Default Rate Remains Very Low, 24 May; Moody’s (2018), Leveraged Finance – US: LBO Credit Quality Is Weak, Bodes Ill for Next Downturn, 18 October; Standard & Poors (2018), When the Cycle Turns: Leverage Continues to Climb: Has It Finally Peaked?, 9 October.

865

FSB, (2019), Global Monitoring Report on Non-Bank Financial Intermediation 2018, February 4, Case Study 2: Recent developments in leveraged loan markets and the role of NBFIs, pp. 73–78.

866

FSB, (2019), ibid., p. 73.

867

FSB, (2019), ibid., pp. 74–75.

868

Zombie firms can be defined as firms that are unable to cover debt servicing costs from current profits over an extended period. See in extenso: R. Banerjee and B. Hofmann, (2018), The Rise of Zombie Firms: Causes and Consequences, in BIS Quarterly Review Q3, September, pp. 67–78. Also see: D. Andrews and F. Petroulakis, (2019), Breaking the Shackles: Zombie Firms, Weak Banks and Depressed Restructuring in Europe, ECB Working Paper Nr. 2240, February 14; D.J. Herok and G. Schnabl, (2018), Europäische Geldpolitik Und Zombiefizierung (European Monetary Policy and Zombification), Austrian Institute Paper Nr. 21, June 1.

869

P. Andrade et al., (2018), Forward Guidance and Heterogeneous Beliefs, BIS Working Paper Nr. 750, October 3, via bis.org

870

Central bank communication is important, but the exact form of that communication is less critical. See in extenso: G.-A. Detmers et al., (2018), Quantitative or Qualitative Forward Guidance: Does It Matter? BIS Working Paper Nr. 742, August 28, via bis.org; S. Morris and H.S. Shin, (2018), Central Bank Forward Guidance and the Signal Value of Market Prices, BIS Working Paper Nr. 692, January 23.

871

As Endrejat and Thiemann correctly highlight, the reorientation of European regulatory agency on shadow banking post-crisis, from curtailing it to facilitating resilient market-based finance, has been a cause for irritation by academic observers, dismissed by some as mere rebranding or taken as a sign of regulatory capture. Not only the redesign of MMFs, STS reforms, ABCP and CRR, as well as the way how they have been transformed in such a way that their final versions allow to reestablish the shadow banking chain linking MMFs, the ABCP market and arguably the regular banking system. They also conclude that it was a coordinated effort by the regulator with private actors in order to maintain a channel for credit creation outside of bank credit, a task made more complicated by the rushed politicized final negotiations coupled with technical complexity. In detail: V. Endrejat and M. Thiemann, (2018), Reviving the Shadow Banking Chain in Europe: Regulatory Agency, Technical Complexity and the Dynamics of Co-habitation, SAFE Working Paper. 222, August 28. It is aimed at creating a regulatory infrastructure able to sustain the orderly flow of real economy debt.

872

Much has been said about the questionable role of finance in economic growth and how too large a financial sector hampers economic growth. Popov reviews and appraises the body of empirical research on the association between financial markets and economic growth that has accumulated over the past quarter-century. The bulk of the historical evidence suggests that financial development affects economic growth in a positive, monotonic way, yet recent research endeavors have provided useful and important qualifications of this conventional wisdom. More precise links between theory and measurement have been studied. Popov also highlights the mechanisms through which financial markets benefit society, as well as the channels through which finance can slow down long-term growth. In detail: A. Popov, (2017), Evidence on Finance and Economic Growth, ECB Working Paper Nr. 2115, December 6.

873

See in detail: CGFS, (2019), Establishing Viable Capital Markets, CGFS Papers Nr. 62, January, via bis.org

874

P.J. König and D. Pothier, (2018), Safe but Fragile: Information Acquisition, Sponsor Support and Shadow Bank Runs, Deutsche Bundesbank Discussion Paper Nr. 15, June 4.

875

Without answering the question directly, they argue that a large proportion of the fall in US GDP associated with the crisis can be explained by two factors: the fragility of financial sector—represented by the increase in leverage and reliance on short-term funding at nonbank financial intermediaries—and the buildup in indebtedness in the household sector. The former has decreased, the latter has increased post-crisis. As argued before, there is, and in contrast with public debt levels, a systemic risk also in private debt that often is ignored. See in detail: D. Aikman et al., (2018), Would Macroprudential Regulation Have Prevented the Last Crisis, Bank of England Staff Working Paper Nr. 747, August 3.

876

See regarding the stability dimension in market-based finance: S. Maijoor and C. Boidard, (2017), Banque de France, Financial Stability Review Nr. 21, April, The Impact of Financial Reforms, pp. 149–156.

877

FSB, (2017), Implementation and Effects of the G20 Financial Regulatory Reforms report, 3rd report, July 3, p. 1.

878

FSB, (2017), ibid., p. 2.

879

See, for example, FSB, (2017), ibid., pp. 15–17.

880

FSB, (2017), ibid., p. 16; FSB, (2016), Thematic Review on the Implementation of the FSB Policy Framework for Shadow Banking Entities, May, section 4.

881

See O. Attanasio et al., (2018), Dismal Ignorance of the ‘Dismal Science’—a Response to Larry Elliot, The Prospects Magazine (www.prospectmagazine.co.uk).

882

See on the OTC derivative reforms: FSB, (2017), ibid., pp. 21–23.

883

See, for example, FSB, (2017), ibid., pp. 24–26. It won’t take long to find firm statements: ‘[t]he aspects of shadow banking generally considered to have made the financial system most vulnerable and contributed to the financial crisis have declined significantly and are generally no longer considered to pose financial stability risks at the current conjuncture’ (p. 24); ‘Reforms have contributed to a reduction in vulnerabilities in other areas associated with the crisis, such as MMFs and repurchase agreements (repos)’ (p. 24); ‘At present, the FSB has not identified other new shadow banking risks that require additional regulatory action at the global level’ (p. 26).

884

See, for example, FSB, (2017), ibid., pp. 27–33.

885

I. Fender and U. Lewrick, (2016), Adding It All Up: The Macroeconomic Impact of Basel III and Outstanding Reform Issues, BIS Working Paper Nr. 591, November.

886

This is also the conclusion of L. Grillet-Aubert et al., (2016), Assessing Shadow Banking – Non-Bank Financial Intermediation in Europe, ESRB report nr. 10, July.

887

FSB, (2017), Implementation and Effects of the G20 Financial Regulatory Reforms report, 3rd report, July 3, pp. 33–34 ff.

888

Including that of the FSB; see FSB, (2017), ibid., pp. 46 ff.

889

Dated 3 July 2017, and accompanying video can be sourced via fsb.org and youtube.com

890

FSB, (2016), Assessment of Shadow Banking Activities, Risks and the Adequacy of Post-Crisis Policy Tools to Address Financial Stability Concerns, July 3.

891

A question that keeps reemerging is as to how domestic regulation causes cross-border spillovers; see in detail: R. Hills et al., (2016), Cross-Border Regulatory Spillovers: How Much? How Important? What Sectors? Lessons from the United Kingdom, Bank of England Staff Working Paper Nr. 595, April. They observe little cross-border effects in the UK but document the literature concluding otherwise.

892

Along the lines of the already discussed five economic functions in which entities engage that might give rise to shadow banking risks including liquidity and maturity transformation, leverage and imperfect credit risk transfer; see in detail: FSB, (2017), Assessment of Shadow Banking Activities, Risks and the Adequacy Of Post-Crisis Policy Tools to Address Financial Stability Concerns, July 3, pp. 21–25.

893

FSB, (2016), Assessment of Shadow Banking Activities, Risks and the Adequacy of Post-Crisis Policy Tools to Address Financial Stability Concerns, July 3, p. 4.

894

Via www.bis.org

895

See also: G. Hoggarth et al., (2016), Capital Inflows – the Good, the Bad and the Bubbly, Financial Stability paper Nr. 40.

896

See for some ideas: F. Restoy, (2018), The Post-Crisis Regulatory Agenda: What is Missing?, Speech, February 19.

897

Regarding this matter, the BIS released two consultative documents, ‘Identification and management of step-in risk’ in December 2015 and March 2017.

898

And of shadow banking in general with a deep intertwining with traditional banking as continued central principle. See: A. Musatov and M. Perez, (2016), Shadow Banking Re-Emerges, Posing Challenges to Banks and Regulators, Dallas Fed Economic Letter, Vol. 11, Nr. 10, July, pp. 1–4. Traditional banks are between a rock and a hard place: by providing liquidity to depositors and credit line borrowers, banks are exposed to double runs on assets and liabilities, that is, these simultaneous activities expose banks to the risk of correlated double runs on their assets (credit lines) and on their liabilities (wholesale uninsured deposits). See in detail: F. Ippolito et al., (2016), Double Bank Runs and Liquidity Risk Management, ESRB Working Paper Series Nr. 8, April, p. 27.

899

See in detail: A. Carstens, (2017), The Nature of Evolving Risks to Financial Stability, Speech, December 15.

900

See Sir J. Cunliffe, (2017), Market-Based Finance: A Macroprudential View, Speech February 9. See in detail the extensive and thematic number of the Financial Stability Review of Banque de France, The Impact of Financial Reforms, April 2017 edition.

901

J. Cunliffe, (2017), ibid., pp. 4–5. In line with earlier statements, see J. Cunliffe, (2015), Market Liquidity and Market-Based Financing, Speech, October 22.

902

J. Cunliffe, (2017), ibid., pp. 7–10. See also: J. Bats and A. Houben, (2017), Bank-Based Versus Market-Based Financing: Implications for Systemic Risk, DNB Working Paper Series nr. 577, December; S. Langfield, and M. Pagano, (2016), Bank Bias in Europe: Effects on Systemic Risk and Growth, Economic Policy Issue 31, pp. 51–106.

903

See in detail J. Baranova et al., (2017), Simulating Stress Across the Financial System: The Resilience of Corporate Bond Markets and the Role of Investment Funds’ Bank of England Financial Stability Paper Nr. 42. All stress-testing models are subject to continuous evaluation. See, for example, the reevaluation of the BCBS of the stress-testing models for banks: BCBS, (2017), Stress testing principles—consultative document, December which will lead to the replacement of the May 2009 principles; BCBS, (2009), Principles for Sound Stress Testing Practices and Supervision, May. For an elaboration on the wide range of stress-testing practices: BCBS, (2017), Supervisory and Bank Stress Testing: Range of Practices, December.

904

See also: CGFS, (2016), Fixed Income Market Liquidity, CGFS Papers Nr. 55, January. Drivers of market liquidity in the fixed-income sphere include technology, competition, leverage, regulation and monetary policy (pp. 15–21).

905

See in detail FSB, (2017), Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, January 12.

906

See K. Polanyi, (2001), The Great Transformation, Beacon Press, Boston, MA [1944].

907

See for an excellent and historical write-up on this topic: B. van Bavel, (2016), The Invisible Hand. How Market Economies Have Emerged and Declined Since AD 500, Oxford University Press, Oxford.

908

FSB, (2017), FSB, (2017), Assessment of Shadow Banking Activities, Risks and the Adequacy Of Post-Crisis Policy Tools to Address Financial Stability Concerns, July 3, p. 27.

909

FSB, (2017), Assessment of Shadow Banking Activities, Risks and the Adequacy Of Post-Crisis Policy Tools to Address Financial Stability Concerns, July 3, pp. 28–32.

910

See, for example, a stylized view of the structural characteristics of credit-based intermediation around which regulation and policy is built: T. Adrian, (2017), Shadow Banking and Market-based Finance, Speech, September 14, Table 1 via imf.org

911

See in detail: J.W. Jurek and E. Stafford, (2015), The Cost of Capital for Alternative Investments, The Journal of Finance, Vol. 70, Issue 5, pp. 2185–2226; A. Muley, (2016), Collateral Re-Use in Shadow Banking and Monetary Policy, MIT Working Paper, January 7, mimeo.

912

D. Nouy, (2017), Safer Than Ever Before? An Assessment of the Impact of Regulation on Banks’ Resilience Eight Years on, in Financial Stability Review, Banque de France, The Impact of Financial Reforms, April, pp. 23–32; also relevant in this context and to be found in the same thematic number of the Financial Stability Review: D.J. Elliott and E. Balta, (2017), Measuring the Impact of Basel III, pp. 33–44; A. Weber, (2017), The Impact of Financial Regulation: A G-SIB Perspective, pp. 45–54; and K. Chousakos and G. Gorton, (2017), Bank Health Post-Crisis, pp. 55–70; S. Krug and H.-W. Wohltmann, (2016), Shadow Banking, Financial Regulation an Animal Spirits – An ACE Approach, Economics Working Paper, Christian-Albrechts-Universität Kiel, Department of Economics, Nr. 2016–08, June. Krug and Wohltmann’s prime finding is not so much the analysis that banks cope with incoming regulation but that ‘an unilateral inclusion of shadow banks into the regulatory framework, i.e. without access to central bank liquidity, has negative effects on monetary policy goals, significantly increases the volatility in growth rates and that its disrupting character materializes in increasing default rates and a higher volatility in the credit-to-GDP gap. However, experiments with a full inclusion, i.e. with access to a lender of last resort, lead to superior outcomes relative to the benchmark without shadow banking activity.’ See also: M. Montagna, (2016), Systemic Risk in Modern Financial Systems, PhD thesis, Kiel University, Kiel, mimeo.

913

T. Adrian, (2017), Shadow Banking and Market-based Finance, Speech, September 14, via imf.org

914

T. Adrian, (2017), ibid., chapter ‘Strengthening Supervision and Regulation – How Far Have We Come?’

915

T. Adrian, (2017), ibid.; also T. Adrian, (2015), Financial Stability Policies for Shadow Banking, in S. Claessens, D. Evanoff, G. Kaufman and L. Laeven (Eds.), Shadow Banking Within and Across National Borders, World Scientific Studies in International Economics, Issue 40; D. King, et al., (2017), Central Bank Emergency Support to Securities Markets, IMF Working Paper Series, WP/17/152; K. Pan, and Y. Zeng, (2017), ETF Arbitrage under Liquidity Mismatch, Working Paper, Harvard University, mimeo.

916

Robbert Dijkgraaf, Physics professor and director of the Institute for Advanced Study in Princeton, made meaningful comments in this respect. I believe he got it right when indicating that the best science is produced not along the lines of what has been done before, although that is tempting within a context ‘peer review pressure’, but that it often is the consequence of eloquently and diligently searching in the dark without structure, processes and frameworks. In his native language, which sounds like ‘doelgericht tasten in het duister’, of which a proper translation could be ‘purposeful sensing in the dark’: R. Dijkgraaf, (2017), Doelgericht tasten in het donker, NRC, via nrc.nl, February 10. What he aims at is that major leap forward is often not the consequence of systematically building on what exists, but steering into unchartered territory with a mission while not forgetting what you already know. The abovementioned peer review dynamics of this day and age contribute in a way to safeguarding quality but also create a situation where certain quality work doesn’t get the attention it deserves (or the funding to even engage in that research). I made the statement before that many ‘renaissance works’ (that we consider tectonically shifting our understanding on a certain matter) would have not seen the light if the authors would have lived and worked at present time.

917

See F. Villeroy de Galhau, (2017), Towards Financial Stability: A Common Good That Needs to Be Consolidated and Reinforced, in Financial Stability Review, Banque de France, The Impact of Financial Reforms, April, pp. 7–12, who tends to move in that direction; also in the same thematic number: A. Persaud, (2017), Have Post-Crisis Financial Reforms Crimped Market Liquidity?, pp. 141–148, and S. Maijoor and C. Boidard, (2017), A Stability Perspective of Market-Based Finance: Designing New Prudential Tools?, pp. 149–156.

918

B. Braun et al., (2018), Governing Through Financial Markets: Towards a Critical Political Economy of Capital Market Union, Competition & Change, Vol 22, Issue 2, pp. 1–16.

919

See about the relationship between regulation and market liquidity: A. Persaud, (2017), Have Post-Crisis Financial Reforms Crimped Market Liquidity, Banque de France, Financial Stability Review Nr. 21, April, The Impact of Financial Reforms, pp. 141–147.

920

E. Farhi and J. Tirole, (2017), Shadow Banking and the Four Pillars of Traditional Financial Intermediation, Working Paper, December 21, mimeo.

921

E. Farhi and J. Tirole, (2017), ibid., p. 39. See also: J. Beguenau and T. Landvoigt, (2017), Financial Regulation in a Quantitative Model of the Modern Banking System, Stanford Working Paper, mimeo; T. Berg and J. Gider (2016), What Explains the Difference in Leverage Between Banks and Non-Banks? Journal of Financial and Quantitative Analysis, Vol. 52, Issue 6, pp. 2677–2702; P. Feve and O. Pierrard, (2017), Financial Regulation and Shadow Banking: A Small-Scale DSGE Perspective, TSE Working Paper Nr. 17-829, July; O. Shy and R. Stenbacka, (2017), Ring-Fencing, Lending Competition, and Taxpayer Exposure?, Working Paper, mimeo.

922

ESRB, (2016), Macroprudential Policy Issues Arising from Low Interest Rates and Structural Changes in the EU Financial System, November, pp. 23–26. Also see: G. Beck et al., (2016), Euro Area Shadow Banking Activities in a Low-Interest Rate Environment: A Flow-of-Funds Perspective, SAFE White Paper Series Nr. 37, February.

923

J. Bats and A. Houben, (2017), Bank-Based Versus Market-Based Financing: Implications for Systemic Risk, DNB Working Paper Nr. 577, December.

924

J. Bats and A. Houben, (2017), ibid., p. 18.

925

J. Bats and A. Houben, (2017), ibid., p. 19.

926

Chiu discusses the limitations that the functional approach has when measuring and defining the shadow banking market. She also proposes to overcome those limitations by ‘deliberate channelling of the functional approach into a rational communicative framework that is inclusive, so that financial innovation and its merits can be fully debated upon, to feed into regulatory policy-making’. She communicated about the Habermasian-based idea at an earlier stage: M. Andenas and I. H-Y Chiu, (2014), The Foundations and Future of Financial Regulation, Routledge, Oxford, chapter three. And then later in I. H.-Y. Chiu, (2018), Taking a Functional Approach to Understanding Shadow Banking: A Critical Look at Regulatory Policy, in Research Handbook on Shadow Banking. Legal and Regulatory Aspects, I.H.-Y. Chiu and Iain MacNeil (eds.), Edward Elgar, Cheltenham, pp. 47–84. The communication framework is intended to achieve optimal fact-finding in order to develop a body of knowledge through which evolving practices are identified and assessed. Such body of knowledge should be, as she indicates, fostered independent of power domination, interest preferences and arguments rooted in national legal structures.

927

Others as well apparently. See, for example, on the impact of blockchain and the underlying technology known as ‘distributed ledger technology’ (DLT): A.P. Donovan, (2018), (Shadow) Banking on the Blockchain: Permissioned Ledgers, Interoperability and Common Standards, in Research Handbook on Shadow Banking. Legal and Regulatory Aspects, I.H.-Y. Chiu and Iain MacNeil (eds.), Edward Elgar, Cheltenham, pp. 314–336; on the role of ETFs, see: P.F. Hanrahan, (2018), Exchange Traded Funds in the Shadow Banking System, in Research Handbook on Shadow Banking. Legal and Regulatory Aspects, I.H.-Y. Chiu and Iain MacNeil (eds.), Edward Elgar, Cheltenham, pp. 363–398; crowdfunding, marketplace lending and peer-to-peer lending all having their own characteristics but all cutting out the financial intermediary: E.F. Greene et al., (2018), Blockchain, Marketplace Lending and Crowdfunding: Emerging Issues and Opportunities in Fintech, in Research Handbook on Shadow Banking. Legal and Regulatory Aspects, I.H.-Y. Chiu and Iain MacNeil (eds.), Edward Elgar, Cheltenham, pp. 253–296.

928

Market participants don’t behave rational, and mirror that of other market agents. This is also (or definitely) true for institutional cash pools like pension funds. See for an analysis of that industry and the herding behaviors observed D. Broeders et al., (2016), Pension Funds’ Herding, DNB Working Paper Nr. 503, February. They distinguish between weak, semi-strong and strong herding behavior. Weak herding occurs if pension funds have similar rebalancing strategies. The motive for weak herding is based on the fact that pension funds have the same market information and will react similar to that as they want stay close to their strategic asset allocation over time. Semi-strong herding arises when pension funds react similarly to other external shocks, such as changes in regulation and exceptional monetary policy operations. Finally, strong herding means that pension funds intentionally replicate changes in the strategic asset allocation of other pension funds. Without an economic reason, that is, it is driven by reputation. They find evidence that Dutch pension funds engage in three types of herding behavior.

929

The saying ‘an empty barrel makes the most noise’ apparently applies here as well.

930

It also creates new types of risks. Leveraged and other high-yield loans are typically syndicated and therefore arranged by banks but distributed to institutional investors. When institutional cash pools cannot be tempted to buy into the new instrument as much as anticipated, banks will have to hold a larger share of the syndicated loan thereby exposing themselves to ‘pipeline risk’. This creates a debt overhang which reduces, once exposure materializes, its subsequent arranging and lending activity. See M. Bruche et al., (2017), Pipeline Risk in Leveraged Loan Syndication, Finance and Economics Discussion Series Nr. 48, Washington: Board of Governors of the Federal Reserve System, April.

931

The European repo market performs as an amplification channel for sovereign debt crises. Amakolla et al. document that ‘following increases in sovereign risk, haircuts set by major CCPs on peripheral sovereign bonds increased significantly. The procyclicality of haircuts and the concentration of bilateral repos raise concerns about the CCP-intermediated repo market as a source of systemic risk in the Eurozone.’ See: A. Armakolla et al., (2017), Repurchase Agreements and the European Sovereign Debt Crises: The Role of European Clearinghouses, Working Paper, October 6, mimeo. Also see: C. Boissel et al., (2017), Sytemic Risk in Clearing Houses: Evidence from the European Repo Market, Journal of Financial Economics, Vol. 125, Issue 3, pp. 511–536.

932

T. Bayoumi, (2017), Unfinished Business: The Unexplored Causes of the Financial Crisis and the Lessons Yet to Be Learned, Yale University Press, New Haven, CT.

933

For Europe. In the US capital, buffers have always been higher and now easily reach 6%. See, for example, J. Cetina et al., (2017), Capital Buffers and the Future of Bank Stress Tests, OFR Brief Series Nr. 17-02, February 7. See also p. 2 on how the capital structure is or should be put together. Capital buffers and stress testing are intrinsically linked in such a way that the Federal Reserve proposed a ‘stress capital Buffer’. See, for example, Board of Governors of the Federal Reserve System, (2018), Proposed Rule Regarding the Stress Buffer Requirements, April 5 (via federalreserve.gov).

934

See on the relationship between bank equity and the cost of capital: S. Alnahedh and S. Bhagat, (2017), Impact of Bank Equity on Bank Cost of Capital, University of Colorado-Boulder Working Paper, mimeo. In contrast to what you might expect, they find that an increase in equity raises the private cost of capital for banks regardless of the size of the FI. More equity, however, has a positive impact on bank lending.

935

See the discussion in the securitization chapter (Volume I).

936

See for some critique on the rollback: P. Jenkins, (2018), Trump’s Deregulators Risk Repeating past Mistakes, Financial Times, Instant Insight, May 31. Small banks can also be dangerous is the argument.

937

Jerome Powell (Fed Chairman) quoted in C.W. Calomiris, (2018), Fix the Volcker Rule, but Look for Alternatives, Too, NY Times, June 4. Calomiris further highlights: ‘[t]he existing enforcement approach is simply too burdensome: It requires banks to show that each trade they undertake isn’t speculative but is initiated to serve as a hedge or to make a market in a particular security. There is no clear criterion to use when making that argument, so there is a significant risk of getting it wrong. To avoid that risk, banks avoid some market making. Aggravating that problem, the rule presumes that any security held for more than 60 days in the trading book is a proprietary trade. To avoid having to defend a 61-day holding, banks may liquidate securities held for market-making purposes. This is a particular problem for certain bonds, where transactions are infrequent.’

938

A.R. Admati, (2017), It Takes a Village to Maintain a Dangerous Financial System, chapter 13 in Just Financial Markets: Finance in a Just Society, (ed. L. Hertog), Oxford University Press, Oxford, pp. 293–322.

939

K. Nyborg, (2017), Central Bank Collateral Framework, Journal of Banking & Finance, Vol. 76, pp. 198–214.

940

See for some insights into these affairs: D. Gabor and J. Vestergaard, (2016), Towards a Theory of Shadow Money, Working Paper, mimeo. The opening question there is ‘How much of what we know about money and central banking is still valid?’ See also: L. Wang et al., (2017), Money and Credit: Theory and Applications, IMF Working Paper Nr. 17/14, January. They develop a theory of money and credit as competing payment instruments. The central bank dislocates the collateral market with its unlimited purchasing program as we have witnessed in recent years. Haircut applied did not reflect all the embedded risk and a premium was paid for the fire purchases. See in detail: C. de Roure, (2016), Fire Buys of Central Bank Collateral Assets, Deutsche Bundesbank Working Paper Nr. 51, Frankfurt am Main.

941

J. Michell, (2016), Do Shadow Banks Create Money, ‘Financialization’ and the Monetary Circuit, UWE Economics Working Paper Series, http://eprints.uwe.ac.uk/28552. Shadow banking is a warehouse of debt claims through which the monetary circuit is able to escape the confines of production (p. 33).

942

Recall the Swiss referendum regarding the return to a ‘Vollgeld’ (full reserve) banking model on 10 June 2018.

943

See for a nice compilation of thoughts: Ph. Hartmann et al. (eds.), (2018), The Changing Fortunes of Central Banking, Cambridge University Press, Cambridge, March. And for an evaluation of their current conduct: M.D. Negro et al., (2017), The Great Escape? A Quantitative Evaluation of the Fed’s Liquidity Facilities. The American Economic Review, Vol. 107, Issue 3, pp. 824–857. Also see: M. Crosignani et al., (2017), The (Unintended?) Consequences of the Largest Liquidity Injection Ever, Finance and Economics Discussion Series Nr. 11. Washington: Board of Governors of the Federal Reserve System, January. They figured out that the European LTRO intervention and the provision of long-term liquidity incentivize purchases of high-yield short-term securities by banks, which could be pledged to obtain central bank liquidity. The effect is known as ‘collateral trade’. Also see: M. Di Maggio et al., (2016), How Quantitative Easing Works: Evidence on the Refinancing Channel, Working Paper, December, mimeo; I. Drechsler et al., (2016), How Borrows from the Lender of Last Resort, The Journal of Finance, Vol. 71, Nr. 5, pp. 1933–1974; I. Chakraborty et al., (2017), Monetary Stimulus and Bank Lending, Working Paper, December 20, mimeo; L. Carpinelli and M. Croisignani, (2017), The Effect of Central Bank Liquidity Injections on Bank Credit Supply, Finance and Economics Discussion Series Nr. 38, Washington: Board of Governors of the Federal Reserve System, March.

944

For example, E.A. Posner, (2016), What Legal Authority Does the Fed Need During a Financial Crisis?, University of Chicago Law School, Coase-Sandor Working Paper Series in Law and Economics Nr. 741, January 22.

945

See regarding the disentanglement between society and economy: A. Ebner, (2015), The Regulation of Markets: Polanyian Perspectives in B. Lange, F. Haines and D. Thomas (eds.), Regulatory Transformations: Rethinking Economy-Society Interactions, Hart Publishing, Oxford, pp. 31ff.

946

See, for example, C. Borio et al., (2015), Labour Reallocation and Productivity Dynamics: Financial causes, Real Consequences, BIS Working Paper Nr. 534, December.

947

K. Sonoda and N. Sudo, (2016), Is Macroprudential Policy Instrument Blunt, BIS Working Paper Nr. 536, January.

948

N. Patel, (2016), International Trade Finance and the Cost Channel of Monetary Policy in Open Economies, BIS Working Paper Nr. 539, January 22. He focuses on the role of trade finance and how it impacts spillover effects.

949

I. Fender and U. Lewrick, (2016), Adding It All Up: The Macroeconomic Impact of Basel III and Outstanding Reform Issues, BIS Working Paper Nr. 591, November. They use historical data for a large sample of major banks to generate a conservative approximation of the additional amount of capital that banks would need to raise to meet the new regulatory requirements, taking the potential impact of current efforts to enhance G-SIBs’ total loss-absorbing capacity into account. To provide a high-level proxy for the effect of changes in capital allocation and bank business models on the estimated net benefits of regulatory reform, they simulate the effect of banks converging toward the ‘critical’ average risk weights (or ‘density ratios’) implied by the combined risk-weighted and leverage ratio-based capital requirements. Also see: J. Caruana, (2016), Financial Regulation: Cementing the Gains of Post-Crisis Reforms, CI Meeting of Central Bank Governors of the Centre for Latin American Monetary Studies (CEMLA), Lisbon, May 10. For a broader evaluation, see K. Alexander and R. Dhumale (eds.), (2012), Research Handbook on International Financial Regulation, Edward Elgar Publishing, Cheltenham.

950

F. Boissay and F. Collard, (2016), Macro-Economics of Bank Capital and Liquidity Regulations, BIS Working Paper Nr. 596, December.

951

What is remarkable in the context of the literature discussion of liquidity regulation and buffers is that in the financial infrastructure of the twenty-first century there is absence of a discussion regarding who, when and how liquidity is provided. See in detail: B. Biais et al., (2016), Who Supplies Liquidity, How and When, BIS Working Paper Nr. 563, May.

952

For a very nice overview and conclusions, see: J. Danielsson and C. Zhou, (2016), Why Risk Is so Hard to Measure, DNB Working Paper Nr. 494, January. Their analysis comes in three parts: the choice of risk measures, the aggregation method when considering longer holding period and the number of observations needed for accurate risk forecast.

953

For example, Minsky’s theories on investment, financial stability, the growing weight of the financial sector, and the role of the state. See: G. Mastromatteo and L. Esposito, (2016), Minsky at Basel: A Global Cap to Build an Effective Postcrisis Banking Supervisory Framework, Levy Economics Institute Working Paper Nr. 875, September. See also regarding the causes of protracted periods of under-investments: G. Guttiérrez and T. Philippon, (2017), Investment-Less Growth: An Empirical Investigation, Working Paper, September, mimeo.

954

S. Ferrari and M. Pirovana, (2016), Does One Size Fit All at All Times? The Role of Country Specificities and State Dependencies in Predicting Banking Crises, NBB Working Paper Nr. 297, May.

955

T. Tressel and Y.S. Zang, (2016), Effectiveness and Channels of Macroprudential Instruments. Lessons from the Euro Area, IMF Working Paper Nr. 16/4, January. They find that instruments targeting the cost of bank capital are most effective in slowing down mortgage credit growth, and that the impact is transmitted mainly through price margins, the same banking channel as monetary policy. Limits on loan-to-value ratios are also effective, especially when monetary policy is excessively loose.

956

See: H. Ichiue and F. Lambert, (2016), Post-Crisis International Banking: An Analysis with New Regulatory Survey Data, IMF Working Paper Nr. 16/88, April.

957

Romer further quotes, ‘how many economists really believe that extremely tight monetary policy will have zero effect on real output?’ (p. 22) in P. Romer, (2016), The Trouble with Macro-Economics, NUY Stern Business School Speech, delivered 5 January 2016 as the Commons Memorial Lecture of the Omicron Delta Epsilon Society. Reply by D. Orrell, (2016), Economic Depression: A Commentary on Paul Romer’s The Trouble with Macroeconomics, World Economics Association Newsletter, Vol. 6, Issue 5, October, pp. 10–11. Full transparency requires me to indicate that Romer’s paper is extremely controversial and opinions vary significantly, ranging from full endorsement to qualifications as ‘unconstructive criticism and arm-chair philosophizing’. See also: R. Reis, (2017), Is Something Really Wrong with Macroeconomics, LSE Working Paper, August, mimeo. He concludes that ‘[m]acroeconomic forecasts perform poorly in absolute terms and given the size of the challenge probably always will. But relative to the level of aggregation, the time horizon, and the amount of funding, macroeconomic forecasts are not so obviously worse than those in other fields.’

958

R. Ging and F. Page, (2016), Shadow Banks and Systemic Risk, Working Paper, mimeo. Also concluding in a similar fashion: D. Acemoglu, et al., (2015), Systemic Risk and Stability in Financial Networks, American Economic Review, Vol. 105, Issue 2, pp. 564–608; D. Duffie, et al., (2014), Systemic Risk Exposures: A 10-by-10-by-10 Approach, Systemic Risk and Macro Modeling, K. Brunnermeier, and A. Krishnamurthy (eds.), University of Chicago Press, Chicago; M. Elliot, et al., (2014), Financial Networks and Contagion, American Economic Review, Vol. 104, Issue 10, pp. 3115–3153.

959

M. H. Rizi et al., (2016), Exploring the Dynamic Relationship in the Shadow Banking System, Working paper, March 15, mimeo.

960

See in detail: K. Judge, (2017), Information Gaps and Shadow Banking, Virginia Law Review, Vol. 103, Nr. 3, May, pp. 411–482; also as Columbia Law and Economics Working Paper Nr. 529. We might add another element in the mix here, that is, regulatory arbitrage. Sponsor banks that issued ABCP conduits, during times that their capital was constrained, also act as administrators due to obtaining informational advantages related to regulatory arbitrage. Choi et al. also test whether regulatory arbitrage affected bank performance and find that the sponsor banks’ various performances, not only return on equity (ROE) and return on assets (ROA) but also net interest margin, are significantly related to ABCP exposure and securitized collateral assets. See in detail: J. Choi et al., (2016), Captivation of Regulatory Arbitrage: Evidence from the Euro-Issued Asset-Backed Commercial Paper, Working Paper, mimeo. Boyer and Kempf argue in the same direction, but from a different angle. Regulatory arbitrage is defined by the efficiency of different banks, an informational benefit they have over the regulators. They conclude that banks with different efficiency levels in risk management are subject to regulatory contracts that allow more efficient banks to have a riskier portfolio. They argue in favor of a liquidity requirement that regulates the riskiness of banks’ portfolio and a tax levied on profit to control the size of banks. But their main result I guess is that ‘the internationalization of banks annihilates the capacity of national public authorities in charge of banks’ regulation to use the proper set of regulatory instruments’. See in detail: P.C. Boyer and H. Kempf, (2016), Regulatory Arbitrage and the Efficiency of Banking Regulation, CESifo Working Paper Nr. 5878, April.

961

See in detail: R. Morgan, (2014), The Money Problem: Rethinking Financial Regulation, University of Chicago Press, Chicago and the reviews by J. Crawford, (2016), Shining a Light on Shadow Money, Vanderbilt Law Review, Vol. 69, pp. 185–207, and K. Judge, (2017), The Importance of ‘Money’, Book Review of The Money Problem: Rethinking Financial Regulation by Morgan Ricks, Harvard Law Review, Vol. 130, Issue 4, pp. 1148–1183.

962

He correctly indicates that this question is different from the question whether banking regulation should simply be expanded to shadow banking entities but is much more fundamental. Should we allow this to happen? Should it be possible for a nonbank to issue deposit-like claims? Or as Ricks puts it: ‘it is whether nonbank entities should be prohibited from issuing cash equivalents—defined on some functional basis—just as they are now prohibited from issuing deposit liabilities’ (p. 3). See: M. Ricks, (2016), Entry Restriction, Shadow Banking and the Structure of Monetary Institutions, Journal of Financial Regulation, Vol. 2, Issue 2, August, pp. 291–295; also as Vanderbilt Law School Working Paper Nr. 37, July.

963

Regarding the latter, Ricks ponders the puzzlingly low yields that characterize the short end of the US Treasury yield curve. Specifically, short-term Treasury yields are much lower than an extrapolation of longer-term yields would predict; ibid., p. 4. This convenience yield benefits public but also shadow banking issuers. Do the latter than capture a public asset value that arises from money creation (private seigniorage).

964

Basel III, Basel IV and other aligned regulation enacted in recent years do narrow operational capabilities of (shadow) banks but focus only on stability as an objective (to the degree they will demonstrate to be effective when the next crisis comes along).

965

In contrast to what the BIS hints at in their 86th Annual Report: BIS, (2016), 86th Annual Report, VI. The Financial Sector: Time to Move On, pp. 103. For an evaluation after ten years about where we are: R. van Tilburg et al., (2018), De lessen van de crisis van 2008: zijn ze geleerd en in de praktijk gebracht, SustainableFinancelab Report, June (via sustainablefiancelab.nl).

966

In fact, I need to rephrase this: a better choice of working would be that mortgage loan crowd out corporate loans. See in detail: L. Zhang et al., (2017), Did Pre-Crisis Mortgage Lending Limit Post-Crisis Corporate Lending? Evidence from UK Balance Sheets, Bank of England Working Paper 651, March. Also concluding a shift away from traditional business lending: D. Bezemer, et al., (2017), The Shift in Bank Credit Allocation: New Data and New Findings, DNB Working Paper 559, June 5. Even more concerning if you want is the fact that the shift toward mortgage lending is associated with the depth of the recession experienced and growth loss during that same period. Mortgage growth combined with increasing bank leverage was particularly damaging to output growth. This had an impact on investment levels and the quality of investment of investment allocation, which was true for both the private and public sectors. See: D. Bezemer and L. Zhang, (2017), A Global House of Debt Effect? Mortgages and Post-Crisis Recessions in Fifty Economies, Working Paper, mimeo (via sustainablefinancelab.nl). Bank-specific capital requirements tend to have a material effect on mortgage loan supply. A rise of only 100 basis points in capital requirements leads to a 5.4% drop in individual loan size. See: A. Uluc and T. Wieladek, (2017), Capital Requirements, Rik Shifting and the Mortgage Market, ECB Working Paper Nr. 2061, May.

967

Details were already discussed. See, for example, M. Behn et al., (2016), The Limits of Model-Based Regulation, ECB Working Paper Nr. 1928, July.

968

J.P. Landau, (2016), A Liquidity-Based Approach to Macroprudential Policy, BIS Papers chapters in: Bank for International Settlements (ed.), Macroprudential policy, Vol. 86, pp. 147–156. Also see: A. Dombret, (2016), Challenges in Identifying and Monitoring Risks from Non-Bank Financial Entities and How to Address Them, Introductory statement by Dr. Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, at the Symposium on Asian Banking and Finance, San Francisco, July 11 (via bis.org).

969

Ibid., p. 155.

Titel: Future Directions
verfasst von: Luc Nijs
Verlag: Springer International Publishing
Buch: The Handbook of Global Shadow Banking, Volume II
Print ISBN: 978-3-030-34816-8

Electronic ISBN: 978-3-030-34817-5

Copyright-Jahr: 2020
DOI: https://doi.org/10.1007/978-3-030-34817-5_7