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Working Paper
Is Stricter Regulation of Incentive Compensation the Missing Piece?
Although a number of steps have been taken to reduce the risk of financial stability, some significant weaknesses remain. This paper examines whether stricter regulation of incentive compensation is the missing piece needed to reduce risk to acceptable levels. Unfortunately, this review of the literatures on the relationship of risk to bank chief operating officer and bank employee compensation suggest both have some potential but that significant concerns remain in both cases. At this point, we cannot confidently say that compensation regulation is the missing piece.
Speech
Financial Stability and Regulatory Policy in a Low Interest Rate Environment
I would suggest that the potential costs of the excessive leverage that arise in a low interest rate environment deserve more research and, I suspect, more focused and proactive policy actions.
Journal Article
The Failure of the Bank of the Commonwealth: An Early Example of Interest Rate Risk
This Economic Commentary describes the collapse and subsequent bailout of the Detroit-headquartered Bank of the Commonwealth in 1972. Commonwealth failed because it invested heavily in long-duration, fixed-rate municipal securities in the mid-1960s in a bet that interest rates would decline. Instead, with the beginning of the Great Inflation of 1965–1980, rates rose. Liquidity problems then ensued, and the bank approached failure. Unable to find an acquirer because of Michigan’s banking restrictions, regulators instead bailed out the bank because of fears of contagion. This article also ...
Journal Article
The Evolution of US Bank Capital around the Implementation of Basel III
Following the Global Financial Crisis of 2007–2008, the capital standards for banks operating in the United States were tightened as US banking regulators implemented the Basel III framework. This Economic Commentary briefly presents the key elements of Basel III relevant to bank capital and analyzes the timing of the evolution of regulatory capital ratios for US bank holding companies during that time. It shows that, on average, banks’ capital ratios increased notably between 2009 and 2012, plateauing before the new rules came into force. While larger and better-capitalized banks ...
Working Paper
Banker Compensation, Relative Performance, and Bank Risk
A multi-agent, moral-hazard model of a bank operating under deposit insurance and limited liability is used to analyze the connection between compensation of bank employees (below CEO) and bank risk. Limited liability with deposit insurance is a force that distorts effort down. However, the need to increase compensation to risk-averse employees in order to compensate them for extra bank risk is a force that reduces this effect. Optimal contracts use relative performance and are implementable as a wage with bonuses tied to individual and firm performance. The connection between pay for ...
Working Paper
How Do Banks Respond to Capital Regulation? — The Impact of the Basel III Reforms in the United States
Understanding banks’ responses to capital regulation is essential for regulators to use this key tool of modern banking regulation effectively. We study how and when US banks responded to changes to the way capital ratios are measured, changes that were introduced as part of the adoption of Basel III. We find that small banks — those below USD 10bn — responded neither before nor after the release of the new rules to the change in measured capital they experienced under the new rules. In contrast, we show that regional banks — those with total assets between USD 10bn and USD 50bn — ...
Journal Article
Bank Regulation Affects Monetary Policy Transmission
How does monetary policy impact banks’ lending behavior when interest rate changes revalue their securities? Detailed supervisory data show that banks with larger losses on securities during the 2022–23 monetary policy tightening cycle extended less credit to firms. This spillover effect was especially strong for securities that were marked to market and not hedged, and for banks required to include unrealized losses in regulatory capital. These conditions lead to larger reductions in corporate debt and investment, increasing monetary policy’s impact on the economy.
Working Paper
Bank Regulation and the Rise of Nonbank Intermediation
We study the rise of nonbank financial intermediation and its implications for systemic risk. We develop a structural network model of banks and nonbank financial institutions (NBFIs) that decomposes intermediation into a capacity channel, driven by bank balance-sheet constraints, and a reliance channel, reflecting NBFI funding reliance. Using U.S. banking confidential supervisory data, we estimate key structural parameters and quantify both channels. We find that fluctuations in bank-NBFI intermediation are primarily explained by the reliance channel, with variation in NBFI fragility ...
Working Paper
Bank Failure, Relationship Lending, and Local Economic Performance
Whether bank failures have adverse effects on local economies is an important question for which there is conflicting and relatively scarce evidence. In this study, I use county-level data to examine the effect of bank failures and resolutions on local economies. Using quasi-experimental techniques as well as cross-sectional variation in bank failures, I show that recent bank failures lead to lower income and compensation growth, higher poverty rates, and lower employment. Additionally, I find that the structure of bank resolution appears to be important. Resolutions that include loss-sharing ...
Working Paper
Sovereign Debt Crises
Sovereign debt crises have been recurrent events over the past two centuries. In recent years, the timing of sovereign crises has coincided or has directly followed banking crises. The link between sovereigns and banks tightened as the contingent liability that the banking sector represents for the sovereign grew, as financial "safety nets" became more common. This chapter analyzes the transmission channels between sovereigns and banks, with a focus on the effect of sovereign distress on bank solvency and financing. It then highlights the notable cost to the real economy of the close ...