Working Paper Series : Institute for Monetary and Financial Stability
Capital adequacy regulation of financial conglomerates in the European Union
Y. Emilie Yoo
- Over the past few decades, changes in market conditions such as globalisation and deregulation of financial markets as well as product innovation and technical advancements have induced financial institutions to expand their business activities beyond their traditional boundaries and to engage in cross-sectoral operations. As combining different sectoral businesses offers opportunities for operational synergies and diversification benefits, financial groups comprising banks, insurance undertakings and/or investment firms, usually referred to as financial conglomerates, have rapidly emerged, providing a wide range of services and products in distinct financial sectors and oftentimes in different geographic locations. In the European Union (EU), financial conglomerates have become part of the biggest and most active financial market participants in recent years. Financial conglomerates generally pose new problems for financial authorities as they can raise new risks and exacerbate existing ones. In particular, their cross-sectoral business activities can involve prudentially substantial risks such as the risk of regulatory arbitrage and contagion risk arising from intra-group transactions. Moreover, the generally large size of financial conglomerates as well as the high complexity and interconnectedness of their corporate structures and risk exposures can entail substantial systemic risk and can therefore threaten the stability of the financial system as a whole. Until a few years ago, there was no supervisory framework in place which addressed a financial conglomerate in its entirety as a group. Instead, each group entity within a financial conglomerate was subject to the supervisory rules of its pertinent sector only. Such silo supervisory approach had the drawback of not taking account of risks which arise or aggravate at the group level. It also failed to consider how the risks from different business lines within the group interrelate with each other and affect the group as a whole. In order to address this lack of group-wide prudential supervision of financial conglomerates, the European legislator adopted the Financial Conglomerates Directive 2002/87/EC8 (‘FCD’) on 16 December 2002. The FCD was transposed into national law in the member states of the EU (‘Member States’) by 11 August 2004 for application to financial years beginning on 1 January 2005 and after. The FCD primarily aims at supplementing the existing sectoral directives to address the additional risks of concentration, contagion and complexity presented by financial conglomerates. It therefore provides for a supervisory framework which is applicable in addition to the sectoral supervision. Most importantly, the FCD has introduced additional capital requirements at the conglomerate level so as to prevent the multiple use of the same capital by different group entities. This paper seeks to examine to what extent the FCD provides for an adequate capital regulation of financial conglomerates in the EU while taking into account the underlying sectoral capital requirements and the inherent risks associated with financial conglomerates. In Part 1, the definition and the basic corporate models of financial conglomerates will be presented (I), followed by an illustration of the core motives behind the phenomenon of financial conglomeration (II) and an overview of the development of the supervision over financial conglomerates in the EU (III). Part 2 begins with a brief elaboration on the role of regulatory capital (I) and gives a general overview of the EU capital requirements applicable to banks and insurance undertakings respectively. A delineation of the commonalities and differences of the banking and the insurance capital requirements will be provided (II). It continues to further examine the need for a group-wide capital regulation of financial conglomerates and analyses the adequacy of the FCD capital requirements. In this context, the technical advice rendered by the Joint Committee on Financial Conglomerates (JCFC) as well as the currently ongoing legislative reforms at the EU level will be discussed (III). The paper finally closes with a conclusion and an outlook on remaining open issues (IV).
Evaluating point and density forecasts of DSGE models
Maik Hendrik Wolters
- This paper investigates the accuracy of point and density forecasts of four DSGE models for inflation, output growth and the federal funds rate. Model parameters are estimated and forecasts are derived successively from historical U.S. data vintages synchronized with the Fed’s Greenbook projections. Point forecasts of some models are of similar accuracy as the forecasts of nonstructural large dataset methods. Despite their common underlying New Keynesian modeling philosophy, forecasts of different DSGE models turn out to be quite distinct. Weighted forecasts are more precise than forecasts from individual models. The accuracy of a simple average of DSGE model forecasts is comparable to Greenbook projections for medium term horizons. Comparing density forecasts of DSGE models with the actual distribution of observations shows that the models overestimate uncertainty around point forecasts.
Schuldenanstieg und Haftungsausschluss im deutschen Föderalstaat : zur Rolle des Moral Hazard
Guntram B. Wolff
- Einleitung: Die deutschen Staatsschulden sind in den letzten Jahrzehnten kontinuierlich gestiegen. Künftige Generationen werden zusätzlich aufgrund der demographischen Entwicklung durch die umlagenfinanzierten sozialen Sicherungssysteme belastet. Gerade auch der Anstieg der Verschuldung der Bundesländer war in den letzten Jahrzehnten spürbar. So betrug die Verschuldung aller deutschen Bundesländer zusammengenommen 1991 noch 168 Mrd. Euro, während Anfang 2007 die Verschuldung 483 Mrd. Euro betrug, was eine knappe Verdopplung der Schuldenquote der Länder (Verschuldung in Prozent des BIP) auf ca. 21 Prozent impliziert. In der aktuellen Diskussion um die Reform des deutschen Föderalismus besteht Einigkeit in der Diagnose des Problems. Die Entwicklung der Staatsschulden ist kritisch und darf sich so nicht fortsetzen. Uneinigkeit herrscht hingegen über die Ursache des Anstiegs. Ebenfalls wird um die beste Möglichkeit, diesen zu bremsen, gerungen. Verschiedene Autoren argumentieren, dass der Verschuldungsanstieg der deutschen Bundesländer vor allem auf den Moral Hazard Anreiz zurückzuführen ist. Der vorliegende Diskussionsbeitrag diskutiert dies als einen der möglichen Gründe des Schuldenanstiegs. Hierzu wird zunächst das Konzept kurz eingeführt. Anschließend wird die bestehende empirische Evidenz für Deutschland diskutiert. Schließlich wird eine Bewertung und Einordnung in die aktuelle Debatte vorgenommen. Schlußbemerkungen: Im vorliegenden Diskussionsbeitrag wird das "Moral hazard" Problem als einer der möglichen Gründe für den beobachteten starken Anstieg der Verschuldung deutscher Bundesländer diskutiert. Es wurde gezeigt, dass die Finanzmärkte kaum auf die erheblichen Unterschiede in den fiskalischen Fundamentaldaten der Länder reagieren. Mit einer Fallstudie wurde außerdem verdeutlicht, dass das aktuelle Bundesverfassungsgerichtsurteil zu einer eventuellen Haushaltsnotlage von Berlin Berlin die Risikoeinschätzung der Märkte für deutsche Bundesländer nicht verändert hat. Alles in allem scheint es sinnvoll, über eine größere Beteiligung der Gläubiger an Risiken einzelner Länder nachzudenken. Dies dürfte aber den Schuldenanstieg nur bei bereits hoch verschuldeten Ländern begrenzen und möglicherweise einem Notlagenfall vorbeugen, nicht aber den grundsätzlichen "Defizit-Bias" der Finanzpolitik kompensieren. Insgesamt scheinen deswegen vorgelagerte Regeln notwendig, um den Anstieg der Verschuldung schon früh zu unterbinden und somit Belastungen zukünftiger Generationen zu reduzieren.
Forecasting and policy making
Maik Hendrik Wolters
A new comparative approach to macroeconomic modeling and policy analysis
Gernot J. Müller
Maik Hendrik Wolters
- In the aftermath of the global financial crisis, the state of macroeconomicmodeling and the use
of macroeconomic models in policy analysis has come under heavy criticism. Macroeconomists
in academia and policy institutions have been blamed for relying too much on a particular class
of macroeconomic models. This paper proposes a comparative approach to macroeconomic policy
analysis that is open to competing modeling paradigms. Macroeconomic model comparison
projects have helped produce some very influential insights such as the Taylor rule. However,
they have been infrequent and costly, because they require the input of many teams of researchers
and multiple meetings to obtain a limited set of comparative findings. This paper provides a new
approach that enables individual researchers to conduct model comparisons easily, frequently, at
low cost and on a large scale. Using this approach a model archive is built that includes many
well-known empirically estimated models that may be used for quantitative analysis of monetary
and fiscal stabilization policies. A computational platform is created that allows straightforward
comparisons of models’ implications. Its application is illustrated by comparing different monetary
and fiscal policies across selected models. Researchers can easily include new models in the
data base and compare the effects of novel extensions to established benchmarks thereby fostering
a comparative instead of insular approach to model development.
Staatsverschuldung als Herausforderung für die Finanzverfassung
(Un)anticipated monetary policy in a DSGE model with a shadow banking system
Manuel M. F. Martins
- Motivated by the U.S. events of the 2000s, we address whether a too low for too long interest
rate policy may generate a boom-bust cycle. We simulate anticipated and unanticipated monetary
policies in state-of-the-art DSGE models and in a model with bond financing via a shadow banking
system, in which the bond spread is calibrated for normal and optimistic times. Our results suggest
that the U.S. boom-bust was caused by the combination of (i) too low for too long interest rates,
(ii) excessive optimism and (iii) a failure of agents to anticipate the extent of the abnormally
Lumpy investment in sticky information general equilibrium
- In this paper, I introduce lumpy micro-level capital adjustment into a sticky information general equilibrium model. Lumpy adjustment arises because of inattentiveness in capital investment decisions instead of the more common assumption of non-convex adjustment costs. The model features inattentiveness as the only source of stickiness. I find that the model with lumpy investment yields business cycle dynamics which differ substantially from those of an otherwise identical model with frictionless investment and are much more consistent with the empirical evidence. These results therefore strengthen the case in favour of the relevance of microeconomic investment lumpiness
for the business cycle.
Organizational choices of banks and the effective supervision of transnational financial institutions
- This paper outlines relatively easy to implement reforms for the supervision of
transnational banking-groups in the E.U. that should not be primarily based on legal form
but on the actual risk structures of the pertinent financial institutions. The proposal also
aims at paying close attention to the economics of public administration and international
relations in allocating competences among national and supranational supervisory bodies.
Before detailing the own proposition, this paper looks into the relationship between
sovereign debt and banking crises that drive regulatory reactions to the financial turmoil in
the Euro area. These initiatives inter alia affirm effective prudential supervision as a pivotal
element of crisis prevention.
In order to arrive at a more informed idea, which determinants apart from a perceived
appetite for regulatory arbitrage drive banks’ organizational choices, this paper scrutinizes
the merits of either a branch or subsidiary structure for the cross-border business of
financial institutions. In doing so, it also considers the policy-makers perspective. The analysis
shows that no one size fits all organizational structure is available and concludes that
banks’ choices should generally not be second-guessed, particularly because they are subject
to (some) market discipline.
The analysis proceeds with describing and evaluating how competences in prudential
supervision are currently allocated among national and supranational supervisory authorities.
In order to assess the findings the appraisal adopts insights form the economics of public
administration and international relations. It argues that the supervisory architecture has to
be more aligned with bureaucrats’ incentives and that inefficient requirements to cooperate
and share information should be reduced. Contrary to a widespread perception, shifting responsibility
to a supranational authority cannot solve all the problems identified.
Resting on these foundations, the last part of this paper finally sketches an alternative
solution that dwells on far-reaching mutual recognition of national supervisory regimes
and allocates competences in line with supervisors’ incentives and the risk inherent in crossborder
The changing dynamics of US inflation persistence: a quantile regression approach
Maik Hendrik Wolters
- We examine both the degree and the structural stability of inflation persis tence at different quantiles of the conditional inflation distribution. Previous research focused exclusively on persistence at the conditional mean of the inflation rate. Economic theory, however, provides various reasons -for example downward wage rigidities or menu costs- to expect higher inflation persistence at the upper than at the lower tail of the conditional inflation distribution.
Based on post-war US data we indeed find slower mean reversion in response to positive than to negative shocks. We find robust evidence for a structural break in persistence at all quantiles of the inflation process in the early 1980s. Inflation persistence has decreased and become more homogeneous across quantiles. Persistence at the conditional mean became more informative about the degree of persistence across the entire conditional inflation distribution. While prior to the 1980s inflation was not mean reverting in response to large positive shocks, our evidence strongly suggests that since the end of the Volcker disinflation the unit root can be rejected at every quantile including the upper tail of the conditional inflation distribution.