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Before the 2007–09 crisis, standard risk measurement methods substantially underestimated the threat to the financial system. One reason was that these methods didn’t account for how closely commercial banks, investment banks, hedge funds, and insurance companies were linked. As financial conditions worsened in one type of institution, the effects spread to others. A new method that more accurately accounts for these spillover effects suggests that hedge funds may have been central in generating systemic risk during the crisis.
In this paper, we develop a state-dependent sensitivity value-at-risk (SDSVaR) approach that enables us to quantify the direction, size, and duration of risk spillovers among financial institutions as a function of the state of financial markets (tranquil, normal, and volatile). Within a system of quantile regressions for four sets of major financial institutions (commercial banks, investment banks, hedge funds, and insurance companies) we show that while small during normal times, equivalent shocks lead to considerable spillover effects in volatile market periods. Commercial banks and, especially, hedge funds appear to play a major role in the transmission of shocks to other financial institutions. Using daily data, we can trace out the spillover effects over time in a set of impulse response functions and find that they reach their peak after 10 to 15 days.
Supranational rules, national discretion: increasing versus inflating regulatory bank capital?
(2020)
We study how higher capital requirements introduced at the supranational level affect the regulatory capital of banks across countries. Using the 2011 EBA capital exercise as a quasi-natural experiment, we find that treated banks exploit discretion in the calculation of regulatory capital to inflate their capital ratios without a commensurate increase in their book equity and without a reduction in bank risk. Regulatory capital inflation is more pronounced in countries where credit supply is expected to tighten, suggesting that national authorities forbear their domestic banks to meet supranational requirements, with a focus on short-term economic considerations.