Florian Heider
- 11 May 2023
- OCCASIONAL PAPER SERIES - No. 272Details
- Abstract
- Since the European Central Bank’s (ECB’s) 2003 strategy review, the importance of macro-financial amplification channels for monetary policy has increasingly gained recognition. This paper takes stock of this evolution and discusses the desirability of further incremental enhancements in the role of financial stability considerations in the ECB’s monetary policy strategy. The paper starts with the premise that macroprudential policy, along with microprudential supervision, is the first line of defence against the build-up of financial imbalances. It also recognises that the pursuit of price stability through monetary policy, and of financial stability through macroprudential policy, are to a large extent complementary. Nevertheless, macroprudential policy may not be able to ensure financial stability independently of monetary policy, because of spillovers originating from the common transmission channels through which the two policies produce their effects. For example, a low interest rate environment can create incentives to engage in more risk-taking, or can adversely impact the profitability of financial intermediaries and hence their capacity to absorb shocks. The paper argues that the existence of such spillovers creates a conceptual case for monetary policy to take financial stability considerations into account. It then goes on to discuss what this conclusion might imply in practice for the ECB. One option would be to exploit the flexible length of the medium-term horizon over which price stability is to be achieved. Longer deviations from price stability could occasionally be tolerated, if they resulted in materially lower risks for financial stability and, ultimately, for future price stability. However, model-based quantitative analysis suggests that this approach may require impractically drawn-out periods of deviation from price stability and potentially result in a de-anchoring of inflation expectations. ...
- JEL Code
- E3 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
- 11 November 2022
- WORKING PAPER SERIES - No. 2745Details
- Abstract
- This paper studies how banks’ balance sheets and funding costs interact in the transmission of monetary-policy rates to banks’ credit supply to firms. To do so, we use credit registry data from Germany and Portugal together with the European Central Bank’s policy-rate cuts in mid-2014. The pass-through of the rate cuts to banks’ funding costs differs across the euro-area currency union because deposit rates vary in their distance to the zero lower bound (ZLB). When the distance is shorter, banks’ financing constraints matter less for the supply of credit and there is more risk taking. To rationalize these findings, we provide a simple model of an augmented bank balance-sheet channel where in addition to costly external financing, there is screening of borrowers and a ZLB on retail deposit rates. An impaired pass-through of monetary policy to banks’ funding costs reduces their ability to lever up and weakens their lending standards.
- JEL Code
- E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
E63 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy
F45 : International Economics→Macroeconomic Aspects of International Trade and Finance
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
- 26 September 2022
- WORKING PAPER SERIES - No. 2732Details
- Abstract
- We study how banks manage their liquidity among the various assets at their disposal. We exploit the introduction of the ECB’s two-tier system which heterogeneously reduced the cost of additional reserves holdings. We find that the treated banks increase reserve holdings by borrowing on the interbank market, decreasing lending to affiliates of the same group, and selling marketable securities. We also find that banks have a preference for a stable portfolio composition of liquid assets over time. Our results imply that frictions in one market for liquidity can spill over to several markets.
- JEL Code
- G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
- 1 October 2021
- WORKING PAPER SERIES - No. 2593Details
- Abstract
- This paper develops a simple analytical framework to study the impact of central bank policy-rate changes on banks’ credit supply and risk-taking incentives. Unobservable expost bank monitoring of loans creates an external-financing constraint, which determines bank leverage. Unobservable, costly ex-ante screening of borrowers determines the level of bank risk-taking. More risk-taking tightens the external-financing constraint. The policy rate affects the external-financing constraint because it affects both the return on outside investors’ alternative investments and loan rates. In a low rate environment, a policy-rate cut reduces bank funding costs less because of a zero lower bound (ZLB) on retail deposit rates. Bank risk-taking is a necessary but not sufficient for a policy-rate cut to become contractionary ("reversal"). Reversal can occur even though banks’ net-interest margins increase. Credit market competition plays an important role for the interplay of monetary policy and financing stability. When banks have market power, a policy-rate cut can increase lending and still lead to risk-taking. We use our analytical framework to discuss the literature on how monetary policy affects the credit supply of banks, with special emphasis on low and negative rates.
- JEL Code
- E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages - Network
- Research Task Force (RTF)
- 22 September 2021
- RESEARCH BULLETIN - No. 87.2Details
- Abstract
- The effect of policy rate cuts on bank lending and risk-taking depends on how the low interest rate environment affects banks’ ability to raise external financing. When interest rates are low, easing monetary policy relaxes banks’ external financing constraint less than when interest rates are high. This reduces the stimulus to bank lending and induces banks to take more risk. There are indeed side effects of monetary stimulus at the zero-lower bound (ZLB).
- JEL Code
- E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages - Network
- Research Task Force (RTF)
- 12 May 2021
- WORKING PAPER SERIES - No. 2549Details
- Abstract
- In this paper, we survey the nascent literature on the transmission of negative policy rates. We discuss the theory of how the transmission depends on bank balance sheets, and how this changes once policy rates become negative. We review the growing evidence that negative policy rates are special because the pass-through to banks’ retail deposit rates is hindered by a zero lower bound. We summarize existing work on the impact of negative rates on banks’ lending and securities portfolios, and the consequences for the real economy. Finally, we discuss the role of different “initial” conditions when the policy rate becomes negative, and potential interactions between negative policy rates and other unconventional monetary policies.
- JEL Code
- E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
- 30 October 2018
- WORKING PAPER SERIES - No. 2191Details
- Abstract
- Protection buyers use derivatives to share risk with protection sellers, whose assets are only imperfectly pledgeable because of moral hazard. To mitigate moral hazard, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some of their own assets. We analyse, in a general-equilibrium framework, whether this leads to inefficient fire sales. If investors buying in a fire sale interim can also trade ex ante with protection buyers, equilibrium is information-constrained efficient even though not all marginal rates of substitution are equalized. Otherwise, privately optimal margin calls are inefficiently high. To address this inefficiency, public policy should facilitate ex-ante contracting among all relevant counterparties.
- JEL Code
- G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
D62 : Microeconomics→Welfare Economics→Externalities
G13 : Financial Economics→General Financial Markets→Contingent Pricing, Futures Pricing
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
- 1 August 2018
- WORKING PAPER SERIES - No. 2173Details
- Abstract
- We show that negative policy rates affect the supply of bank credit in a novel way. Banks are reluctant to pass on negative rates to depositors, which increases the funding cost of high-deposit banks, and reduces their net worth, relative to low-deposit banks. As a consequence, the introduction of negative policy rates by the European Central Bank in mid-2014 leads to more risk taking and less lending by euro-area banks with greater reliance on deposit funding. Our results suggest that negative rates are less accommodative, and could pose a risk to financial stability, if lending is done by high-deposit banks.
- JEL Code
- E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages - Network
- Research Task Force (RTF)
- 6 December 2017
- RESEARCH BULLETIN - No. 41Details
- Abstract
- Regulation has encouraged the use of collateral and central clearing. This Research Bulletin article summarises research on why such regulation promotes financial stability.
- JEL Code
- E59 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Other
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
- 7 November 2017
- WORKING PAPER SERIES - No. 2107Details
- Abstract
- This paper examines the role of collateral in the financial system, with special emphasis on the implications for financial stability and the conduct of monetary policy. First, we review what drives the demand and supply for both real and financial collateral assets. Then we examine financial stability issues and the case for regulating the use of collateral. We discuss the role and design of market infrastructures such as central clearing counterparties (CCPs). Finally, we examine the interaction of standard and non-standard monetary policy and the functioning of private collateralised markets. We show that the use of collateral is neither a sufficient nor a necessary condition for financial stability. To ensure the stability of collateralised markets a mix of micro- and macro-prudential regulation, as well as a sufficient supply of safe public assets that can be used as collateral, are needed.
- JEL Code
- E59 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Other
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation - Network
- Discussion papers
- 29 June 2016
- WORKING PAPER SERIES - No. 1925Details
- Abstract
- This paper documents stress in the unsecured overnight interbank market in the euro area over the course of the financial and sovereign debt crisis in Europe. We find that stress i) leads some banks to borrow in the market at rates that are higher than the rate of the marginal lending facility of the ECB, ii) leads to less cross-border transactions and contributes to the fragmentation of the euro area money market. A triple-difference estimate shows that the borrowing of banks in the periphery from banks in the core almost disappears in the second half of 2011. Domestic borrowing, however, replaces the loss of cross-border borrowing. Our findings document the severe malfunctioning of the market for liquidity caused by asymmetric information problems in crisis times. We exploit euro area payments data to construct a novel dataset of interbank lending and borrowing. We verify the validity of our approach using the post-trading structure MID, maintained at Banco de Espa
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
F36 : International Economics→International Finance→Financial Aspects of Economic Integration
- 19 February 2016
- WORKING PAPER SERIES - No. 1886Details
- Abstract
- This paper investigates the impact of ample liquidity provision by the European Central Bank on the functioning of the overnight unsecured interbank market from 2008 to 2014. We use novel data on interbank transactions derived from TARGET2, the main euro area payment system. To identify exogenous shocks to central bank liquidity, we exploit the timing of ECB liquidity operations and use a simple structural vector auto-regression framework. We argue that the ECB acted as a de-facto lender-of-last-resort to the euro area banking system and identify two main effects of central bank liquidity provision on interbank markets. First, central bank liquidity replaces the demand for liquidity in the interbank market, especially during the financial crisis (2008-2010). Second, it increases the supply of liquidity in the interbank market in stressed countries (Greece, Italy and Spain) during the sovereign debt crisis (2011-2013).
- JEL Code
- E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
F36 : International Economics→International Finance→Financial Aspects of Economic Integration
G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
- 1 October 2012
- WORKING PAPER SERIES - No. 1481Details
- Abstract
- We study the optimal design of clearing systems. We analyze how counterparty risk should be allocated, whether traders should be fully insured against that risk, and how moral hazard affects the optimal allocation of risk. The main advantage of centralized clearing, as opposed to no or decentralized clearing, is the mutualization of risk. While mutualization fully insures idiosyncratic risk, it cannot provide insurance against aggregate risk. When the latter is significant, it is efficient that protection buyers exert effort to find robust counterparties, whose low default risk makes it possible for the clearing system to withstand aggregate shocks. When this effort is unobservable, incentive compatibility requires that protection buyers retain some exposure to counterparty risk even with centralized clearing.
- JEL Code
- G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
- 30 May 2012
- WORKING PAPER SERIES - No. 1439Details
- Abstract
- We offer a theoretical framework to analyze corporate lending when loan officers must be incentivized to prospect for loans and to transmit the soft information they obtain in that process. We explore how this multi-task agency problem shapes loan officers' compensation, banks' use of soft information in credit approval, and their lending standards. When competition intensifies, prospecting for loans becomes more important and banks' internal agency problem worsens. In response to more competition, banks lower lending standards, may choose to disregard soft and use only hard information in their credit approval, and in that case reduce loan officers to salespeople with steep, volume-based compensation. Our model generates "excessive lending" as banks' optimal response to an internal agency problem.
- JEL Code
- D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
L13 : Industrial Organization→Market Structure, Firm Strategy, and Market Performance→Oligopoly and Other Imperfect Markets
- 10 January 2012
- WORKING PAPER SERIES - No. 1413Details
- Abstract
- We analyze optimal hedging contracts and show that although hedging aims at sharing risk, it can lead to more risk-taking. News implying that a hedge is likely to be loss-making undermines the risk-prevention incentives of the protection seller. This incentive problem limits the capacity to share risks and generates endogenous counterparty risk. Optimal hedging can therefore lead to contagion from news about insured risks to the balance sheet of insurers. Such endogenous risk is more likely to materialize ex post when the ex ante probability of counterparty default is low. Variation margins emerge as an optimal mechanism to enhance risk-sharing capacity. Paradoxically, they can also induce more risk-taking. Initial margins address the market failure caused by unregulated trading of hedging contracts among protection sellers.
- JEL Code
- G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G22 : Financial Economics→Financial Institutions and Services→Insurance, Insurance Companies, Actuarial Studies
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
- 11 December 2009
- WORKING PAPER SERIES - No. 1126Details
- Abstract
- We study the functioning and possible breakdown of the interbank market in the presence of counterparty risk. We allow banks to have private information about the risk of their assets. We show how banks
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design
- 11 November 2009
- WORKING PAPER SERIES - No. 1107Details
- Abstract
- We study the functioning of secured and unsecured inter-bank markets in the presence of credit risk. The model generates empirical predictions that are in line with developments during the 2007-2009 financial crises. Interest rates decouple across secured and unsecured markets following an adverse shock to credit risk. The scarcity of underlying collateral may amplify the volatility of interest rates in secured markets. We use the model to discuss various policy responses to the crisis.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
- 30 September 2009
- WORKING PAPER SERIES - No. 1096Details
- Abstract
- The paper shows that mispriced deposit insurance and capital regulation were of second order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms’ leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks’ liability structure away from deposits towards non-deposit liabilities. We find that unobserved time-invariant bank fixed effects are ultimately the most important determinant of banks’ capital structures and that banks’ leverage converges to bank specific, time invariant targets.
- JEL Code
- G32 : Financial Economics→Corporate Finance and Governance→Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
- 24 September 2007
- OCCASIONAL PAPER SERIES - No. 72Details
- Abstract
- The extended period of limited growth experienced until recently in many European countries raises the issue as to which policies could be most effective in improving their economic performance. This paper argues that further financial sector reforms may be a valuable complement to ongoing efforts to reform labour and product markets. There is a long-standing view in the economic literature that well-functioning financial systems allow economies to exploit the benefits of innovation in terms of productivity and growth. Moreover, measured productivity differentials between Europe and the United States seem to originate particularly in the financial sector and from sectors that are particularly dependent on external financing. Building on and summarising the existing literature, this paper first introduces a number of concepts that are important for financial sector analyses and policies. Second, it presents a selection of indicators describing the efficiency and development of the European financial system from the perspective of a variety of dimensions. Third, an attempt is made to estimate the extent to which greater financial efficiency might improve the allocation of productive capital in Europe. While in the recent past the research and policy debate in Europe has focused on fostering financial integration, the present paper puts the main emphasis on financial development or modernisation in the context of the finance and growth literature. The results suggest that there are a number of ways in which the financial market framework conditions in Europe can be improved to increase the contribution of the financial system to innovation, productivity and growth. The most robust conclusions can be drawn for certain aspects of corporate governance, the efficiency of legal systems in resolving conflicts in financial transactions and some structural features of European bank sectors.
- JEL Code
- G00 : Financial Economics→General→General
O16 : Economic Development, Technological Change, and Growth→Economic Development→Financial Markets, Saving and Capital Investment, Corporate Finance and Governance
O43 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Institutions and Growth
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
- 21 March 2007
- WORKING PAPER SERIES - No. 735Details
- Abstract
- This paper shows that there is a natural trade-off when designing market based executive compensation. The benefit of market based pay is that the stock price aggregates speculators' dispersed information and there-fore takes a picture of managerial performance before the long-term value of a firm materializes. The cost is that informed speculators' willingness to trade depends on trading that is unrelated to any information about the firm. Ideally, the CEO should be shielded from shocks that are not informative about his actions. But since information trading is impossible without non- nformation trading (due to the "no-trade" theorem), shocks to prices caused by the latter are an unavoidable cost of market based pay. This trade-off generates a number of insights about the impact of market conditions, e.g. liquidity and trading horizons, on optimal market based pay. A more liquid market leads to more market based pay while short-term trading makes it more costly to provide such incentives leading to lower CEO effort and worse firm performance on average. The model is consistent with recent evidence showing that market based CEO incentives vary with market conditions, e.g. bid-ask spreads, the probability of informed trading (PIN) or the dispersion of analysts' forecasts.
- JEL Code
- G39 : Financial Economics→Corporate Finance and Governance→Other
D86 : Microeconomics→Information, Knowledge, and Uncertainty→Economics of Contract: Theory
D82 : Microeconomics→Information, Knowledge, and Uncertainty→Asymmetric and Private Information, Mechanism Design