Michael Wedow
- 6 June 2023
- WORKING PAPER SERIES - No. 2825Details
- Abstract
- Using a sample of open-end corporate bond funds domiciled in the euro area, we exploit the COVID-19 market turmoil in March 2020 to examine two channels through which liquidity buffers can reduce procyclicality in the investment fund sector. First, we find that liquidity buffers reduced outflows during March 2020 only to a limited extent. Second, we find that funds entering the crisis with higher liquidity buffers were less likely to involve in cash hoarding and more likely to use cash buffers to meet outflows. Our results suggest that higher liquidity buffers can reduce procyclicality primarily through supporting the liquidity management strategies employed by fund managers.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
- 3 April 2023
- MACROPRUDENTIAL BULLETIN - ARTICLEDetails
- Abstract
- This article analyses the financial stability risks of investment funds active in euro area commercial real estate (CRE) markets. It finds that real estate investment funds (REIFs) have grown significantly in the past decade, and have a large market footprint in several euro area countries where the outlook for CRE markets has deteriorated sharply. In addition, REIFs are exposed to liquidity risk when they offer frequent redemptions, which could affect the stability of CRE markets. REIFs should therefore be subject to a common and comprehensive policy framework to reduce the liquidity mismatch and risks to financial stability.
- JEL Code
- G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
R33 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→Nonagricultural and Nonresidential Real Estate Markets
- 16 November 2022
- FINANCIAL STABILITY REVIEW - BOXFinancial Stability Review Issue 2, 2022Details
- Abstract
- This box assesses the development of the liquidity mismatch for a broad sample of euro area open-ended bond funds. This mismatch arises if funds primarily invest in less liquid assets while at the same time offering their investors the option of short-term redemptions. In 2017 the Financial Stability Board (FSB) published policy recommendations to address structural vulnerabilities related to asset management activities, including liquidity mismatch. Our results suggest that the liquidity mismatch increased in the years up to the pandemic. In March 2020 many funds faced substantial redemption pressures, especially those with a relatively large structural liquidity mismatch, creating large fire-sale externalities. The increase in cash holdings after this shock indicates procyclicality in liquidity management strategies, suggesting that fund managers do not necessarily have the incentives to maintain sufficient liquidity buffers. Policies that aim to better align redemption terms with asset liquidity would help to enhance the resilience of the investment fund sector, as the liquidity mismatch is still prevalent and has not declined since the publication of the FSB policy recommendations in 2017.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
- 21 January 2022
- MACROPRUDENTIAL BULLETIN - ARTICLE - No. 16Details
- Abstract
- This article assesses proposed reforms to the European Money Market Funds (MMF) Regulation to enhance the resilience of the sector. Specifically, the article provides a rationale for requiring private debt MMFs to hold higher levels of liquid assets, of which a part should be public debt, and considers the design and calibration of such a requirement. The article also proposes that the impediments to the use of liquidity buffers should be removed and authorities should have a role in releasing these buffers. Finally, while the removal of a stable net asset value for low-volatility MMFs would reduce cliff effects, we argue that this might not be necessary if liquidity requirements for these private debt MMFs are sufficiently strengthened.
- JEL Code
- G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G01 : Financial Economics→General→Financial Crises
- 12 April 2021
- MACROPRUDENTIAL BULLETIN - ARTICLE - No. 12Details
- Abstract
- Following the onset of the coronavirus (COVID‑19) crisis, a significant number of European investment funds suspended redemptions. We find that many of those funds had invested in illiquid assets, were leveraged or had lower cash holdings than funds that were not suspended. Furthermore, suspensions were more likely to be seen in jurisdictions where pre-emptive liquidity measures were not available. Our findings also suggest that suspensions have spillover effects on other funds and sectors, highlighting the importance of pre-emptive liquidity management measures.
- JEL Code
- G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G01 : Financial Economics→General→Financial Crises
- 12 April 2021
- MACROPRUDENTIAL BULLETIN - ARTICLE - No. 12Details
- Abstract
- During the market turmoil of March 2020, many money market funds (MMFs) and other investment funds which were exposed to liquidity risk through a liquidity mismatch between their assets and liabilities experienced significant outflows. Those funds reacted in a procyclical manner by either selling assets in already stressed markets or curtailing investors’ access. That behaviour resulted in knock-on effects on other sectors of the economy and amplified the stress within the financial system. This overview article discusses financial stability risks arising from liquidity transformation by MMFs and other investment funds, a subject which is then explored in greater depth in the three other articles in this issue of the Macroprudential Bulletin. While the liquidity transformation carried out by investment funds serves an important economic function, by intermediating savings and real economy financing, it can also generate risks to financial stability. With this in mind, this article argues for a macroprudential approach to the regulation of investment funds to enhance their resilience and facilitate a stable provision of funding to the wider economy in both normal market conditions and periods of market stress.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
- 19 May 2020
- WORKING PAPER SERIES - No. 2413Details
- Abstract
- Does leverage drive investor flows in bond mutual funds? Leverage can increase fund returns in good times, but it can also magnify investors’ losses and their response to bad performance. We study bond fund flows to provide new evidence for the link between mutual fund leverage and financial fragility. We find that outflows are greater in leveraged funds during stressed periods and after bad performance, compared with unleveraged funds. We provide supporting evidence that leverage exacerbates the negative externality in investors' redemption decisions. In this regard, we find that fund managers in leveraged funds react more procyclically to net outflows compared with fund managers in unleveraged funds. Such procyclical security sales in leveraged funds may increase investors’ first-mover advantages and their response to bad performance. These findings suggest that leverage amplifies fragility in the bond mutual fund sector.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G20 : Financial Economics→Financial Institutions and Services→General
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
- 3 March 2020
- FINANCIAL INTEGRATION AND STRUCTURE ARTICLEFinancial Integration and Structure in the Euro Area 2020Details
- Abstract
- This special feature analyses euro area investment preferences in the investment fund sector and discusses the implications for financial integration. We investigate the traditional perception that investors tend to hold a disproportionate share of domestic assets in their portfolio, a phenomenon generally known as “home bias”. We argue that measures of home bias that neglect fund holders’ countries of origin are biased, in particular when investments are concentrated in financial centres. By taking into account fund holders’ country of origin rather than assuming the fund’s domicile as investment origin, this study revisits and corrects measures of home bias in the euro area.
- 3 March 2020
- FINANCIAL INTEGRATION AND STRUCTURE ARTICLEFinancial Integration and Structure in the Euro Area 2020Details
- Abstract
- This special feature discusses how a common sovereign safe asset in the euro area could benefit financial stability by fostering financial integration and development, and by changing the structure of asset markets. The discussion focuses on the potential benefits of a well-designed common safe asset that has certain desirable characteristics, while it does not provide an assessment of specific design options. This special feature should be viewed as part of a broader discussion on how to complete the banking union, which also includes considerations regarding a European deposit insurance scheme and changing the regulatory treatment of sovereign exposures.
- 29 October 2019
- MACROPRUDENTIAL BULLETIN - ARTICLE - No. 9Details
- Abstract
- A recent ECB study shows that leverage is an important driver in investors’ redemption decisions. Regulatory changes to the UCITS framework facilitated the use of derivatives, increasing leverage for some European mutual funds which amplified investors' responsiveness to negative returns in a procyclical manner.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
- 29 July 2019
- WORKING PAPER SERIES - No. 2298Details
- Abstract
- This paper illustrates that systemically important banks reduce a range of activities at year-end, leading to lower additional capital requirements in the form of G-SIB buffers. The effects are stronger for banks with higher incentives to reduce the indicators, and for banks with balance sheet structures that can more easily be adjusted. The observed reduction in activity may imply an overall underestimation of banks' systemic importance as well as a distortion in their relative ranking, with implications for banks' ability to absorb losses. Moreover, a reduction in the provision of certain services at year-end may adversely affect overall market functioning.
- JEL Code
- G20 : Financial Economics→Financial Institutions and Services→General
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
- 4 October 2018
- OCCASIONAL PAPER SERIES - No. 214Details
- Abstract
- This study provides a conceptual and monitoring framework for systemic liquidity, as well as a legal assessment of the possible use of macroprudential liquidity tools in the European Union. It complements previous work on liquidity and focuses on the development of liquidity risk at the system-wide level. A dashboard with a total of 20 indicators is developed for the financial system, including banks and non-banks, to assess the build-up of systemic liquidity risk over time. In addition to examining liquidity risks, this study sheds light on the legal basis for additional macroprudential liquidity tools under existing regulation (Article 458 of the Capital Requirements Regulation (CRR), Articles 105 and 103 of the Capital Requirements Directive (CRD IV) and national law), which is a key condition for the implementation of macroprudential liquidity tools.
- 2 October 2018
- MACROPRUDENTIAL BULLETIN - ARTICLE - No. 6Details
- Abstract
- This article evaluates whether the global systemically important bank (G-SIB) framework has incentivised banks to adopt window-dressing behaviour, and whether their engagement in capital market activities has facilitated it. Window-dressing behaviour could have detrimental effects on financial stability, for at least two reasons: first, it may imply an underestimation of banks’ overall systemic importance and a distortion of the relative ranking in favour of banks that engage in more window-dressing behaviour; second, overall market functioning may be adversely affected if banks reduce the provision of certain services towards the end of the year. The evidence presented in this article suggests that both G-SIBs and banks with reporting obligations have reduced their overall risk score and some of their individual risk indicators at the end of a calendar year, both in absolute terms and relative to the other banks in the sample. The results also indicate that year-end reductions in capital market activities are a main driver of the observed window-dressing behaviour.
- JEL Code
- G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
G38 : Financial Economics→Corporate Finance and Governance→Government Policy and Regulation
- 11 April 2018
- OCCASIONAL PAPER SERIES - No. 208Details
- Abstract
- On 24 November 2015, the European Commission published a proposal to establish a European Deposit Insurance Scheme (EDIS). The proposal provides for the creation of a Deposit Insurance Fund (DIF) with a target size of 0.8% of covered deposits in the euro area and the progressive mutualisation of its resources until a fully-fledged scheme is introduced by 2024. This paper investigates the potential impact and appropriateness of several features of EDIS in the steady state. The main findings are the following: first, a fully-funded DIF would be sufficient to cover payouts even in a severe banking crisis. Second, risk-based contributions can and should internalise specificities of banks and banking systems. This would tackle moral hazard and facilitate moving forward with risk sharing measures towards the completion of the Banking Union in parallel with risk reduction measures; this approach would also be preferable to lowering the target level of the DIF to take into account banking system specificities. Third, smaller and larger banks would not excessively contribute to EDIS relative to the amount of covered deposits in their balance sheet. Fourth, there would be no unwarranted systematic cross-subsidisation within EDIS in the sense of some banking systems systematically contributing less than they would benefit from the DIF. This result holds also when country-specific shocks are simulated. Fifth, under a mixed deposit insurance scheme composed of national deposit insurance funds bearing the first burden and a European deposit insurance fund intervening only afterwards, cross-subsidisation would increase relative to a fully-fledged EDIS. The key drivers behind these results are: i) a significant risk-reduction in the banking system and increase in banks' loss-absorbing capacity in the aftermath of the global financial crisis; ii) a super priority for covered deposits, further contributing to protect EDIS; iii) an appropriate design of risk-based contributions, benchmarked at the euro area level, following a "polluter-pays" approach.
- JEL Code
- G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
- 29 November 2017
- FINANCIAL STABILITY REVIEW - ARTICLEFinancial Stability Review Issue 2, 2017Details
- Abstract
- Effectively functioning repo markets are of key importance for both financial stability and monetary policy, but the excessive use of repos may also be a source of systemic risk as witnessed during the recent financial crisis. Regulatory reforms introduced since the start of the crisis have aimed to contain systemic risk related to the excessive build-up of leverage and unstable funding, but recently some concerns have been raised about their potential effects on the functioning of the repo market. This special feature presents new evidence on the drivers of banks’ activity in the repo market with respect to regulatory reforms. In addition, it takes a closer look at the repo market structure and pricing dynamics, in particular around banks’ balance sheet reporting dates. While the observed volatility around reporting dates suggests that the calculation methodology for some regulatory metrics should be reviewed, overall, the findings indicate that unintended consequences of regulatory reforms on the provision of repo services by euro area banks have not been material.
- JEL Code
- G00 : Financial Economics→General→General
- 11 July 2017
- OCCASIONAL PAPER SERIES - No. 193Details
- Abstract
- This paper considers the growth of dark pools: trading venues for equities without pre-trade transparency. It first documents the emergence and expansion of dark pools in European equity markets in the context of regulatory changes and increased high-frequency trading (HFT). It finds that the market share of trading conducted in dark pools has stabilised below 10% and is similar across groups of stocks from different countries. Second, this paper assesses the nature of competition between dark pools, which is based on price and services offered to clients. It documents a substantial degree of horizontal differentiation among European dark pools, with venues providing different options for placing and processing orders likely to attract different types of traders. The hypothesis that most dark pools are primarily used to shield large orders from information leakage is not supported by evidence. This finding is based on a simple indicator that assesses different dark pools in terms of the level of protection from information leakage due to trading with HFT or predatory traders. Finally, this paper evaluates the benefits and costs of the use of dark pools from the perspective of individual traders as well as for market efficiency and financial stability. Recent evidence appears to reject the notion that dark pools adversely affect volatility in stock markets.
- JEL Code
- G10 : Financial Economics→General Financial Markets→General
G14 : Financial Economics→General Financial Markets→Information and Market Efficiency, Event Studies, Insider Trading
G18 : Financial Economics→General Financial Markets→Government Policy and Regulation
- 10 February 2017
- WORKING PAPER SERIES - No. 2017Details
- Abstract
- We test if unconventional monetary policy instruments influence the competitive conduct of banks. Between q2:2010 and q1:2012, the ECB absorbed
- JEL Code
- C30 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→General
C78 : Mathematical and Quantitative Methods→Game Theory and Bargaining Theory→Bargaining Theory, Matching Theory
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
L51 : Industrial Organization→Regulation and Industrial Policy→Economics of Regulation
- 15 April 2016
- OCCASIONAL PAPER SERIES - No. 171Details
- Abstract
- Following the emergence of the financial crisis in August 2007, the Basel Committee on Banking Supervision established in 2010 a new global regulatory framework. In addition to raising capital requirements, it introduced three ratios, two of which set out minimum standards for liquidity and funding risk, i.e. the liquidity coverage ratio and the net stable funding ratio, and one which aims to limit leverage in the banking system, i.e. the leverage ratio. All three ratios can have a number of implications for monetary policy implementation, in particular the liquidity coverage ratio and the net stable funding ratio owing to the special role of central banks in providing liquidity. This paper investigates the extent to which the regulatory initiatives might have already had an impact on banks
- JEL Code
- G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
E58 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Central Banks and Their Policies
- 27 November 2014
- FINANCIAL STABILITY REVIEW - ARTICLEInitial Considerations regarding a Macro-Prudential Instrument based on the Net Stable Funding RatioFinancial Stability Review Issue 2, 2014Details
- Abstract
- The financial crisis led to a broad consensus among policy-makers and regulators that macro-prudential frameworks, in addition to micro-prudential policy, must be part of the solution to ensure the resilience of the financial system. The counter-cyclical capital buffer represents the first step in this direction taken by the Basel Committee on Banking Supervision. Regarding liquidity issues, two micro-prudential standards have been designed. The delegated act implementing the liquidity coverage ratio (LCR) at the European level has recently been adopted by the European Commission and the net stable funding ratio (NSFR) standard has just been finalised by the Basel Committee on Banking Supervision and was published on 31 October. After implementing these new standards, it will be necessary to monitor their impact on banks’ behaviour, market liquidity, monetary policy and financial stability before considering introducing any additional instruments. At this stage, the need for a liquidity-based macro-prudential tool is in the early stages of identification and discussion. Therefore, this special feature aims to provide some initial technical considerations regarding the macro-prudential use of the NSFR. The discussion considers two broad perspectives. The first is the need for a counter-cyclical NSFR to complement the counter-cyclical capital buffer. While capital and liquidity standards pursue different objectives, the two can also be used in conjunction depending on the specific risk to financial stability being targeted. The second perspective regards the use of the NSFR as a stand-alone macro-prudential tool, together with its potential trigger mechanism and its use in the current low yield environment.
- JEL Code
- G00 : Financial Economics→General→General
- 8 July 2010
- OCCASIONAL PAPER SERIES - No. 117Details
- Abstract
- The extensive public support measures for the financial sector have been key for the management of the current financial crisis. This paper gives a detailed description of the measures taken by central banks and governments and attempts a preliminary assessment of the effectiveness of such measures. The geographical focus of the paper is on the European Union (EU) and the United States. The crisis response in both regions has been largely similar in terms of both tools and scope, and monetary policy actions and bank rescue measures have become increasingly intertwined. However, there are important differences, not only between the EU and the United States (e.g. with regard to the involvement of the central bank), but also within the EU (e.g. asset relief schemes).
- JEL Code
- C43 : Mathematical and Quantitative Methods→Econometric and Statistical Methods: Special Topics→Index Numbers and Aggregation
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
O47 : Economic Development, Technological Change, and Growth→Economic Growth and Aggregate Productivity→Measurement of Economic Growth, Aggregate Productivity, Cross-Country Output Convergence
R31 : Urban, Rural, Regional, Real Estate, and Transportation Economics→Real Estate Markets, Spatial Production Analysis, and Firm Location→Housing Supply and Markets