Macroprudential Regulation and Systemic Capital Requirements

In the aftermath of the financial crisis, there is interest in reforming bank regulation such that capital requirements are more closely linked to a bank's contribution to the overall risk of the financial system. In our paper we compare alternative mechanisms for allocating the overall risk of a banking system to its member banks. Overall risk is estimated using a model that explicitly incorporates contagion externalities present in the financial system. We have access to a unique data set of the Canadian banking system, which includes individual banks' risk exposures as well as detailed information on interbank linkages including OTC derivatives. We find that systemic capital allocations can differ by as much as 50% from 2008Q2 capital levels and are not related in a simple way to bank size or individual bank default probability. Systemic capital allocation mechanisms reduce default probabilities of individual banks as well as the probability of a systemic crisis by about 25%. Our results suggest that financial stability can be enhanced substantially by implementing a systemic perspective on bank regulation.Financial stability

Using Market Information for Banking System Risk Assessment

We propose a new method for the analysis of systemic stability of a banking system relying mostly on market data. We model both asset correlations and interlinkages from interbank borrowing so that our analysis gauges two major sources of systemic risk: correlated exposures and mutual credit relations that may cause domino effects of insolvencies. We apply our method to a data set of the ten major UK banks and analyze insolvency risk over a one-year horizon. We also suggest a stress-testing procedure by analyzing the conditional asset return distribution that results from the hypothetical failure of individual institutions in this system. Rather than looking at individual bank defaults ceteris paribus, we take the change in the asset return distribution and the resulting change in the risk of all other banks into account. This takes previous stress tests of interlinkages a substantial step further.Systemic Risk; Financial Stability; Stress Testing; Interbank Market

Macroprudential Policy: A Summary

The 2007 global financial crisis brought sharply into focus the need for macroprudential policy as a means of controlling systemic financial stability. This has become a focal point for policy-makers and numerous central banks, including the Bank of Canada, but it has its drawbacks, particularly here in Canada.As a counterbalance to microprudential policy, the idea of a macroprudential outlook reaches beyond the notion that as long as every banking institution is healthy, financial stability is assured. Macroprudential policy recognizes that all those financial institutions are linked, and that stability at the individual level may translate to fragility and uncertainty at the macro level.There are two approaches to macroprudential policy, and both come with downsides. One approach examines the network factor, in which banks are linked through their inter-connected financial transactions. A domino effect can thus be created; when one bank defaults, it causes a chain reaction down the line, creating instability in other banks in the network. The extent of this contagion of instability can be clearly observed through this model; unfortunately, it requires the use of detailed information typically available only to a limited circle of bank supervisors.The second approach gleans information from bank stock prices in a poorly performing market. This information is easily available and accessed, but the downside is the lack of clear understanding on how exactly these shocks travel through the complex links of the global banking system.Canada’s banking system is small and has only six major banks. However, it is important to understand how they are interconnected and how each individual bank can contribute to overall risk. Not only do banks need to be sufficiently capitalized in the normal business cycle, but it may be worthwhile for the sake of overall financial stability to create mechanisms, as regulators in some countries are doing, that require banks to hold more capital in good economic times so that they can use it as a buffer in case of a downturn. Another important macroprudential tool is to identify how much each bank contributes to systemic risk. This would entail identifying the banks that pose a greater threat to stability and having them hold extra capital. Assigning proper capital requirements is, however, not as straightforward as it may seem as the risk of the banking system changes when capital requirements change. One study has shown that when properly done such a requirement can reduce by one-quarter the probability of a financial crisis.Implementing macroprudential policy in Canada faces some challenges. With both housing prices and the level of Canadians’ personal debt high, sudden corrections to the financial system can create problems. Also, the interconnections between Canadian and foreign banks could result in the former being much more greatly influenced by financial-crisis spillover from the latter, something Canada generally avoided during the 2007 economic meltdown. There’s no consensus as yet on the objectives of macroprudential policy. However, it is a necessary complement to microprudential policy and provides a means of managing systemic risk with the goal of greater global financial stability

Macroprudential Policy: A Review

The severity and longevity of the recession caused by the 2007 financial crisis has highlighted the lack of a reliable macro-based financial regulation framework. As a consequence, addressing the link between the stability of the financial system as a whole and the performance of the overall economy has become a mandate for policymakers and scholars. Many countries have adopted macroprudential tools as policy responses for safeguarding the financial system. This paper provides a literature review of macroprudential policies, its objectives and the challenges that a macro-based framework needs to overcome, such as financial stability, procyclicality, and systemic risk

Liquidity fragmentation on decentralized exchanges

We study economies of scale in liquidity provision on decentralized exchanges, focusing on the impact of fixed transaction costs such as gas prices on liquidity providers (LPs). Small LPs are disproportionately affected by the fixed cost, resulting in liquidity supply fragmentation between low- and high-fee pools. Analyzing Uniswap data, we find that high-fee pools attract 58% of liquidity supply but execute only 21% of trading volume. Large (institutional) LPs dominate low-fee pools, frequently adjusting positions in response to substantial trading volume. In contrast, small (retail) LPs converge to high-fee pools, accepting lower execution probabilities to mitigate smaller liquidity management costs

Using Market Information for Banking System Risk Assessment

We propose a new method for the analysis of systemic stability of a banking system relying mostly on market data. We model both asset correlations and interlinkages from interbank borrowing so that our analysis gauges two major sources of systemic risk: correlated exposures and mutual credit relations that may cause domino effects of insolvencies. We apply our method to a data set of the ten major UK banks and analyze insolvency risk over a one-year horizon. We also suggest a stress-testing procedure by analyzing the conditional asset return distribution that results from the hypothetical failure of individual institutions in this system. Rather than looking at individual bank defaults ceteris paribus, we take the change in the asset return distribution and the resulting change in the risk of all other banks into account. This takes previous stress tests of interlinkages a substantial step further

Miner Collusion and the BitCoin Protocol

Bitcoin users can offer fees to miners who record their transactions in the Blockchain. We document high variation of bitcoin fees, not only over time, but also within blocks. Further, the blockchain rarely runs at capacity, even though fees tend to be higher when blocks are fuller, so miners appear to be leaving money on the table. We present a simple model of price discrimination to explain our results. We note that mining pools facilitate collusive equilibria, and estimate that they have extracted least 200 million USD a year in excess fees by making processing capacity scarce.Non UBCUnreviewedAuthor affiliation: University of CalgaryFacult

Macroprudential Policy: A Summary

The 2007 global financial crisis brought sharply into focus the need for macroprudential policy as a means of controlling systemic financial stability. This has become a focal point for policy-makers and numerous central banks, including the Bank of Canada, but it has its drawbacks, particularly here in Canada. As a counterbalance to microprudential policy, the idea of a macroprudential outlook reaches beyond the notion that as long as every banking institution is healthy, financial stability is assured. Macroprudential policy recognizes that all those financial institutions are linked, and that stability at the individual level may translate to fragility and uncertainty at the macro level. There are two approaches to macroprudential policy, and both come with downsides. One approach examines the network factor, in which banks are linked through their inter-connected financial transactions. A domino effect can thus be created; when one bank defaults, it causes a chain reaction down the line, creating instability in other banks in the network. The extent of this contagion of instability can be clearly observed through this model; unfortunately, it requires the use of detailed information typically available only to a limited circle of bank supervisors. The second approach gleans information from bank stock prices in a poorly performing market. This information is easily available and accessed, but the downside is the lack of clear understanding on how exactly these shocks travel through the complex links of the global banking system. Canada’s banking system is small and has only six major banks. However, it is important to understand how they are interconnected and how each individual bank can contribute to overall risk. Not only do banks need to be sufficiently capitalized in the normal business cycle, but it may be worthwhile for the sake of overall financial stability to create mechanisms, as regulators in some countries are doing, that require banks to hold more capital in good economic times so that they can use it as a buffer in case of a downturn. Another important macroprudential tool is to identify how much each bank contributes to systemic risk. This would entail identifying the banks that pose a greater threat to stability and having them hold extra capital. Assigning proper capital requirements is, however, not as straightforward as it may seem as the risk of the banking system changes when capital requirements change. One study has shown that when properly done such a requirement can reduce by one-quarter the probability of a financial crisis. Implementing macroprudential policy in Canada faces some challenges. With both housing prices and the level of Canadians’ personal debt high, sudden corrections to the financial system can create problems. Also, the interconnections between Canadian and foreign banks could result in the former being much more greatly influenced by financial-crisis spillover from the latter, something Canada generally avoided during the 2007 economic meltdown. There’s no consensus as yet on the objectives of macroprudential policy. However, it is a necessary complement to microprudential policy and provides a means of managing systemic risk with the goal of greater global financial stability