Financial markets

Stijn Claessens, Nicholas Coleman, Michael Donnelly, 18 May 2016

Since the Global Crisis, interest rates in many advanced economies have been low and, in many cases, are expected to remain low for some time. Low interest rates help economies recover and can enhance banks’ balance sheets and performance, but persistently low rates may also erode the profitability of banks if they are associated with lower net interest margins. This column uses new cross-country evidence to confirm that decreases in interest rates do indeed contribute to weaker net interest margins, with a greater adverse effect when rates are already low.    

Filippo Ippolito, José-Luis Peydró, Andrea Polo, Enrico Sette, 10 May 2016

By providing liquidity to credit line borrowers and depositors, banks are potentially exposed to simultaneous runs on their assets and liabilities. This risk became a reality when the European interbank market froze in the summer of 2007. This column discusses the risk of double-bank runs, liquidity risk management by banks and the implications for the regulation of the financial sector, in particular Basel III. In 2007, banks with a larger exposure to the interbank market suffered a spike in drawdowns on their outstanding credit lines to firms, and were effectively exposed to a ‘double-run’. Importantly, this fragility was mitigated by active pre-crisis liquidity risk management by banks. 

Nicholas Ford, Charles Yuji Horioka, 05 May 2016

The Feldstein-Horioka puzzle concerns why levels of investment and saving are correlated across countries. This is puzzling because financial markets can rapidly move capital between countries, and there is no reason why the best investment opportunities should be in a saver’s home country. This column posits a disarmingly simple solution to this longstanding puzzle – global capital markets cannot by themselves achieve net capital transfers between countries. This solution may have implications for related issues such as the interaction of interest rates, exchange rates, and current account imbalances.

Dennis Bams, Magdalena Pisa, Christian C. P. Wolff, 02 May 2016

In the absence of full information about small businesses’ risk of loan default, banks are unable to accurately calculate counterparty risk. This column suggests that banks can use industry and linked-industry data to better establish counterparty risk, because distress from one industry is transmitted to supplier and customer industries. A reliable and easily available signal for such distress is any failure reported by S&P.

Galina Hale, Tümer Kapan, Camelia Minoiu, 28 April 2016

Since the Global Crisis, cross-border lending among banks and its role in the transmission of financial shocks have gained a lot of attention. This column describes evidence from direct and indirect lending exposures among a large number of banks. The findings show that a larger number of exposures to banks in countries experiencing a systemic banking crisis reduces profitability and the supply of new credit. Both direct and indirect connections have economically significant effects, supporting the notion that interconnected systems are prone to shock transmission.

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