COVID-19 and non-performing loans: lessons from past crises

Anil Ari, Sophia Chen, and Lev Ratnovski of ECB in this research look at NPL story.

During crises, the number of loans that cannot be paid back increases. What are the lessons from past crises for non-performing loan resolution after COVID-19? In this article we use a new database covering non-performing loans (NPLs) in 88 banking crises since 1990 to find out. The data show that dealing with NPLs is critical to economic recovery.

Compared with the 2008 crisis, some factors are conducive to NPL resolution this time: banks have higher capital, the forward-looking IFRS 9 accounting standards can help NPL recognition, and the COVID-19 crisis was not preceded by a credit boom. However, other factors could make NPL resolution more challenging: government debt is substantially higher, banks are less profitable, and corporate balance sheets are often weak.

 

History of Repo markets in US..

I wrote a piece in BQ looking at evolution of Repo markets in India.

John Mullin writes on repo markets in US.

What led to rise of Repo market? In 1970s as inflation rose deposit rates could not rise due to regulatory caps. This is much like India where interbank repo markets developed as call rates were capped.

Rakesh Mohan 2006 Speech on Avian Influenza Pandemic: Remains relevant to fighting the crisis today

Came across this 2006 speech by Rakesh Mohan, who was then Deputy Governor at RBI.

He outlined what to expect in case there is an outbreak of large scale pandemic :

Tryst with destiny, planning and deficit financing

My new piece on Moneycontrol:

The media is rife with discussions on whether and how the RBI should monetise the government’s deficits. India is no stranger to deficit financing as its 5-year Plans were based on it, which in turn created several problems for the Indian economy. We explore this long history and also try and answer the questions of today at the end.

Read on for details…

The drivers of cyber risk

Iñaki Aldasoro, Leonardo Gambacorta, Paolo Giudici and Thomas Leach of BIS in this research:

Cyber incidents are becoming more sophisticated and their costs difficult to quantify. Using a unique database of more than 100,000 cyber events across sectors, we document the characteristics of cyber incidents. Cyber costs are higher for larger firms and for incidents that impact several organisations simultaneously. The financial sector is exposed to a larger number of cyber attacks but suffers lower costs, on average, thanks to proportionately greater investment in information technology (IT) security. The use of cloud services is associated with lower costs, especially when cyber incidents are relatively small. As cloud providers become systemically important, cloud dependence is likely to increase tail risks. Crypto-related activities, which are largely unregulated, are particularly vulnerable to cyber attacks.

 

17 May 2020: Bank for International Settlements turns 90!

BIS turned 90 recently.

In this podcast, Piet Clement explains the origins of the BIS and the roles it has played since opening on 17 May 1930.

ECB announces new measures to increase share of female staff members

I had earlier written on how and why central banks have to take measure to increase women staff in their organisations.

ECB’snew targets to increase women employment at the central bank:

The European Central Bank (ECB) today announced a new programme to further improve the gender balance of its staff at all levels. The strategy defines target percentages focusing on the annual share of women being appointed to new and open positions as well as targets for the overall share of female staff at various salary levels. The strategy covers the period until 2026, so as to fall within the mandate of President Christine Lagarde.

“We want gender balance to be the norm now rather than a revolution to fight later,” said President Lagarde. “Let us not forget that gender is one of the many dimensions of diversity that we must all value. We should mirror the society we serve.”

….

The new programme follows the ECB’s first set of gender targets, which aimed to double the share of women in management positions over the period from 2013 to 2019. The ECB exceeded one of its targets by achieveing a figure of 30% female senior managers at the end of 2019, compared to a target of 28%. The share of women in all management positions rose from 17% to 30%, which was still below the target figure of 35%.

Hmm..

India’s Inflation decoded through power of words: Media does a great job tracking inflation

Shweta Kumari and Geetha Giddi of RBI in this May-2020 Bulletin article:

Media, as an important channel for dissemination of information, has the potential to influence public sentiment and expectations. This article utilises high
frequency unstructured information sourced from the online print media, in the specific context of retail inflation in India. Using Support Vector Machines
(SVM) classifier, a widely used technique for sentiment classification, sentiment is extracted from the news and a sentiment index is constructed. Empirical results suggest that the media sentiment index tracks inflation very well. Its directional accuracy, is high and statistically significant. Further, the Granger Causality test results also indicate that the sentiment index has significant predictive ability for retail inflation.

A Dane in the making of European Monetary Union – A conversation with Niels Thygesen

Interesting looking paper by Central Bank of Belgium econs:

Niels Thygesen (born 1934) played for nearly five decades an influential role in the process of economic and monetary integration in Europe. He is especially known as a member of the Delors Committee and as the first Chair of the European Fiscal Board. As part of a research program on collecting memories, this paper publishes the results of several interviews with him. His early life offers insightful observations on Danish attitudes towards Europe and on the development of the economics profession in the postwar years (he was close to Nobel Prize laureates as Franco Modigliani and Milton Friedman). Thygesen’s involvement with the process of European monetary integration really started in 1974 with his membership of the Marjolin Committee (which provided an assessment of the failure of the 1970 Werner Report). Since then he has been involved in a multitude of committees and initiatives, like the OPTICA groups, the All Saints Day Manifesto, the Trilateral Commission, the Committee for Monetary Union in Europe (an initiative of Giscard and Schmidt) and the Euro50 Group.

Such papers are really useful to understand some of the core ideas and beliefs which led to Euro..

 

Negative rates and the transmission of monetary policy

Miguel Boucinha and Lorenzo Burlon of ECB in this article:

The stimulus to the broader economy provided by NIRP has been effective in inducing an easing of financing conditions and thereby, ultimately, contributing to price stability. The interest rate cut has been channelled through both standard and non-standard transmission mechanisms, generating a reduction in bank funding costs and spurring loan creation. Effects were heterogeneous across bank characteristics. However, the dispersion in some bank responses does not challenge the overall positive first-order effect of NIRP on financing conditions. Notwithstanding the potential headwinds to transmission discussed above, as yet there is no sign that the stimulus provided by the measure has been exhausted, as new channels emerge while others fade away. Ultimately, the macroeconomic response has been sizeable and has helped to bring inflation closer to the ECB’s aim.

Protracted periods of negative rates do, however, have the potential to hinder the transmission of monetary policy. Prolonged periods of negative rates are qualitatively different from brief, “experimental” periods. If negative policy rates had proved to be short-lived, they might have become a mere footnote in central banking history. As negative rates persist, however, banks react to them to avoid the negative effects on profitability, although their leeway to do so is eroded over time. In the current euro area monetary policy environment, the effects of a long period of negative rates require continuous and careful monitoring as we venture further into uncharted territory.

Overall, NIRP still largely benefits the macroeconomic outlook and price stability. In order to support the bank-based transmission of monetary policy, the ECB has adopted a two-tier system for reserve remuneration. In parallel, specific risks to financial stability are addressed by action from other policy areas, which are specifically mandated to tackle phenomena and behaviours associated with such risks. Microprudential supervision monitors banks’ risk-taking behaviour, and so far it has provided an adequate set of incentives for intermediaries to calibrate their risk attitude to the macroeconomic circumstances. Moreover, national and supranational macroprudential authorities can effectively monitor and respond to localised house price bubbles and other threats to financial stability. Such mitigating action allows the euro area economy to continue to benefit from the significant and necessary stimulative impact of NIRP, which has proven to be an integral and effective part of the ECB’s policy response to past and current challenges.

 

Core Inflation Measures in India – An Empirical Evaluation using CPI Data

RBI’s new WP by Janak Raj, Sangita Misra, Asish Thomas George and Joice John.

This paper assessed eleven possible candidates for their suitability as measures of core inflation in India based on Consumer Price Index (CPI) (2012=100) for the period 2012 to 2019. These included six exclusion-based measures, viz., (i) CPI excluding food and fuel; (ii) CPI excluding food, petrol and diesel; (iii) CPI excluding food, fuel, petrol and diesel; (iv) CPI excluding food, petrol, diesel, gold and silver; (v) CPI excluding food, fuel, petrol, diesel, gold and silver; and (vi) CPI excluding food, fuel, petrol, diesel, gold, silver and housing and five statistical measures, viz., (i) median; (ii) 5 per cent trimmed mean; (iii) 10 per cent trimmed mean; (iv) 20 per cent trimmed mean; and (v) historical standard deviation.

All these candidates were tested for the standard properties of core inflation, viz., ease of communication, equality of means, lower volatility, unbiasedness, revertability, co-integration and attraction conditions. Historical standard deviation-based measure satisfied all the properties of core inflation, except ease of communication – in general, use of statistical measures pose formidable challenges for monetary policy communication.

All the six exclusion based measures satisfied all properties but revertability, i.e., headline inflation reverting to core inflation over the medium term. This was possibly due to a low food inflation episode from January 2017 to August 2019. Controlling for this time period, all the exclusion-based core inflation measures, other than CPI excluding food, fuel, petrol, diesel, gold, silver and housing, revert to headline inflation satisfying all the desirable properties of core inflation.

What to expect from Facebook’s Libra 2.0?

My new piece in moneycontrol.

Amidst all the chaos, the Libra Association (LA) released a new paper on Libra titled Libra 2.0. The article explores the changes and modifications in Libra 2.0.

Should ECB issue an e-Euro?

On 27-March-2020, Banque de France invited applications from different industry players to figure whether ECB should issue a CBDC.

In view of the opportunities opened up by technological progress and in an effort to avoid  excessive fragmentation in settlement procedures, the Banque de France is taking steps to review and adjust the conditions under which it provides financial intermediaries with central bank money. With this in mind, the Banque de France is launching a programme of experiments to test the integration of a central bank digital currency (CBDC) in innovative procedures for the
exchange and settlement of tokenised financial assets between financial intermediaries.

These experiments will act as a contribution by the Banque de France to a broader discussion within the Eurosystem, which will make any decision on whether to set up a CBDC. The tests are not intended to be continued on a long-term basis or applied on a wide scale by the Banque de France itself.

Clearly BdF is taking a lead in Europe’s CBDC.

Yves Mersch, ECB Board member recently spoke  on whether ECB should issue a CBDC. He says Wholesale CBDC (CBDC between banks) is not an issue at all. The real deal is retail CBDC:

A wholesale CBDC, restricted to a limited group of financial counterparties, would be largely business as usual. However, a retail CBDC, accessible to all, would be a game changer. So a retail CBDC is now our main focus.

Setting up a CBDC would require a solid legal basis, in line with the principle of conferral under EU law. One key consideration here is whether a retail CBDC could and should have the same legal tender status as banknotes and coins. In practice, legal tender status implies that a CBDC would have to be usable at any location and under any condition, possibly even offline. Without legal tender status, the legal basis would need to be clarified, as would the relationship between a CBDC and euro banknotes and coins, along with the process by which one could be exchanged for the other. Should it not be acknowledged that the ECB’s exclusive right to authorise issuance in euro would also be applicable to a digital issuance?

A retail CBDC could be based on digital tokens, which would circulate in a decentralised manner – that is without a central ledger – and allow for anonymity towards the central bank, similar to cash. Some argue that a token-based digital currency might not guarantee complete anonymity. If that proved to be the case, it would inevitably raise social, political and legal issues. We are currently looking into the legal questions raised by the potential use of intermediaries to facilitate the circulation of a CBDC and also the processing of transactions in a CBDC. To what extent are we permitted to outsource public law tasks to private entities? And what would be the appropriate extent of supervision over such entities?

Alternatively, a retail CBDC could be based on deposit accounts with the central bank. Though involving vast numbers of accounts, it would not be a particularly innovative option from a technological viewpoint. For the euro area, it would basically mean increasing the number of current deposit accounts offered from around ten thousand to between 300 and 500 million. A CBDC of this nature would enable the central bank to register transfers between users, thereby providing protection against money laundering and other illicit uses (or those considered illicit by the rulers of the day), depending on the degree of privacy granted to users.

These are just two of the many ways to design a CBDC. We are currently scrutinising the various options to assess their potential impact – both positive and negative – on the financial system and on our ability to honour our mandate.

A retail CBDC is technologically possible. Yet ECB (and other central banks) is not interested in retail CBDC. Why? Because central banks will then do woks of commercial banks:

You may wonder why central banks have not chosen to provide retail access to central bank money, despite the technology for an account-based CBDC already being largely available. The main reason is that introducing a retail CBDC could have major consequences for the financial system.

If households were able to convert commercial bank deposits into a CBDC at a rate of 1 to 1, they may find it far more attractive to hold a risk-free CBDC rather than bank deposits. During a systemic banking crisis, this could trigger digital bank runs of unprecedented speed and scale, magnifying the effects of such a crisis.

Banks might manage to render their deposits more attractive than central bank ones. They could, for instance, provide additional services to those offered by central banks. Such services could include paying bills, or cross-selling financial insurance products. Otherwise – even in the absence of a crisis – a readily convertible CBDC could crowd out bank deposits, leading to the disintermediation of the banking sector. This could have far-reaching implications for the structure of the financial system and for the ability of central banks to perform their core tasks and ensure that their monetary policy is transmitted to the real economy.

If the central bank were to take retail deposits, it might also have to provide loans, with all the ensuing consequences. The central bank would need to launch customer-facing business lines. Deposit and lending facilities would also require the central bank to take on the burden of regulatory compliance in areas such as anti-money laundering, consumer protection and confidentiality.

Some argue that this may reinforce monetary sovereignty, as disintermediation would make the financial system safer and reduce the moral hazard of banks by diminishing their role in money creation.^[5]

But disintermediation would be economically inefficient and legally untenable. The EU Treaty provides for the ECB to operate in an open market economy, essentially reflecting a policy choice in favour of decentralised market decisions on the optimal allocation of resources. Historical cases of economy-wide resource allocation by central banks are hardly models of efficiency or good service. Furthermore, a retail CBDC would create a disproportionate concentration of power in the central bank.

Options?

What, then, could be done to mitigate the impact of a CBDC on the financial system?

One option could be to remunerate CBDC at below-market rates in order to create incentives for non-banks to rely more on market-based alternatives rather than on central bank deposits. The drawback would be that, in times of crisis, it may become necessary to apply highly negative rates, which could generate criticism from the public and substantially undermine public confidence in the central bank as well as in the basic values of saving which underlie our societies.

Another option is a tiered remuneration system.^[6] In line with the functions of money, the first tier could serve as a means of payment. The central bank would have to refrain from setting a lower or a negative interest rate in order to keep a CBDC attractive to the public as a means of payment. While the second tier could serve as a store of value, the central banks could discourage people from using it as such by setting unattractive interest rates. However, such schemes should draw from the experience of multiple exchange rate regimes. And the repercussions of the intentional use of such schemes need to be subjected to an additional comprehensive investigation.

 

 

A Philosopher-Banker Who’s Shaking Up a Nation (Suriname)

Interesting piece in NYT:

Steven Coutinho had long wanted to help Suriname, his homeland, overcome its colonial past. A huge financial scandal gave him his chance.

Is central bank currency fundamental to the monetary system?

Hanna Armelius, Carl Andreas Claussen and Scott Hendry of Bank of Canada in this paper look at one of the fundamental questions of monetary economics: Why do we need a central bank currency? Why can’t we just work with commercial bank deposits to work as money?

In this paper, we discussed whether the ability of individuals to convert commercial bank money into central bank money is fundamentally important for the monetary system. This is a significant question because cash, the only form of central bank money that the public currently has access to, is becoming marginalized in some countries. The question is highly relevant to the discussion about whether central banks need to issue a retail CBDC.
Theory suggests that commercial bank money is sufficient if it is safe. We have argued that instituted measures like deposit insurance, lender of last resort, regulations and supervision, together with sound government finances and macroeconomic policies, make commercial bank money safe up to the limit of the deposit insurance guarantee—and often beyond.

Thus, to begin with, neither cash nor a CBDC seems fundamental to the monetary systems in countries with these measures in place.

We discussed two other potential reasons why cash or a CBDC might be fundamental. The first is the role of convertibility of bank deposits into cash or a CBDC for the uniformity of money. We argue that the uniformity of money can be maintained without cash or a CBDC if:
• institutions are strong,
• the government has the ability and willingness to quickly address systemic problems, and
• payment alternatives are instantaneous and fully understood to be so.

Weakness in any of these components may leave some role for cash or a CBDC to help ensure the uniformity of different types of money.

The second reason is the role of convertibility of commercial bank money into central bank money in giving a sense of control to economic agents that mistrust banks. Research has shown that individuals who feel they are in control are more willing to take risks. Thus, in this sense, one of the roles of cash, and potentially of CBDC, may be to promote a sense of control for individuals. Furthermore, by extension this will support individuals’ trust and
confidence in their financial well-being and the financial sector.

Our overall conclusion is that the question of whether general public access to central bank money in the form of cash or a CBDC is fundamental to the monetary system is a judgment call and depends on the national context. In the two countries that are now experiencing the most rapid decrease in cash, Sweden and Norway, the governments have a proven record of protecting commercial bank money in times of crisis. People therefore have good reasons to
believe their commercial bank money is safe should a new crisis come along. However, the perceived control provided by the ability to convert commercial bank money into cash or a CBDC may still be needed to make people willing to hold the former. We find that more research into this mechanism is needed before we can draw any definite conclusions. 

Teachable Moments from the Pandemic: Canadian edition

Stephen S. Poloz, Outgoing Governor of Bank of Canada in this speech points to some teachable moments from the pandemic.

He starts saying how Canada gets hits twice each time there is an economic shock:

How to Avoid a W-Shaped Recession: Don’t withdraw health or economic stimulus measures

Jeffrey Frankel in this piece:

As policymakers plan their COVID-19 responses, policymakers should remember a simple rule of thumb: let “W” stand for premature “withdrawal” of public-health or economic-stimulus measures. As previous crises have shown, such proposals should be avoided like the plague.

….

Of course, a cure or vaccine would be a game changer. But even in the best-case scenario, testing and approving any breakthrough could take a year and a half. If economic activity remained severely depressed for that long would, the status of the current recession would be confirmed as by far the worst since the Great Depression of the 1930s.

But there is an even more devastating scenario: a prolonged W-shaped recovery, caused by political leaders’ failure to heed the lessons of history. Two policy mistakes – echoing those made in the interwar period – seem particularly likely.

The first mistake – toward which many leaders, beginning with US President Donald Trump, have already shown a dangerous predilection – would be to declare “victory” over the virus prematurely, abandon public-health interventions, and allow a second wave of infections to take hold. That is what happened during the so-called Spanish flu pandemic a century ago. The first wave hit the US in early 1918. The second wave, in September 1918, was far deadlier. The third wave persisted into 1920.

In 1918, like today, cities instituted social-distancing measures, including school closures, prohibitions on public gatherings, and face-mask requirements. But delayed action was common, and few maintained the interventions for long. A 2007 study from the National Academy of Sciences found that US cities’ success in reducing the number of deaths “was often very limited because of interventions being introduced too late and lifted too early.”

In fact, nobody upheld the public-health interventions as long as they should have. San Francisco reduced mortality by at least 25% – the highest rate among US cities. But, rather than reinforcing its commitment to its interventions, this success led the city to cancel its restrictions in November; a second, much deadlier wave of infections followed in December and January. Had San Francisco sustained its social-distancing rules for longer, the National Academy of Sciences estimates, it could have cut the death toll by 95%. 

Political leaders might also abandon economic stimulus too soon – the second mistake that could lead to a W-shaped recession. The events of 1936-37 in the US show just how devastating this decision can be.

In 1936, satisfied with progress in recovering from the depression that had begun seven years earlier, President Franklin D. Roosevelt’s administration curbed federal spending and raised taxes. At the same time, the US Federal Reserve tightened monetary policy, doubling bank reserve requirements and sterilizing gold inflows. By 1937, the US economy had relapsed into a severe recession, which lasted through 1938.

140 years of central banking in Romania

Mugur Isărescu, Governor of the National Bank of Romania, gives a speech on the occasion:

Recent history has shown us that central banks have always exerted their full functions within mandate to support countries and people to overcome the economic effects of wars, catastrophes and disasters of any kind. These trying times make no exception. The outstanding cooperation within the framework of the prestigious Bank for International Settlements, of its remarkable members and management, will stand proof for deepening our commitments that
bind us all.

On a more positive note, I wish to let you know that the National Bank of Romania celebrates today its 140 year anniversary. The day of April 29th has a strong historical significance. Since mid19th century, the Romanian society had witnessed swift, in-depth social, economic, political and institutional changes. So, steps were taken to found a central bank, drawn on the statutory principles of Banque de France and the National Bank of Belgium. On April 29th 1880, the Law on the establishment of a discount and circulation bank, i.e. the act laying down the setting up of the National Bank of Romania, was published, ranking our institution among the first modern central banks.

There is much more here on the website of NBR.

The National Bank of Romania was established on 17/29 April 1880 as a result of the Romanian liberal way of thinking centred on the idea of putting in place a solid credit system. The then Minister of Finance, Ion Campineanu, became the first governor, Eugeniu Carada-the true founder-together with Emil Costinescu were responsible for the organisation and functioning of the Mint, while Theodor Stefanescu was in charge of the accounting organisation of the Bank

The start-up capital amounted to lei 30 million, of which lei 10 million was state owned. The NBR was first improperly accommodated in a small space on the premises of The Rural Estate Credit. As of 16th December, the state withdrew from the association with the NBR, which turned into a privileged privately-owned bank, and the government’s rights passed on to the shareholders. The Bank was granted the prerogative to issue currency by 31st December 1920, subsequently extended to 31st December 1930.

Climate Change in India: Macroeconomic Impact and Policy Options for Mitigating Risks

Amidst all the chaos, RBI researchers (Archana Dilip and Sujata Kundu) released this useful piece in RBI Apr-2020 bulletin.

Climatic conditions, comprising the two key indicators – precipitation and temperature, play a crucial role in the overall health of the Indian economy. Over the years, India has witnessed changes in climatic patterns in line with the rest of the world. With increase in population and economic activity, the cumulative level of GHG emissions has increased causing the average temperature to rise over time. Importantly, the rainfall pattern, particularly with respect to the SWM, which provides around 75 per cent of the annual rainfall, has undergone significant changes. Moreover, the occurrence of extreme weather events like floods/unseasonal rainfall, heat waves and cyclones has increased during the past two decades and data reveal that some of the key agricultural States in India have been the most affected by such events.

Two separate indices were constructed at the all-India level – the temperature index and the precipitation index – and their impact on food inflation and economic activity indicators was analysed. The results indicated weather conditions, especially rainfall, to have a strong influence on the food inflation trajectory and the impact was found to last for a couple of months. Within food, vegetables prices are the most vulnerable to rainfall shocks. The results also showed weather conditions to have a significant impact on some of the key indicators of economic activity like PMI, IIP, demand for electricity, trade, tourist arrivals, and tractor and automobile sales. This article also highlighted various policy tools that could help mitigate climate change risks.

Again, full of interesting table, graphs and maps…

Impact of AI and Machine Learning on Bank Supervision

Good to read something different from central bankers.

James Proudman of Bank of England in this speech discusses how AI and ML are changing bank supervision:

Technology is rapidly changing the world around us. As prudential regulators, we need to understand the impact of that technology. First and foremost, we need to understand its impact on the firms we supervise – and the financial system as a whole – if we are to understand properly risks to financial
stability, and safety and soundness – just as we have always done. There is nothing new in this.

But what is new is the need – and opportunity – to take advantage of the new technology in our own business processes to change the way supervision is done. Providing answers to the questions I have outlined in the preceding remarks will help us to know how far we might, in time, go in introducing technology into supervision, and provide a road map for the future of how prudential supervision could be done.

What is the opportunity for supervisors and supervised firms?

How might this transformation impact the ‘day job’ and skills of supervisors?

The aim is ‘human centred automation’: using technology to free up supervisors’ time to focus on where they can add the highest value – making supervisors’ jobs more productive, more insightful and more rewarding.

To do so is likely to require some change in skills – incorporating more quantitative and analytical skills – without altering the fundamental ability to apply judgement to assess key risks to firms’ safety and soundness and evaluate practical mitigants.

And how might changes like those I have described impact firms’ experience of being supervised? For the better, I believe. Smarter, quicker supervision should generate fewer costly ad hoc data requests from firms; and generate better-informed, more timely and more insightful supervision.