Archive for the ‘Financial Markets/ Finance’ Category

Reducing reserves and central bank balance sheets

April 19, 2021

Chris Papadopoullos in this OMFIF post discuss ways for central banks to reduce balance sheets if at all:

More than a decade of government bond purchases has put central banks firmly in the fiscal equation. Central banks have always had some impact on fiscal policy, but now it is more direct. To raise interest rates, they must pay interest on reserves. Selling the bonds they have bought may be difficult while government debts are high.

This threatens their independence, but there is a way out. Central banks could swap their bonds for shorter maturing debt and then sell that back to the market. As central bank reserves are like short term government debt securities, it should not have a noticeable economic impact. Easy in theory, tricky in practice.

fall in demand for reserves by banks is needed though. Under Basel III banking rules, banks are required to hold a certain level of ‘high quality liquid assets’, which include reserves and short-term government bonds. The key to significantly reducing reserve levels is to create a system that allows banks to hold mostly Treasuries for their HQLA requirements in normal times and quickly convert these to bank reserves in a crisis.

To achieve this, two senior Federal Reserve economists, Jane Ihrig and David Andolfatto, have proposed a standing repurchase agreement facility that would allow banks to convert US Treasuries to central bank reserves. This would make it easier for central banks to reduce reserve levels in calm periods without generating upsets.

Inflation in the aftermath of wars and pandemics: Evidence since 1300s

April 15, 2021

Kevin Daly and Rositsa D. Chankova in this voxeu article:

How well does New Zealand’s financial system serve the Maori community?

April 15, 2021

Roanna McLeod and Victor Lam in this RBNZ research analyse how well the local community of Maoris is served by financial system. The paper evaluates the role of iwis, largest group amidst Maori society play in providing financial services:


Report on the public consultation on a digital euro

April 14, 2021

ECB has published the public consultation of Digital Euro:

Although not representative of the European population as a whole, the input received from citizens and professionals signals that privacy, security, usability, low cost and accessibility are among the most popular features that respondents expect from a possible digital euro. Most respondents stress the value of privacy, often acknowledging requirements to avoid illicit activities while protecting the confidentiality
of payments data.

The vast majority of respondents see intermediaries playing a role in the digital euro ecosystem, mainly as a way of enabling the introduction of innovative and efficient services and facilitating integration with existing offerings. Mixed views are expressed on the use of tools to avoid unwanted macroeconomic consequences, which is a technical topic but with a substantial amount of public interest. Generally, respondents expect cross-border and cross-currency payments to be supported in a fast, interoperable and low-cost manner.

Overall, most of the respondents are willing to support a digital euro, especially given the Eurosystem’s commitment ever since its public engagement on the topic began that it would not use a digital euro to either discontinue cash or lower interest rates in the economy.

The responses from the public consultation provide valuable input to the Eurosystem’s ongoing assessments and upcoming decisions on a possible digital euro, even though it is accepted that the sample of respondents is not representative of the European population. At the same time, experiments to assess the strengths and weaknesses of different design options and further analysis of the policy implications of a digital euro are necessary to obtain a comprehensive assessment of the technical input received.

This analysis does not pre-empt decisions, reach conclusions or commit the Eurosystem to provide a digital euro of any kind. Nor does it prevent the Eurosystem  from further investigating and engaging with the general public and relevant stakeholders on the topic of a digital euro.


Real interest rates and demographic developments across generations: A panel-data analysis over two centuries

April 14, 2021

Lucas Fuhrer and Nils Herger in this Swiss National Bank paper:

This paper empirically examines the effect of population growth on long-term real interest rates. Although this effect is well founded in macroeconomic theory, the corresponding empirical results have been rather tenuous and surprisingly unstable. As the demographic interest rate impact is theoretically based on intergenerational relationships, we not only contemplate gross population growth rates but also distinguish between demographic growth resulting from a birth surplus and net migration.

Within a panel covering 12 countries and the years since 1820, our results suggest that there is a positive, statistically significant, and stable effect from the birth surplus on real interest rates. Conversely, the corresponding effect of net migration seems to be much more volatile. Hence, our results suggest that it is mainly population growth occurring through a birth surplus that affects the equilibrium real interest rate.


The challenge of Big Tech finance: Bloodhounds ore regulators are at risk of losing the scent.

April 13, 2021

Barry Eichengreen in this Proj Synd article:

Traditionally, regulators require credit providers to list the variables that form the basis for lending decisions so that the regulators can determine whether the variables include prohibited group characteristics. And they require lenders to specify the weights attached to the variables so that they can establish whether lending decisions are uncorrelated with ethnic or racial characteristics once conditioned on those other measures. But as Big Tech companies’ artificial intelligence-based algorithms replace loan officers, the variables and weights will be changing continuously with the arrival of new data points. It’s not obvious that regulators can keep up.

In algorithmic processes, moreover, the source of bias can vary. The data used to train the algorithm may be biased. Alternatively, the training itself may be biased, with the AI algorithm “learning” to use the data in biased ways. Given the black-box nature of algorithmic processes, the location of the problem is rarely clear.

Finally, there are risks to competition. Banks and fintechs rely on cloud computing services operated by the Big Tech firms, rendering them dependent on their most formidable competitors. Big Techs can also cross-subsidize their financial businesses, which are only a small part of what they do. By providing a range of interlocking services, they can prevent their customers from switching providers.

Regulators have responded with open banking rules requiring financial firms to share their customer data with third parties when customers consent. They have authorized the use of application programming interfaces that allow third-party providers to plug directly into financial websites to obtain customer data.

In an old parable about banks and regulators, the banks are greyhounds – they run very fast. The regulators are bloodhounds, slow afoot but faithfully on the trail. In the age of the platform economy, the bloodhounds are going to have to pick up the pace. Given that only three central banks report having dedicated fintech departments, there is reason to worry that they will lose the scent.

This greyhound vs bloodhounds is interesting way to explain the problem….

Arbitrage Capital of Global Banks

April 13, 2021

Paul Krugman pays tribute to Prof Robert Mundell

April 12, 2021

Paul Krugman pays tribute to Prof Robert Mundell who passed away recently:

Supervising cryptoassets for anti-money laundering

April 8, 2021

Rodrigo Coelho, Jonathan Fishman and Denise Garcia Ocampo in this BIS article:

Although certain cryptoassets have the potential to make payments and transfers more efficient, some of their features may heighten money laundering/terrorist financing (ML/TF) risks. In particular, the speed of transactions, global reach, potential for anonymous activity and the potential for transactions to take place without financial intermediaries make cryptoassets vulnerable to misuse. In fact, the scale of illicit use of cryptoassets is already significant, highlighting the importance of AML/CFT regulation and supervision, as well as law enforcement, in this area.

The Financial Action Task Force has acted swiftly with a view to preventing the misuse of cryptoassets for ML/TF. However, the effectiveness of international standards depends on effective implementation by national authorities, and the supervision of cryptoasset service providers remains nascent globally. This paper aims to contribute to the international debate by assessing emerging regulatory approaches and supervisory practices and identifying policy priorities to address common challenges faced by financial authorities.

Cryptocurrencies have become cryptoassets and the technology is increasingly being seen for transferring and remitting funds.

Europe’s growth gap: reconciling Keynes and Schumpeter

April 7, 2021

Governor François Villeroy de Galhau of Banque De France in this speech points to growing growth gaps between Europe and US.

How to bridge the gap? Take advice of Keynes or Schumpeter?


RBI’s Financial Inclusion Index

April 7, 2021

RBI in Apr-21 policy:

Financial Inclusion has been viewed as a key enabler for achieving inclusive and sustainable development worldwide. This has been a thrust area for Government, Reserve Bank and other regulators, with a number of steps having been taken and significant progress made over the years. To measure the extent of financial inclusion in the country, the Reserve Bank will construct and periodically publish a “Financial Inclusion Index” (FI Index). The FI Index would be based on multiple parameters and shall reflect the broadening and deepening of financial inclusion in the country. To begin with, the FI Index will be published annually in July for the financial year ending previous March.

This follows RBI’s announcement of digital payments index in Feb-20 policy which started publishing in Jan-21.


RBI rejigs Deputy Governors’ portfolio yet again..

April 6, 2021

RBI rejigs the Deputy Governors’ (DG) Portfolio yet again. Shri BP Kanungo retired and his portfolio was allocated to the three DGs.

Since July 23, 2019, when Viral Acharya left the RBI, the central bank has reshuffled the DG portfolio four times with three of these reshuffles in 2020 alone.  The reshuffling happens as Government is unable to appoint a replacement for a retiring/resigning DG.

In an earlier piece, I had written about this constant rejigging and even suggested ways to avoid this…

Will bitcoin follow the mania, panic and crash trajectory?

April 6, 2021

My new piece in Hindustan Times.

Bitcoin’s current surge is difficult to decipher. If the world was preferring bitcoin as a currency, one could still understand this frenzy. But bitcoin’s user base is still insignificant

Could Index Funds Be ‘Worse Than Marxism’?

April 6, 2021

Annie Lowrey in this Atlantic piece says that economists and policy makers are worried that the Vanguard model of passive investment is hurting markets.

In the 1970s, John Bogle pioneered ETFs as a low cost option for retail stock investors. It was seen as a kind of financial revolution.

The revolution has become something else since then. and have grown really big to control 20-30% of US stock markets. The Big 3 ETF companies constitute 90% of ETF market.   Lowrey’s article has many more details.

To see ETFs which to certain extent was seen as this uber capitalism idea to now be compared as Marxism is like full circle…

How all good things eventually become bad things.

A global database on central banks’ monetary responses to Covid-19

April 5, 2021

Carlos Cantú, Paolo Cavallino, Fiorella De Fiore and James Yetman in this BIS paper:

The Covid-19 pandemic has been a global shock of unprecedented size that has hit most countries around the world. Central banks have responded quickly, on a massive scale. We present a novel database that provides information on central banks’ responses to Covid-19 in 39 economies, including both advanced and emerging market economies. Monetary policy announcements are listed and classified under five types of tools: interest rate measures, reserve policies, lending operations, asset purchase programmes and foreign exchange operations. Within each category, the database provides additional information such as maturity, eligible counterparties, types of assets and the availability of fiscal backup. It also indicates whether the policy tool was newly introduced or had been previously deployed. The database has a companion dashboard to visualise the data graphically.

There is a dashboard and an excel file of the various measures by central banks. Really useful for research.

The initial deposit decision and the occurrence of bank runs

April 5, 2021
Johan de Jong of University of Amsterdam models bank runs in a different setting:
In studies of bank runs the initial deposit decision is typically not taken into account. However, it is unlikely that people will entrust money to a bank that they expect to fail in the near future. The aim of this study is to investigate to what extent this mechanism prevents bank runs. It introduces an experiment in which participants first have to choose if they want to receive their endowments as a deposit in a `risky’ bank that pays a high interest or a `safe’ bank that pays a lower interest. 
After this decision they can withdraw the money from their account or leave it in to receive the interest. The availability of different deposit options leads to a very clear theoretical prediction: all choose to deposit in the risky bank with the high interest rate and consequently leave the deposit in the bank. In the experiment the first prediction is not confirmed: almost half of the participants choose to deposit in a
safer alternative. However, in contrast to the control treatment in which participants are not offered a choice, only very few of those that choose the risky bank withdraw their deposits later.

Eastern Carribean Central Bank becomes first central bank to issue digital currency in a currency union

April 2, 2021

Phew, The initial CBDC race is being won by most unlikeliest of countries.

After Bahamas becoming first to issue CBDC, ECCB becomes first to issue a CBDC in a currency union.

On 31 March, ‘DCash’, designed and developed by the international fintech company, Bitt, in partnership with the Eastern Caribbean Central Bank (ECCB), became the world’s first retail central bank digital currency (CBDC) to be publicly issued within a formal currency union.

Governor of the ECCB, Timothy N. J.  Antoine, conducted DCash’s first cross-border transactions by sending $100 DCash from the ECCB’s Headquarters in Saint Christopher (St. Kitts) and Nevis to DCash Wallet holders in the three other pilot countries: Antigua and Barbuda, Grenada and Saint Lucia.

This historic transaction was the climax of over two years of extensive research, consultations, planning, software development, operational training, merchant acquisition, customer service, and marketing achieved through collaboration with the ECCB, Bitt and multiple external stakeholders.

The DCash pilot will demonstrate – the functionality and efficacy of Bitt’s full digital currency management system in operation within a multinational financial ecosystem. Bitt’s central bank solution enables the ECCB to mint, issue, redeem and destroy the digital Eastern Caribbean dollar. Bitt’s financial institution solution allows financial institutions to manage typical banking and customer service relationships for business and consumer clients. The DCash Merchant app allows businesses to manage both consumer and business-to-business transactions, vendor payments, e-commerce, and internal cash/DCash management. Bitt’s free digital wallet solution empowers ECCU residents to make in-person or remote transactions to and from other DCash Wallet holders or organizations.

Here is website of Dcash having more details.


Speaking at the virtual launch, Bitt’s CEO, Brian Popelka, commented, “CBDCs are truly transforming the way that financial transactions are conducted around the world. This change brings significant benefits especially to emerging economies. DCash is a game-changer for the people of the Eastern Caribbean and Bitt is exceedingly proud to be the ECCB’s digital currency management systems partner on this globally-pioneering pilot. As they launch the world’s first CBDC within a currency union, Bitt extends wholehearted congratulations to the ECCB and the citizens and residents of the ECCU”.

During his official address, ECCB Governor, Timothy N. J. Antoine, stated, “In March 2019, the ECCB announced its bold decision to develop its own central bank digital currency. I said, then, ‘we will not outsource our development’. The ECCB chose to partner with Bitt because of the company’s shared values of citizen empowerment through financial inclusion and its respect and understanding of the unique needs of emerging economies. These past two years have been an intensely collaborative journey and both Bitt and the ECCB have learnt many transferable lessons along the way. I wish to thank Bitt for being our official technology partner in the development of DCash and for helping us deliver all the transformational opportunities that this central bank digital currency will bring to the people of the ECCU”.


20 years of American banking history in 67 tables and charts

April 2, 2021

Paul Kupiec of AEI in this paper:

I review 20 years of financial data and highlight important changes in the banking industry. Post financial crisis laws and regulations and new Federal Reserve monetary policies have left a lasting impact on the industry. By 2021, the number of independent depository institutions declined to just over half of the number that existed in 2000, and the assets and activities of the industry have become much more concentrated in a few large “systemically important” institutions.

Moreover, the characteristics of the largest banks has changed. In 2000, they invested 57.5 percent of their assets in private sector business and consumer loans. By 2021, that share fell to a historically low 40 percent. In response to higher regulatory capital requirements and other enhanced prudential regulations, the largest banks replaced business and consumer loans with interest-bearing Federal Reserve deposits, US Treasury securities and other federally-guaranteed securities. The largest banks now dedicate 30 percent of their assets to directly funding the federal government and government-guaranteed activities.

Under the post-crisis policy regime, the largest banks increased slightly their share of equity funding whereas these same banks dramatically increased their use of government-insured and implicitly-insured deposits. In 2000, the largest banks used deposits to raise about 66 percent of their funding. Today deposits fund 80 percent of their operations. The increase in deposits was used to replace subordinated debt, federal funds and other credit instruments whose owners faced loss should the bank fail. Historically, at-risk bank creditors were the most active monitors of a bank’s financial condition, increasing interest rates or withdrawing their funding at the first sign of bank distress. Today, monitoring of the largest banks is left almost exclusively to federal government regulators who have a checkered history when it comes to prescience and transparency.

To be clear, the largest banks are not being accused of anything nefarious. They are merely responding to the incentives created by Congress, heightened prudential regulatory standards, and the unconventional Federal Reserve monetary policies that have impacted the banking industry and wider economy.

Confronting the Hazards of Rising Leverage

March 31, 2021

IMF’s Global Financial Stability Report-Apr 2021 has two chapters – One on rising leverage in non-financial sector and other on commercial real estate.

IMF economists in this blogpost explain the rising leverage bit:

Leverage, the ability to borrow, is a double-edged sword. It can boost economic growth by allowing firms to invest in machinery to expand their scale of production, or by allowing people to purchase homes and cars or invest in education. During economic crises, it can play a particularly important role by providing a bridge to the economic recovery.


Even before the COVID-19 crisis, leverage in the nonfinancial private sector—comprising households and nonfinancial firms—had been increasing steadily in many countries. From 2010–19, this sector’s global leverage rose from 138 percent to 152 percent, with leverage of firms reaching a historical high of 91 percent of GDP. Easy financial conditions in the aftermath of the global financial crisis of 2008–09 have been a key driver of the rise in leverage.

In both advanced and emerging market economies, borrowing has increased even further as a result of the policy support provided in response to the COVID-19 shock. In addition, the decline in output suffered by many countries has contributed to the increase in the debt-to-GDP ratio, and corporate leverage has risen an additional 11 percentage points of GDP through to the third quarter of 2020.

Policy faces a dilemma which they have created:

Policymakers face a dilemma. Accommodative policies (cut in policy rates in conjunction with quantitative easing to reduce firms’ and households’ borrowing costs) and the resulting favorable financial conditions have been supportive of growth but also fueled an increase in leverage. Such an increase, while needed in the short term to cushion the global economy from the devastating impact of the pandemic, may be a vulnerability that poses a risk to financial stability further down the road.

Indeed, our latest analysis provides evidence of this tradeoff.

Easing financial conditions—when investors lower their pricing of credit risk—provide a boost to economic activity in the short term. However, the easing comes with a cost. Further along in the medium term, a heightened risk of a sharp downturn arises, starting at 7-8 quarters out. This tradeoff becomes more accentuated during credit booms. That is, the near-term boost is greater, while the medium-term downside risks are also larger.

The authors say Macropru policies can help:

Our analysis suggests there are measures policymakers can take to resolve, or at least lessen, this dilemma. Macroprudential policies—such as setting limits on borrower eligibility, raising minimum capital, or liquidity ratios for banks—can tame buildups in nonfinancial sector leverage.

The analysis shows that, after countries tighten borrower-related tools (e.g., reducing the maximum loan-to-value ratio for mortgage borrowers), leverage for households slows. When policymakers tighten liquidity regulations on banks (e.g., raising the minimum amount of liquid assets that must be held in proportion to total assets), leverage of firms slows in response. And when policymakers in emerging markets tighten foreign currency constraints on banks (e.g., limiting their open foreign currency positions), leverage of firms slows down as well.

Importantly, macroprudential tightening can mitigate downside risk to growth, thus alleviating the key policy tradeoff. Furthermore, if policymakers loosen financial conditions via monetary policy but also concurrently tighten macroprudential tools, medium-term downside risks to economic activity can be mostly contained.

Given the economic slide, macropru policies are also difficult to get going.

We are not out of the economic hole. Infact, we keep moving from one hole to another…

Don’t Let Financial Regulators Dream Up Climate Solutions

March 30, 2021

There is a rush of central banks responding to climate risks.

John Cochrane provides a contrarian view and says they shouldn’t get into climate change:


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