Session 12: Banks and Financial Frictions

Wed, Sep 1 2021, 9:00am - Thu, Sep 2 2021, 11:55am PDT
Organized by
  • Juliane Begenau, Stanford GSB
  • Lars Peter Hansen, University of Chicago
  • Ben Hebert, Stanford GSB
  • Monika Piazzesi, Stanford University

This segment would feature post-crisis research on the central role of banks in the economy, their incentives for risk-taking, developments in fintech, the role of banks for financial stability and payments provision, and the importance of financial frictions for households and firms more generally. This is an extremely active area of research. 

In This Session

Wednesday, September 1, 2021

Sep 1
9:00 am - 9:55 am PDT

Private Renegotiations and Government Interventions in Debt Chains

Presented by: Vincent Glode (The Wharton School, University of Pennsylvania)
Co-author(s): Christian Opp (University of Rochester)

We propose a model of strategic debt renegotiation in which businesses are sequentially interconnected through their liabilities. This financing structure, which we refer to as a debt chain, gives rise to externalities, as a lender’s willingness to provide concessions to its privately informed borrower depends on how the lender’s own liabilities are expected to be renegotiated. Our analysis reveals how government interventions that aim to prevent default waves should account for these private renegotiation incentives and their interlinkages. Our results shed light on the effectiveness of subsidies and debt reduction programs following economic shocks such as pandemics or financial crises.

Sep 1
10:00 am - 10:55 am PDT

The Non-U.S. Bank Demand for U.S. Dollar Assets

Presented by: Tobias Adrian (International Monetary Fund)
Co-author(s): Peichu Xie (International Monetary Fund)

The USD asset share of non-U.S. banks captures the relative demand for USD denominated assets by these investors. An instrumental variable strategy identifies a causal link from the USD asset share to the USD exchange rate. Furthermore, cross-sectional asset pricing tests show that the USD asset share is a highly significant pricing factor for carry trade strategies. The USD asset share also forecasts the movement of foreign currency against U.S. dollar with economically large magnitude, high statistical significance, and large explanatory power, both in sample and out of sample, pointing towards time varying risk premia. It takes 2-5 years for exchange rate risk premia to normalize in response to demand shocks. 

Sep 1
11:00 am - 11:55 am PDT

The Collateral Link between Volatility and Risk Sharing

Presented by: Guillermo Ordonez (University of Pennsylvania)
Co-author(s): Sebastian Infante (Federal Reserve Board)

We show that aggregate volatility affects the extent to which agents can share idiosyncratic risks in financial markets. The channel is the valuation of private and public assets, which are both used as collateral in insurance contracts, but are differentially exposed to volatility. While aggregate volatility decreases the value of private assets—they are exposed to more variation—it increases the value of public assets— they become more valuable to smooth consumption intertemporally. Hence, a more volatile economy tends to damage risk sharing when the composition of collateral is biased toward private assets. By endogenizing the creation of private assets, we provide conditions under which more public collateral and more economic stability induce more private issuance, making risk sharing increasingly fragile to volatility shocks. Consistent with the model, we find empirical evidence in the U.S. that a more intense use of private assets increases the sensitivity of risk sharing to aggregate volatility.

Thursday, September 2, 2021

Sep 2
9:00 am - 9:55 am PDT

Dynamic Banking and the Value of Deposit

Presented by: Patrick Bolton (Columbia Business School)
Co-author(s): Ye Li (Ohio State University), Neng Wang (Columbia Business School), and Jinqiang Yang (Columbia University)

We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike capital of nonfinancial firms, deposits can have a negative marginal q for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. When banks have insufficient equity capital to buffer risk, deposit inflows and the associated uncertainty in future leverage can destroy value. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation and offers new perspectives on the challenges that banks face in a low interest rate environment.

Sep 2
10:00 am - 10:55 am PDT

Banks, Maturity Transformation, and Monetary Policy

Presented by: Pascal Paul (Federal Reserve Bank of San Francisco)

Banks engage in maturity transformation and the term premium compensates them for bearing the associated interest rate risk. Consistent with this view, I show that banks’ net interest margins and term premia have comoved in the United States over the last decades. On monetary policy announcement days, banks’ stock prices fall in response to an increase in expected future short-term interest rates but rise if term premia increase. These effects are muted for nonbank equity, amplified for banks with a larger maturity mismatch, and reflected in bank cash-flows. The results reveal that banks are not immune to interest rate risk.

Sep 2
11:00 am - 11:55 am PDT

Dynamic Banking with Non-Maturing Deposits

Presented by: Urban Jermann (University of Pennsylvania)
Co-author(s): Haotian Xiang (Peking University)

Bank liabilities include debt with long-term maturities and deposits that typically are not withdrawn for extended periods. This subjects bank liabilities to debt dilution. Our analysis shows that this has major effects for how monetary policy shocks are transmitted to banks and for optimal capital regulation. Interest rate cuts produce protracted increases in bank risk which are stronger in low-rate regimes. Capital regulation addresses debt dilution but is subject to a time-inconsistency problem. We compare Ramsey and Markov-perfect optimal policies and find that regulator commitment significantly impacts optimal bank capital regulation, sometimes in unexpected ways.