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| Working Papers – 2020 |
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Insurance Pricing, Distortions, and Moral Hazard: Quasi-Experimental Evidence from Deposit Insurance FDIC Center for Financial Research Working Paper No. 2020-08 This Version: July 2021 Abstract Pricing is integral to insurance design, directly influencing firm behavior and moral hazard, though its effects are insufficiently understood. I study a quasi experiment in which deposit insurance premiums were changed for U.S. banks with staggered timing, generating differentials between banks in both levels and risk-based “steepness” of premiums. I find evidence that differentials in premiums resulted in distortions, including regulatory arbitrage, but also provided strong incentives to curb moral hazard. I find that firms that faced stronger pricing incentives to become (or remain) safer were more likely to subsequently do so than similar firms that faced weaker pricing incentives. JEL Code: G21; G22; G28; D22; D47 |
Interbank Networks in the Shadows of the Federal Reserve Act FDIC Center for Financial Research Working Paper No. 2020-07 This Version: August 2020 Abstract Central banks offer public liquidity to banks (through lending facilities and promises of bailouts) with the intention of stabilizing the financial system. However, shadow banks may receive access to that liquidity through an interbank system. We build a model that shows that the public liquidity provision of the Federal Reserve Act increased systemic risk through three channels: by reducing aggregate liquidity, by expanding the whole-sale funding market, and by crowding out the private insurance that had previously served to smooth cross-regional liquidity shocks. Then, using unique data on Virginia state banks that contain detailed disaggregated information on interbank deposits and short-term funds, we show that the introduction of the Federal Reserve System changed the structure and nature of the overall interbank network in ways that are consistent with the model. JEL Code: E58, G21, G28, H63, L51 |
Stressed Banks? Evidence from the Largest-Ever Supervisory Review FDIC Center for Financial Research Working Paper No. 2020-06 This Version: August 2020 Abstract Regulation needs effective supervision; but regulated entities may deviate with unobserved actions. For identification, we analyze banks, exploiting the European Central Bank’s asset-quality-review (AQR) and supervisory security and credit registers. After the announcement of the AQR, reviewed banks reduce riskier securities and credit (also overall securities and credit supply), with the largest impact on riskiest securities (rather than riskiest credit), and with immediate negative spillovers on asset prices and firm-level credit supply. Exposed (unregulated) nonbanks buy the risk that reviewed banks shed. The AQR drives the results, not end-of-year effects. After the AQR compliance, reviewed banks reload riskier securities, but not riskier credit, with medium-term negative firm-level real effects (costs of supervision/safe-assets increase). JEL Code: G20, E50, N22 |
Why Do Models that Predict Failure Fail? FDIC Center for Financial Research Working Paper No. 2020-05 This Version: August 2020 Abstract In the first portion of this paper, we utilize millions of loan-level servicing records for mortgages originated between 2004 and 2016 to study the performance of predictive models of mortgage default. We find that the logistic regression model – the traditional workhorse for consumer credit modeling – as well as machine learning methods can be very inaccurate when used to predict loan performance in out-of-time samples. Importantly, we find that this model failure was not unique to the early-2000s housing boom. We use the Panel Study of Income Dynamics in the second part of our paper to provide evidence that this model failure can be attributed to intertemporal heterogeneity in the relationship between variables that are frequently used to predict mortgage performance and the realized post-origination path of variables that have been shown to trigger mortgage default. Our findings imply that model instability is a significant source of risk for lenders, such as financial technology firms, that rely heavily on predictive statistical models and machine learning algorithms for underwriting and account management. Keywords: Mortgages, Predictive Modeling, Machine Learning, Fintech, Lending, Lucas Critique |
Shared Destinies? Small Banks and Small Business Consolidation FDIC Center for Financial Research Working Paper No. 2020-04 This Version: August 2022 Abstract We identify a new source of consolidation in the banking industry. For decades, both the financial and real sides of the economy have experienced considerable consolidation. We show that banking-sector consolidation is, in part, a consequence of real-sector consolidation; because small banks are a disproportionate source of small-business credit, they are disproportionately exposed to shocks to small-business growth. Using a Bartik instrument based on national small-business trends and county-level industry exposure, we show that changes to the real-side demand for small-business credit is partially responsible for the relative decline in small banks’ deposits, income, and loan growth. JEL Codes: G21, G34, L25, R12 |
Shadow Insurance? Money Market Fund Investors and Bank Sponsorship FDIC Center for Financial Research Working Paper No. 2020-03 This Version: June 2020 Abstract In this paper, we argue that bank-sponsored prime institutional money market funds (PI-MMFs) are different from non-bank-sponsored PI-MMFs. This difference can arise because the sponsoring bank holding companies (BHCs) can extend shadow insurance to ailing affiliated MMFs. We hypothesize that PI-MMFs price this shadow insurance through higher expense ratios. Indeed, after September 2008 when industry risk increased, expense ratios were seven basis points higher than those of non-BHC-sponsored MMFs. This increase is of similar size to the average deposit insurance premium charged by the FDIC in 2008. We also show, despite higher expense ratios, the redemptions in BHC-sponsored MMFs were lower in contrast to expectations of prior literature. JEL Codes: G2, G21, G23, G28, H12, H81 |
The Effect of Central Bank Liquidity Support during Pandemics: Evidence from the 1918 Influenza Pandemic FDIC Center for Financial Research Working Paper No. 2020-02 This Version: May 2020 Abstract The coronavirus outbreak raises the question of how central bank liquidity support affects financial stability and promotes economic recovery. Using newly assembled data on cross-county flu mortality rates and state-charter bank balance sheets in New York State, we investigate the effects of the 1918 influenza pandemic on the banking system and the role of the Federal Reserve during the pandemic. We find that banks located in more severely affected areas experienced deposit withdrawals. Banks that were members of the Federal Reserve System were able to access central bank liquidity, enabling them to continue or even expand lending. Banks that were not System members, however, did not borrow on the interbank market but rather curtailed lending, suggesting that there was little-to-no pass-through of central bank liquidity. Further, in the counties most affected by the 1918 pandemic, even banks with direct access to the discount window did not borrow enough to offset large deposit withdrawals and so liquidated assets, suggesting limits to the effectiveness of liquidity provision by the Federal Reserve. Finally, we show that the pandemic caused only a short-term disruption in the financial sector. JEL Codes: E32, G21, N22 |
Information Management in Times of Crisis FDIC Center for Financial Research Working Paper No. 2020-01 This Version: February 2020 Abstract How does information management and control affect bank stability? Following a national bank holiday in 1933, New York state bank regulators suspended the publication of balance sheets of state-charter banks for two years, whereas the national-charter bank regulator did not. We use this divergence in policies to examine how the suspension of bank-specific information affected depositors. We find that state-charter banks experienced significantly less deposit outflows than national-charter banks in 1933. However, the behavior of bank deposits across both types of banks converged in 1934 after the introduction of federal deposit insurance. JEL Codes: G21, G28, N22 |
The Center for Financial Research (CFR) Working Paper Series allows CFR staff and their coauthors to circulate preliminary research findings to stimulate discussion and critical comment. Views and opinions expressed in CFR Working Papers reflect those of the authors and do not necessarily reflect those of the FDIC or the United States. Comments and suggestions are welcome and should be directed to the authors. References should cite this research as a “FDIC CFR Working Paper” and should note that findings and conclusions in working papers may be preliminary and subject to revision.