The Shadow Cost of Bank Capital Requirements

Transcription

1 The Shadow Cost of Bank Capital Requirements Roni Kisin Washington University in St. Louis Asaf Manela Washington University in St. Louis April 2015

2 How Costly Are Capital Requirements for Banks? Banks private costs shape regulation, but they have not been measured empirically

3 Revealed Preference Approach Banks used a costly ABCP loophole to bypass capital constraints (Acharya, Schnabl, and Suarez, 2013) Banks trade off the benefit of reduced capital vs. the cost of the loophole Loophole usage reveals the shadow costs of capital requirements (Anderson and Sallee, 2011)

4 The Loophole: Asset-backed Commercial Paper Conduits ABCP stops rolling over before assets stop performing, but conduit assets are not counted toward regulatory assets (10% after 2004)

5 The Loophole: Conduit Assets and Capital Requirements US Banks are considered well-capitalized by their regulator if 1. Leverage ratio = 2. Tier 1 risk-based ratio = 3. Total risk-based ratio = Tier 1 capital 3% to 5% Average Total Assets Tier 1 capital Risk-weighted Assets 6% Total risk based capital Risk-weighted Assets 10% Banks hold the assets, without decreasing capital ratios

6 Who Used the Loophole? 18 US bank holding companies (out of 2, 500+) About 100 times larger than the average BHC 60% of US total bank assets

7 Loophole Usage Reveals the Shadow Cost max r,k,θ Π = j [r j c (k) αθ] q j (r) I (θ > 0) F s.t. regulatory capital constraint: K (q, k, θ) σ Π σ 1 Q = λ α K θ For banks with interior solution θ (0, 1) }{{} α = λk θ λ = α }{{} K θ cost benefit θ share of assets in ABCP α incremental marginal cost of loophole use k true (economic) capital ratio

8 Sufficient Conditions for Identification For banks with interior solution θ (0, 1) }{{} α = λk θ λ = α }{{} K θ cost benefit C1 Constrained banks exploit the loophole C2 Constrained banks do not exhaust the loophole (θ (0, 1)) C3 Marginal borrowers do not value loans financed with ABCP conduits differently from those financed with other sources

9 C1: Constrained Banks Exploit the Loophole (Fig 3) 60 Density of Tier 1 Risk Based Ratio ABCP Sponsors (mean:.09; med:.086; sd:.015) Other BHC (mean:.133; med:.118; sd:.062)

10 C1 (cont d): Zooming in on Specific Banks (Fig 4) BANK OF AMERICA CITIBANK.13 Tot RB Tot RB T1 RB T1 RB T1 Lev T1 Lev Tot RB T1 RB STATE STREET T1 Lev T1 Lev JPMORGAN CHASE T1 RB Tot RB

11 C2: Constrained Banks do not Exhaust the Loophole.03 Fraction of Assets in ABCP Conduits (Participating Banks) q4 2003q2 2003q4 2004q2 2004q4 2005q2 2005q4 2006q2 2006q4 2007q2 Mean Median

12 Estimating the Shadow Cost: Estimating Expressions Leverage ratio: λ s it = α t K s θ,it dπ it = λ s it Q it dσ λ T1Lev it = α t Kit T1Lev Tier-1 risk-based ratio: λ T1RB it = α t K T1RB it Total risk-based ratio: λ TotRB it = α t K TotRB it A it Q it Q r it (1 β ABCP ) j w jq ijt Q r it (1 β ABCP ) j w jq j

13 Estimating the Shadow Cost: Measuring the Inputs λ it = α t = α t Qit r K θ,it K it (1 β ABCP ) j w jq ijt Marginal benefits are easy to measure: K θ,it = K it(1 β ABCP ) j w jq ijt Q r it Marginal costs (α t ) are harder to measure

14 Marginal Cost of the Loophole (α t ): Direct Measure α t = ( r ABCP t ) rt CP (1 τ) is 30-day AA ABCP rate from the Fed is 30-day AA financial CP rate from the Fed τ = 35% is corporate tax rate rt ABCP rt CP

15 Shadow Costs of 1 pp Increase in Regulatory Ratios (Tbl 3) Shadow Cost Change in Profit (Mil.) N T1 RB Tot RB T1 Lev T1 RB Tot RB T1 Lev BANK OF AMERICA BANK OF NEW YORK BANK ONE CITIBANK COMPASS BANK FIFTH THIRD BANK FLEET FNB OMAHA JPMORGAN CHASE KEYBANK MARSHALL-ILSLEY MELLON BANK PNC BANK STATE STREET SUNTRUST US BANK WACHOVIA ZIONS Mean Std. Error [ ] [ ] [ ] [4.39] [3.16] [5.42]

16 Change in Profits ($Mil): 1pp Increase in Tier 1 Risk-Based Ratio 50 CITI JPM 40 BOFA WACHOVIA 10 0 BNY STATE STR FLEET US BK BK ONE SUN MELLON COMPASS M I PNC 5/3 KEYBANK OMAHA ZIONS Log Total Assets

17 Aggregate Cost for Participating Banks (Fig 7) 350 Aggregate Effect on Profits (Mil.) q4 2003q2 2003q4 2004q2 2004q4 2005q2 2005q4 2006q2 2006q4 2007q2 Tier 1 Risk Based Tier 1 Leverage Total Risk Based

18 Upper Bound for the Shadow Cost Goal: Allow for measurement error in α in λ = α K θ FOC in k it : α it = K θ,it K k,it c (k it ) c (k it ) is hard to measure but can be bounded c (k) = r e (1 τ) r d + k r e k + (1 τ) (1 k) r d k r e (1 τ) r d Assuming uniform α α t min i K θ,it K k,it [r e,it (1 τ) r d,it ]

19 Range of Aggregate Effects on Profits (Fig 9) Tier 1 Risk Based Ratio (Mil.) Baseline Estimate Upper Bound M&M with Taxes

20 Discussion λ is an individual marginal compliance cost of a small increase in capital requirements in equilibrium Marginal compliance costs are first-order effects on profits of a small increase in capital requirements What about substantial changes?

21 Discussion: Substantial Changes in Capital Requirements If indirect profits are non-increasing and weakly convex in σ, then the marginal cost is an upper bound for the total cost. (sufficient condition) Holds, for example, if capital requirements reduce the tax benefit of debt (M&M) if government guarantees of debt are important (Merton, 1977) if credit demand is convex enough (Kashyap et al., 2010)

22 How Can the Costs Be So Modest? The aggregate cost is $220 million per year, with an upper bound of about $1 billion These are effects on profits during an economic expansion, after banks use all available tools to mitigate the impact Banks either neutralize or overstate the effect of capital requirements on cost of capital

23 Alternative Definitions of a Binding Constraint Fig. 7: Estimates increase only slightly as we focus on banks closer to threshold.0045 Shadow Cost of Tier 1 Risk Based Ratio Constraint.004 N = N = 214 N = 252 N = 268 N = 279 N = 286 N = 291 N = 293 N = Distance from Tier 1 Risk Based Ratio Constraint 95% Confidence Interval Mean Shadow Cost Median Shadow Cost

24 Risk Weighting of Conduit Assets Fig. 8: Estimates are 50% smaller if most assets have high risk-weights to 150% larger for the lowest risk-weight Average Effect on Profits Risk Weighting of ABCP Assets Fin CP, Extended Model Benchmark Estimate Fed Funds Rate, Extended Model Benchmark Estimate

25 Potential Value from ABCP Financing If the ABCP arrangement created additional value for banks, our benchmark would overestimate the shadow cost Suppose ABCP financing reduce the marginal cost by γ > 0. Shadow cost becomes λ = α K θj γ K θj

26 Conclusion 1 pp increase costs $220 million per year in aggregate, with an upper bound of about $1 billion Latest revision of US bank regulation increased capital requirements by similar amounts We expect a hardly noticeable effect on bank profitability Our approach could be applied more broadly to study regulation of financial intermediaries and provides calibration targets for structural macroeconomic models

27 Related Literature We show how bank capital regulation loopholes can be used to produce estimates of its shadow cost Hasnon, Kashyap and Stein (2011): M&M with taxes Baker and Wurgler (2013): implication of low-risk anomaly Macro-finance studies of constrained financial intermediaries Koijen and Yogo (2013): the shadow cost of statutory reserve regulation for life insurers Loophole approach avoids fully specifying the competitive equilibrium and estimating demand elasticities, markups, etc. Recent calibrations can use our estimates as calibration target Begenau (2014) Gornall and Strebulaev (2014) Nguyen (2014)

28 Appendix Risk-weighted Assets Risk weight w j applied to each asset of risk group j Four major risk weights groups: 0% (cash) 20% (OECD sovereign debt) 50% (residential mortgages) 100% (corporate loans) Securitized assets get % weights based on ratings Conversion factor β [0, 1] converts off-balance sheet items Leverage ratio denominator is on-balance sheet assets (w = 100%, β = 0)

29 Appendix Role of ABCP loophole was widely recognized at the time If the bank were to provide a direct corporate loan, even one secured by the same assets, it would appear on the bank s balance sheet as an asset and the bank would be obligated to maintain regulatory capital for it. An ABCP program permits the Sponsor (i.e., the commercial bank) to offer receivable financing services to its customers without using the Sponsor s balance sheet or holding incremental regulatory capital. Moody s (2003) "We don t simply look at the assets, although we do due diligence. We know the sponsors, the entity. But we also look through to the liquidity support providers. And we wouldn t buy any asset-backed commercial paper conduit unless we re 100 percent sure that they are fully supported by a bank institution." Steven Meier, Chief Investment Officer, State Street

30 Appendix C2: Constrained Banks do not Exhaust the Loophole.5 Mean Fraction of Loans in ABCP Conduits by Asset Type q4 2003q2 2003q4 2004q2 2004q4 2005q2 2005q4 2006q2 2006q4 2007q2 Credit Cards Residential Loans Consumer Loans Commercial Loans

31 Appendix Loophole Use in a Dynamic Model Not much changes in the dynamic model, but adjustment costs can bias results λ t captures per-period shadow cost of compliance The effect of a permanent increase in σ on the bank s present value of profits discounted at rate δ (0, 1) is V t σ 1 Q t = E t [ δ s Q t+s λ t+s Q s=0 t ] = λ t 1 δ (1 + g) Costs of a permanent increase accrue long after rules revision Allowing for loophole use adjustment costs κ (1) λ t α t + κ {L t L t 1 δe t [L t+1 L t ]} K t (2) θ t+1 Allowing for anticipation of financial crisis λ t = α t + π t κδe t [L t+1 z t+1 = 0] K t θ t+1 (3)