New banking regulations and the liquidity of financial markets

Transcription

1 New banking regulations and the liquidity of financial markets Darrell Duffie Stanford University Are We Ready for the Next Financial Crisis? Lessons Yet To Be Learned Rotman School, University of Toronto, March 22, 2018 Based in part on research with Leif Andersen, Antje Berndt, and Yang Song Duffie New banking regulations and the liquidity of financial markets 1

2 A bank-intermediated over-the-counter market c 1 c 2 d 1 c 5 c 3 d 2 d 3 c 6 c 7 c 4 Duffie New banking regulations and the liquidity of financial markets 2

3 Implications of post-crisis regulations for market efficiency 1 More financial stability from higher bank capitalization and bail-in failure resolution. 2 Increased cost of access to bank balance sheets. The leverage-ratio rule has reduced incentives to intermediate safe assets. Bail-in failure resolution has significantly increased bank funding costs. 3 Market infrastructure and new competition rules lower the need for balance-sheet space. Duffie New banking regulations and the liquidity of financial markets 3

4 Dealer balance sheet assets debt equity Duffie New banking regulations and the liquidity of financial markets 4

5 More equity to fund more assets assets debt old assets debt equity equity new assets new equity Duffie New banking regulations and the liquidity of financial markets 5

6 Legacy shareholders have subsidized creditors assets debt old assets debt equity equity new assets new equity Higher capitalization implies a value transfer from legacy shareholders to creditors. Duffie New banking regulations and the liquidity of financial markets 6

7 Debt overhang assets debt old assets debt equity equity new assets new equity For shareholders to break even, the new assets must be purchased at a profit that exceeds the value transfer to creditors. (Myers, 1977) Duffie New banking regulations and the liquidity of financial markets 7

8 SLR is more binding than risk-based capital ratios Results of the Fed s 2017 stress tests for the largest US dealer banks Excess capital ratio (%) CET1 (CCAR) CET1 (DFAST, adj.) SLR (CCAR) SLR (DFAST, adj.) JPM CITI BAML GS MS CCAR: stressed CET1 after assumed payouts, less 4.5%; stressed SLR less 3.0%. DFAST, adjusted: stressed CET1 (no payouts) less (4.5% + G-SIB surcharge); stressed SLR less the G-SIB minimum of 5%. Duffie Data source: Board of Governors ofnew thebanking Federal regulations Reserve, and the2017. liquidity of financial markets 8

9 European banks reduce their balance sheets at quarter ends Daily collateral outstanding in the tri-party repo market and the Federal Reserve s overnight reverse repo (ON RRP) facility Billions of dollars 600 U.S. banks European banks Other banks Fed (ON RRP) /2016 4/2016 7/ /2016 1/2017 4/2017 Figure Source: Egelhov, Martin, Zinsmeister, Federal Reserve Bank of New York, August, Notes: Banks headquartered in the euro area and Switzerland report leverage ratios as a snapshot of their value on the last day of each quarter, while their U.S. counterparts report quarterly averages. Totals only include trades backed by Fedwire-eligible securities that is, U.S. Treasury and agency securities. Duffie New banking regulations and the liquidity of financial markets 9

10 Impact of the leverage-ratio regulation on repo intermediation costs to legacy shareholders repo asset repo claim repo asset repo claim old assets old debt old assets old debt equity equity safe assets new equity Duffie New banking regulations and the liquidity of financial markets 10

11 Impact of SLR on UST repo market efficiency Decline in GCF net lending volume 25 GCF triparty rate spread (basis points) Q1 13 Q3 14 Q1 14 Q3 15 Q1 15 Q3 16 Q1 16 Q3 17 Q1 17 Q3 18 Q1 (a) bid-ask spreads up (b) inter-dealer positions down Figure: (a) Average within-quarter difference between overnight GCF and Tri-party repo rates. Data sources: Bloomberg and BNY-Mellon. (b) Figure source: Antoine Martin, FRBNY (2016). Duffie New banking regulations and the liquidity of financial markets 11

12 Cross-currency basis and bank funding costs Funding value adjustments now leave wider arbitrage bounds on the basis Five-Year Cross-Currency Basis: G10 Currencies Basis Points CDS rate US banks European banks AUD CAD CHF DKK EUR GBP JPY NOK NZD SEK (a) 5-year USD cross-currency basis. Source: Du, Tepper, and Verdelhan (2017) year (b) 5-year dealer credit spreads Duffie New banking regulations and the liquidity of financial markets 12

13 CIP arbitrage can be costly to dealer shareholders Debt overhang cost for funding synthetic dollar deposits EUR USD USD debt assets debt old assets old debt equity equity To benefit shareholders, the trade profit must exceed the funding value adjustment (FVA), a debt-overhang cost. Duffie New banking regulations and the liquidity of financial markets 13

14 Funding cost to shareholders EUR USD USD debt old assets old debt equity funding value adjustment (FVA) A debt-funded safe arbitrage is not valuable to bank shareholders unless it s excess yield is above the bank s credit spread. Source: Andersen, Duffie, Song (2018) Duffie New banking regulations and the liquidity of financial markets 14

15 Credit spreads: funding-cost wedge and arbitrage bounds one year IBOR OIS spread (basis points) EURIBOR OIS (Eonia) USD LIBOR OIS (Fed funds) year Figure: Spreads between one-year IBOR and OIS rates. Data source: Bloomberg. Duffie New banking regulations and the liquidity of financial markets 15

16 At a given solvency level, big-bank credit spreads are higher Time fixed-effects in the relationship between CDS rates and distance to default CDS time fixed effect Big banks All other firms year Figure: From work in progress with Antje Berndt. Duffie New banking regulations and the liquidity of financial markets 16

17 Central counterparties reduce need for balance-sheet space c 1 c 2 d 1 CCP c 5 c 3 d 2 d 3 c 6 c 7 c 4 Duffie New banking regulations and the liquidity of financial markets 17

18 Compression eliminates space used for redundant swaps 40 d 5 40 d 5 10 d d 2 10 d 1 60 d 4 d 1 20 d d 3 d 3 Figure: Counterparty exposures and initial margin are reduced without changing market exposures. Providers include TriOptima, which has eliminated over $1 quadrillion notional of swaps. Duffie New banking regulations and the liquidity of financial markets 18

19 A bank-intermediated bilateral OTC market c 1 c 2 d 1 c 5 c 3 d 2 d 3 c 6 c 7 c 4 Duffie New banking regulations and the liquidity of financial markets 19

20 Improving trade competition Objective: Migration of actively traded products to all-to-all trade platforms c 1 c 2 d 2 d 1 CLOB c 3 c 4 c 6 c 5 Duffie New banking regulations and the liquidity of financial markets 20

21 OTC competition after Dodd-Frank and MiFID Buy-side firms request quotes at multilateral trading platforms c 1 MTP d 1 d 2 Duffie New banking regulations and the liquidity of financial markets 21

22 Excessive fragmentation across platforms d 1 d 2 MTP 1 c 1 MTP 2 d 2 d 3 Duffie New banking regulations and the liquidity of financial markets 22

23 Reducing fragmentation improves competition c 1 MTP d 1 d 2 d 3 Duffie New banking regulations and the liquidity of financial markets 23

24 Figure: Source: Hendershoc Source: and Hendershott Madhavan (2014) and Madhavan (2016) Duffie New banking regulations and the liquidity of financial markets 24 At corporate bond platforms Dealer competition lowers buy-side trade costs 60 Investment Grade High Yield Cost in Basis Points Number of dealers responding

25 Now typical fragmented two-tiered OTC markets c 1 c 2 d 1 c 5 MTP 1 CLOB MTP 3 c 3 d 2 d 3 c 6 c 7 MTP 2 Duffie New banking regulations and the liquidity of financial markets 25