Showing papers on "Liquidity risk published in 2019"

Machine Learning in Banking Risk Management: A Literature Review

Abstract: There is an increasing influence of machine learning in business applications, with many solutions already implemented and many more being explored. Since the global financial crisis, risk management in banks has gained more prominence, and there has been a constant focus around how risks are being detected, measured, reported and managed. Considerable research in academia and industry has focused on the developments in banking and risk management and the current and emerging challenges. This paper, through a review of the available literature seeks to analyse and evaluate machine-learning techniques that have been researched in the context of banking risk management, and to identify areas or problems in risk management that have been inadequately explored and are potential areas for further research. The review has shown that the application of machine learning in the management of banking risks such as credit risk, market risk, operational risk and liquidity risk has been explored; however, it doesn’t appear commensurate with the current industry level of focus on both risk management and machine learning. A large number of areas remain in bank risk management that could significantly benefit from the study of how machine learning can be applied to address specific problems.

Solvency: Models, Assessment and Regulation

Abstract: Introduction General Outline of the Book Organizations A Selection of Solvency Readings Solvency: What Is It? In the 18th Century What Does Solvency Mean? PAST AND PRESENT: A HISTORICAL REVIEW AND DIFFERENT APPROACHES TO SOLVENCY The European Union: Solvency 0 and Accounting The Works of Campagne Other Steps toward the First Directives The Non-Life Directives (First, Second, and Third) The Life Directives (First, Second, and Third) Calculating the Solvency Margin for Non-Life Insurance Business The Insurance Accounting Directive (IAD) The European Union: Solvency I The Muller Report Comments from Groupe Consultatif The Solvency I Directives Calculating the Solvency Margin for Non-Life Insurance Business Steps toward Solvency II: Bank for International Settlements (BIS): The New Basel Capital Accord IASB: Toward a New Accounting System IAIS: Insurance Principles and Guidelines IAA: A Global Framework for Solvency Assessment EU: Solvency II - Phase I Steps toward Solvency II: 2 Australia Canada Denmark Finland The Netherlands Singapore Sweden Switzerland U.K. U.S. Some Other Systems Summary of Different Systems PRESENT: MODELING A STANDARD APPROACH The Fundamental Ideas A Model for the Solvency Assessment Level of Capital Requirements Risks and Diversification Risk Measures Valuations Fair Value: Introduction Purposes of Valuation Best Estimate of Insurance Liability and Technical Provisions Fair Value Dependencies, Baseline, and Benchmark Models Risk Measures Assume Normality Assume Nonnormality Correlations between Risks: Different Levels of Conservatism Parameters in a Factor-Based Model One Example of Risk Categories and Diversification Insurance Risk Market Risk Credit Risk Operational Risk Liquidity Risk Dependency A Proposal for a Standard Approach: From Formula to Spreadsheet The Insurance Risk, CIR Market Risk, CMR Credit Risk, CCR Operational Risk, COR The Total Factor-Based Model A Spreadsheet Approach Parameter Estimates An Example PART C PRESENT AND FUTURE: EU SOLVENCY II - PHASE 2: GROUPS AND INTERNAL MODELING IN BRIEF The European Union: Reinsurance, Insurance Groups, and Financial Conglomerates Reinsurance Insurance Groups and Financial Conglomerates The European Union: Solvency II - Phase II Recommendations for the First Pillar Recommendations for the Second Pillar Recommendations for the Third Pillar General Considerations The First Wave of Requests (Pillar II) The Second Wave of Requests Will Include the Following Issues (Pillar I) The Third Wave of Requests Will Include the Following Issues (Pillar III) A Brief Summary Further Steps Internal Models and Risk Management Forecasting the Future and Risk Management APPENDICES Appendix A A Proposal for a Standard Approach: One Step toward Application Insurance Risk Market Risk Credit Risk Operational Risk Appendix B Insurance Classes Non-Life Classes Life Classes Appendix C From the Non-Life Directives Solvency 0 Solvency I Appendix D From the Life Directives Solvency 0 Solvency I Appendix E IAIS: Insurance Principles, Standards, and Guidelines Principles Standards Guidances Appendix F From the Proposed Reinsurance Directive Chapter 3: Rules Relating to the Solvency Margin and to the Guarantee Fund Appendix G Annex I and Annex II in the Insurance Group Directive Annex I : Calculation of the Adjusted Solvency of Insurance Undertakings Annex II: Supplementary Supervision for Insurance Undertakings That Are Subsidiaries of an Insurance Holding Company, a Reinsurance Undertaking or a Non-Member-Country Insurance Undertaking Appendix H From the Financial Conglomerates Directive Amendments to the Non-Life Directive Made (EEC, 1973) Amendments to the Life Directive (EEC, 1979) Amendments to the Insurance Group Directive (COM, 1998) Annex I: Capital Adequacy Appendix I Prudent Person Rule Article 18: Investment Rules

Towards (de-)financialisation: the role of the state

Abstract: Understanding the nature of state financialisation is crucial to ensure de-financialisation efforts are successful. Therefore, this article provides a structured overview of the emerging literature on financialisation and the state. We define financialisation of the state broadly as the changed relationship between the state, understood as sovereign with duties and accountable towards its citizens, and financial markets and practices, in ways that can diminish those duties and reduce accountability. We then argue that there are four ways in which financialisation works in and through public institutions and policies: adoption of financial logics, advancing financial innovation, embracing financial accumulation strategies and directly financialising the lives of their citizens. Organising our review around the two main policy fields of fiscal and monetary policy, four definitions of financialisation in the context of public policy and institutions emerge. When dealing with public expenditure on social provisions, financialisation most often refers to the transformation of public services into the basis for actively traded financial assets. In the context of public revenue, financialisation describes the process of creating and deepening secondary markets for public debt, with the state turning into a financial market player. Finally, in the realm of monetary policy, financial deregulation is perceived to have paved the way for financialisation, while inflation targeting and the encouragement, or outright pursuit, of market-based short-term liquidity management among financial institutions constitute financialised policies.

Stealing Deposits: Deposit Insurance, Risk-Taking and the Removal of Market Discipline in Early 20th Century Banks

Abstract: Deposit insurance reduces liquidity risk but can increase insolvency risk by encouraging reckless behavior. Several U.S. states installed deposit insurance laws before the creation of the Federal Deposit Insurance Corporation, and those laws applied only to some depository institutions within those states. These experiments present a unique testing ground for investigating the effect of deposit insurance. We show that deposit insurance removed market discipline constraining uninsured banks. Taking advantage of World War I's rise in world agricultural prices, insured banks increased their insolvency risk and competed aggressively for deposits. When prices fell after the war, the insurance systems collapsed and suffered high losses.

Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads

Abstract: Euro-area sovereign bond and interbank interest rate spreads spiked in the 2007–2009 Global Financial Crisis and the subsequent European Debt Crisis, substantially elevating financing costs. I use a model-free measure of market liquidity to precisely identify the relative contribution of credit versus liquidity to spreads in these episodes. In the Financial Crisis, liquidity is paramount, accounting for 36% of trough-to-peak widening, after controlling for credit. However, default risk becomes relatively more important to sovereign spreads in the Debt Crisis. Aggregate bond liquidity explains a substantial portion of interbank spreads throughout the sample.

The internal determinants of bank profitability and stability: An insight from banking sector of Pakistan

Abstract: The purpose of this study is to examine the internal determinants of bank profitability and stability in Pakistan banking sector. Because of specific research objectives, this study excludes the external factors of profitability and stability to find the role of bank internal determinants in achieving high performance.,A panel regression analysis is built on a balanced panel data using 24 commercial banks over the sample period of 2007-2015. The authors performed a separate analysis of bank profitability and stability. Both models used a comprehensive set of bank internal determinants.,The results that were obtained from profitability model indicated that bank size, credit risk, funding risk and stability have statistically significant impacts on profitability, while liquidity risk showed the statistically insignificant impact on profitability. Regression findings from stability model reveal that bank size, liquidity risk, funding risk and profitability have statistically significant impacts on stability, while credit risk had an insignificant effect on stability. However, the effect of the financial crisis is uniform and showed statistically insignificant impact in both models.,Overall, the authors’ findings bring some new but useful insights to the banking literature. Some recommendations may be functional for the sustainable performance of banks.,In view of study results, the authors provide interesting insights into the practices and characteristics of banks in Pakistan. This study also highlights significant bank internal determinants to improve understanding in the existing literature.

From Commodity to Fiat and Now to Crypto: What Does History Tell Us?

Abstract: Over time, there has been a tendency for political jurisdictions and residents to converge on a single currency. Monopoly over seigniorage is a source of political power and a valuable lifeline when sovereignty is threatened. Moreover a uniform currency, insofar as it is free of counterparty and liquidity risk, facilitates economic activity. But will digital currencies now reverse this trend toward uniformity, given the apparent ease with which they can be created? The information sensitivity of those units, evident in the fact that they trade at varying prices, suggests that they do not yet provide the core functions of money. So-called stable coins are intended to bridge this gap, but whether they can be successfully scaled up and maintain their stability is doubtful. The one unit that can clearly meet these challenges is central bank digital currency. But there would be both costs and benefits of moving in this direction.

The interrelationship between liquidity creation and bank capital in Vietnamese banking

Abstract: The purpose of this paper is to investigate the interrelationship between liquidity creation (LC) and bank capital in Vietnamese banking between 2007 and 2015,A three-step procedure is used to measure LC Thereafter, a simultaneous equations model with a three-stage least squares estimator is employed to examine the links between LC and bank capital,The findings show that large banks mainly contributed a strong growth in LC in Vietnam between 2007 and 2015 The findings also indicate that off-balance sheet activities only played a small role in LC In addition, the findings indicate a negative two-way relationship between LC and bank capital in Vietnam The results of the robust checks reinforce the main findings,The evidence shows that the implementation of Basel III may reduce LC and greater LC may increase banks’ insolvency Consequently, this trade-off between the benefits of financial stability induced by tightening capital requirements and those of enhanced LC has important implications for Vietnamese authorities in strengthening the banking system,This study is the first attempt to investigate the interrelationship between LC and bank capital in Vietnam, in which fat liquidity creation and non-fat liquidity creation are used and alternative measures of LC are also employed to provide robustness to the main findings

Liquidity Risk and the Dynamics of Arbitrage Capital

Abstract: We develop a dynamic model of liquidity provision, in which hedgers can trade multiple risky assets with arbitrageurs. We compute the equilibrium in closed form when arbitrageurs’ utility over consumption is logarithmic or risk-neutral with a non-negativity constraint. Liquidity is increasing in arbitrageur wealth, while asset volatilities, correlations, and expected returns are hump-shaped. Liquidity is a priced risk factor: assets that suffer the most when liquidity decreases, e.g., those with volatile cashflows or in high supply by hedgers, offer the highest expected returns. When hedging needs are strong, arbitrageurs can choose to provide less liquidity even though liquidity provision is more profitable.

Non-performing loans, governance indicators and systemic liquidity risk: evidence from Greece

Abstract: In this study we propose a new determinant of non-performing loans for the case of the Greek banking sector. We employ aggregate yearly data for the period 1996-2016 and we conduct a Principal Component Analysis for all the Worldwide Governance Indicators (WGI) for Greece, aiming to isolate the common component and thus to create the GOVERNANCE indicator. We find that the GOVERNANCE indicator is a significant determinant of Greek banks’ non-performing loans indicating that both political and governance factors impact on the level of the Greek non-performing loans. An additional variable that also has a statistically significant impact on the level of Greek non-performing loans, when combined with WGI in the dynamic specification of our model, is systemic liquidity risk. Our results could be of interest to policy makers and regulators as a macro prudential policy tool.

The Behavior of an Institutional Investor with Arbitrage Opportunities and Liquidity Risk

Abstract: This study analyzes the efficiency of liquidity flows in stabilizing distressed markets from a theoretical perspective We show that even in the event of a major negative market shock, a financial institution can increase its investment in the market when there is a strong incentive for arbitrage profit However, the institution may choose to reduce its investment if the fear from liquidity risk exceeds the arbitrage incentive In addition, our model reveals a positive relationship between funding liquidity and market liquidity Our findings help to explain several financial issues in distressed markets, including the flight to quality, liquidity dry-ups, asset fire sales, and market shock amplifications

The Cross-Section of Cryptocurrency Returns

Abstract: At a given point in time, bitcoin prices are different on exchanges located in different countries, or against different currencies. While existing literature attributes the largest price differences to frictions, like market segmentation, trading platforms advertize how to execute trades based on this information. We provide a novel risk-based explanation of these price differences for a sample containing the most reputable exchanges and after accounting for all transaction costs and limitations to trade. Bitcoin prices for more ``expensive'' pairs are riskier because they depreciate more in bad times for cryptocurrency investors, when aggregate liquidity and investor sentiment are lower.

Liquidity Risk and Investors’ Mood: Linking the Financial Market Liquidity to Sentiment Analysis through Twitter in the S&P500 Index

Abstract: Microblogging services can enrich the information investors use to make financial decisions on the stock markets. As liquidity has immediate consequences for a trader’s movements, this risk is an attractive area of interest for both academics and those who participate in the financial markets. This paper focuses on market liquidity and studies the impact on liquidity and trading costs of the popular Twitter microblogging service. Sentiment analysis extracted from Twitter and different popular liquidity measures were gathered to analyze the relationship between liquidity and investors’ opinions. The results, based on the analysis of the S&P 500 Index, found that the investors’ mood had little influence on the spread of the index.

Exploring the role of risk and corruption on bank stability: evidence from Pakistan

Abstract: This paper aims to explore the impact of liquidity risk, credit risk, funding risk and corruption on bank stability of the banking system in Pakistan.,The empirical analysis is confined to 24 retail banks, which include 5 Islamic and 19 conventional banks during the period of 2007-2015.,The findings of this study suggest that bank size, liquidity risk, funding risk and corruption exert a positive impact on bank stability. Additionally, the authors find a negative relationship between credit risk and bank stability.,As per the knowledge of the authors, the present research is the first attempt that discusses the issues of bank stability related to risk and corruption faced by the banking system.

Negative monetary policy rates and portfolio rebalancing: Evidence from credit register data

Abstract: We study negative interest rate policy (NIRP) exploiting ECB’s NIRP introduction and administrative data from Italy, severely hit by the Eurozone crisis. NIRP has expansionary effects on credit supply—and hence the real economy—through a portfolio rebalancing channel. NIRP affects banks with higher ex-ante net short-term interbank positions or, more broadly, more liquid balance-sheets, not with higher retail deposits. NIRP-affected banks rebalance their portfolios from liquid assets to credit—especially to riskier and smaller firms—and cut loan rates, inducing sizable real effects. By shifting the entire yield curve downwards, NIRP differs from rate cuts just above the ZLB.

Novel Financial Capital Flow Forecast Framework Using Time Series Theory and Deep Learning: A Case Study Analysis of Yu’e Bao Transaction Data

Abstract: Appropriate monetary liquidity is important for financial institutions. When institutions lack adequate cash flow for customer redemption, their income will decrease, their reputation will be affected, and they may even go bankrupt. However, the opposite extreme in which more cash is reserved than needed may result in lost opportunities to make successful investments. This study uses Yu'e Bao transaction data to investigate a method for forecasting financial capital flow. Yu'e Bao, which is a financial product launched by Alibaba, faces the core challenge of maximizing commercial profits to reduce investment risks. Liquidity risk is considered the main factor in Yu'e Bao's investment strategy. First, a linear model called YEB_ARIMA is proposed by determining the autocorrelation (ACF) and partial autocorrelation (PACF) parameters, which are optimized by the grid search method. Second, a deep learning model called YEB_LSTM is introduced to strengthen the expressiveness of the model that yields nonlinear transaction features. Then, a hybrid learning method called YEB_Hybrid is applied to improve the original weak classifiers. This model includes both a linear combination and logistic regression learning. Third, a set of experiments and analyses are conducted based on subscription and redemption datasets to demonstrate that the hybrid model achieves an accuracy of 84.39% and 84.36%, respectively, under a variety of evaluation indexes. Finally, various proposed fund reserve ratios are provided based on capital forecasts.

Emergent international liquidity agreements: central bank cooperation after the global financial crisis

Abstract: Central bank currency swap agreements have proliferated rapidly among emerging market economies (EMEs) since 2008. More than 80 such agreements have been signed in recent years. The accumulation of these agreements has resulted in the emergence of a new $1 trillion liquidity system by 2015. What explains the rapid proliferation of these agreements? What are the political and economic implications of the liquidity network for the international monetary system and the global financial architecture? I specify two key consequences of the global financial crisis and its aftermath that have led EME central banks to seek out swap agreements: volatile international capital flows and a recognition of the risks of dollar dependence in trade. I conclude that these liquidity agreements are unlikely to induce much change in the international monetary system. However, the system is transforming the global financial architecture through the creation of large liquidity lines for systemically important EMEs.

The Welfare Effects of Bank Liquidity and Capital Requirements

Abstract: The stringency of bank liquidity and capital requirements should depend on their social costs and benefits. This paper investigates the welfare effects of these regulations and provides a quantification of their welfare costs. The special role of banks as liquidity providers is embedded in an otherwise standard general equilibrium growth model. In the model, capital and liquidity regulation mitigate moral hazard on the part of banks due to deposit insurance, which, if unchecked, can lead to excessive risk taking by banks through credit or liquidity risk. However, these regulations are also costly because they reduce the ability of banks to create net liquidity and they can distort capital accumulation. For the liquidity requirement, the reason is that safe, liquid assets are necessarily in limited supply and may have competing uses. A key insight is that equilibrium asset returns reveal the strength of preferences for liquidity, and this yields two simple formulas that express the welfare cost of each requirement as a function of observable variables only. Using U.S. data, the welfare cost of a 10 percent liquidity requirement is found to be equivalent to a permanent loss in consumption of about 0.03%. Even using a conservative estimate, the cost of a similarly-sized increase in the capital requirement is about five times as large. At the same time, the financial stability benefits of capital requirements are also found to be broader.

Banking Regulation and Market Making

Abstract: We model how securities dealers respond to regulations on leverage, position, and liquidity such as those imposed by the Basel III framework. The dealers respond by endogenously moving to make markets on an agency basis, matching buyers to sellers rather than taking client positions on the balance sheet.

Impacts of risk and competition on the profitability of banks: Empirical evidence from Pakistan.

Abstract: The purpose of this paper is to investigate the impact of risk and competition on the profitability of the Pakistani banking industry. Data are retrieved from the annual statements of banks, the Ministry of finance Pakistan and the World Bank covering the period of (2007-2017). Two steps Generalized Method of Moments (GMM) with the collapse command is used as an estimation technique to overcome endogeneity, unobserved heterogeneity and autocorrelation problems. The results of the study showed that the liquidity risk has positive while credit risk, insolvency risk and competition hurt negatively the profitability of Pakistani banks. The results of the study also revealed that capitalization, size, taxation and GDP growth rate positively affect the Banks' profits while banking sector development and infrastructure negatively affect banking profitability in Pakistan. The operational cost management positively affects net interest margins but negatively affects ROA and PBT in the Pakistani banking industry.

Liquidity and Price Pressure in the Corporate Bond Market: Evidence from Mega-Bonds

Abstract: Larger bonds offer greater liquidity, which should reduce their yields. A simple way for firms to reduce financing costs is to sell bonds with large face values. We find that mega-bonds are more liquid than smaller bonds. However, offering yield spreads on mega-bonds are not lower and are higher than spreads of bonds issued by similar companies. The discount applied to large new issues is consistent with price pressure effects that are also present in the secondary market prices of the issuing firm’s existing bonds. Our results suggest a hidden cost to issuing very liquid bonds.

Measuring impact of working capital efficiency on financial performance of a firm: An alternative approach

Abstract: The purpose of this study is to introduce working capital efficiency multiplier (WCEM) as a direct profitability measure of working capital management. The existing accounting measures in the literature establish an indirect approach to study the relationship between working capital efficiency and profitability of the firms.,Using the help of a set of companies from CMIE Prowess database, the study introduces WCEM as a direct profitability measure of working capital efficiency.,In this study, a new direct measure of working capital efficiency is introduced which is multiplicative in nature. WCEM is a product of three components, namely, WACC, ratio of the sum of trade receivables and inventories to trade payables and ratio of net working capital (NWC) to net sales.,The importance of direct measure like WCEM could be enormous in performance evaluation of a firm. It can be used as an indicator for choosing a suitable investment opportunity by an investor. This is due to the fact that the firm that is highly efficient in managing working capital is less exposed to liquidity risk. At the same time, the firm is less dependent on external financing. Therefore, such firms eventually create more value for their shareholders. Another indication that WCEM provides is to gauge the bargaining power of the firm and its competitive position in the market. Lower WCEM indicates higher bargaining power of a firm across the value chain, and its superior position relative to its competitors.,Most of the studies on WCM are of the empirical type and there is a complete dearth on theoretical framework. Researchers hereafter can consider WCEM as one of the financial performance variables in place of the existing measures such as return on asset (ROA), return on invested capital (ROIC), return on equity (ROE), gross operating income (GOI) and net operating income (NOI) and thereby can contribute new empirical insights through their research outcomes.