Riskmitigating Effects of Being Prompt and Transparent Seung

Risk-mitigating Effects of Being Prompt and Transparent Seung Jung Lee (FRB) Lucy Qian Liu (IMF) Viktors Stebunovs (FRB) “International Capital Flows and Financial Policies” 1 st Joint Workshop of Bank of England, Banque de France, IMF, and OECD October 20, 2020 The paper’s views are the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the FRS, or the IMF, its Executive Board, or its management. 1

Introduction • Policy makers’ dilemma: • Effects of low-for-long interest rates on risk-taking by banks, esp. in leveraged lending, a lot of which is cross-border. • Limited if any macroprudential tools that target such lending. • Literature: • Risk-taking channel of monetary policy in corporate lending. • Credit risk and pricing of loans, but not quantities of risky loans. • Little on potential mitigants of the strength of the channel. • Altavilla, Boucinha, Peydro, and Smets (2019) on ECB stringency. • Efficacy of micro- & macroprudential tools in mitigating credit risk of lending. • Not in the context of a risk-taking channel of monetary policy. • Paper: Efficacy of M&M tools & private monitoring in curtailing global originations of risky U. S. dollar syndicated loans in response to 2

Syndication • Syndication: Multiple lenders make a loan to a borrower. • Thomson Reuters LPC Deal. Scan: U. S. dollar term loans over 19952014. • Originations of syndicated loans: Comparable to U. S. dollar bond issuance. • Demand: Lots of low-rated borrowers from the around the world. • Supply: Banks from around the world originate loans and partially sell them within a month (Lee, Liu, & Stebunovs, 2019). • Key to identification: Banks within a syndicate face different Supervision, Regulation, and Monitoring measures (SRMs): 3

Hint at the results • Does SRM affect banks’ risk-taking differently when policy rates are • low? Merge Deal. Scan, Moody’s Analytics Expected Default Frequencies (EDFs) for borrower credit risk, and Barth, Caprio, and Levine surveys of SRMs. • Prompt corrective power (PCP): Power to intervene automatically if triggers set off; range 0… 6. • Figure: More of risky lending by banks that face stringent PCP when • less Is PCP special? Why PCP is effective? A complement or a substitute for policy rates are low but not other SRMs? 4 when rates are high.

Regression model • LHS: Stake of bank l in syndicated loan j to borrower b made at time t. • RHS: R is a shadow federal funds rate (Wu and Xia, 2016). • Identification: Within-asyndicate variation in bank SRMs. • Interactions of EDFs with SRM & R. • θER < 0: Risk-taking channel of monetary policy. • θESR > 0: Mitigation of the channel. • About intensive rather than extensive margin. • Barth, Caprio, and Levine: A 5

Results for prompt corrective power • PCP up from the median to the maximum, risk-taking due to lower rates down by a third. • PCP works b/c of early interventions, cease & desist orders, suspensions of 6 capital payouts.

Overview of the other results • SRMs that have statistically robust effects before & after the Global Financial Crisis. • Effective official supervision: • Declaring insolvency power: In contrast to PCP, is a gone concern measure. • [Supervisory forbearance may amplify a risk-taking channel of monetary policy. ] • Effective private monitoring and external governance. • Financial statement transparency: In part, explains the paper’s title. • Ineffective regulation: • Activity restrictions & capital regulation: Former not correlated with capital ratios. • Certain SRMs are complements rather than substitutes of PCP. • Small microprudential leakages b/c of shadow bank participation in loan 7 origination:

Conclusions • Regulators may do without macroprudential tools that target leveraged lending. • SRMs may reduce financial stability risks from leveraged lending by curtailing (term) loan originations in response to lower policy rates. • However, because a significant share of syndicated lending is crossborder: • Spillovers from abroad may be an issue. • Positive externalities from more stringent SRMs abroad. • In response to most stringent SRMs, shadow banks may grow to dominate (term) loan originations. • Caveats: Do not study • Extensive margin (decisions to originate risky loans). • Intensity of the usage of SRMs (reluctance to use power is a possibility). 8 • COVID-19 pandemic: Stimulate lending by relaxing SRMs?

Appendix: Marginal effects in PCP reg. 9