Research Exchange: March 2025

Selected Outside Research

Bank Economic Capital

This paper develops new approaches to calculating "economic capital", a measure of bank solvency that is more conceptually sound than conventional accounting measures. The economic capital metric introduced in this paper calculates the fair or market value of a bank's assets and liabilities while incorporating liquidity risks associated with deposit withdrawals. This calculation applies a novel methodology that estimates innovations in a bank's asset and liability values using reported book values and the maturity structure of the bank's balance sheet. Empirical validation using regulatory data shows that the economic capital metrics developed in the paper predict bank distress and insolvency more effectively than standard accounting-based solvency measures. Importantly, the analysis demonstrates that by ignoring liabilities, particularly demand deposits, the traditional metrics significantly understate banking sector vulnerabilities compared to measurement based on economic capital.

Bank Economic Capital

Discount Window Borrowing and the Role of Reserves and Interest Rates

The borrowing activity of banks at the Federal Reserve's discount window is influenced by both internal liquidity conditions and prevailing market interest rates. Analyzing weekly data from 2016 to 2024, this study finds that borrowing becomes materially more likely when a bank's reserve balances fall below its recent norms or when the primary credit rate edges below competing FHLB advance rates. These sensitivities vary meaningfully across institutions: mid-sized banks and FHLB members show heightened responsiveness to reserve levels, while well-capitalized and large banks exhibit greater reactivity to term spreads. The analysis also indicates that even banks with comparatively ample reserve levels may still respond to a drop below recent levels-especially in stress periods -suggesting that relative, not absolute, liquidity positions drive activity.

Discount Window Borrowing and the Role of Reserves and Interest Rates

Rushing to Judgment and the Banking Crisis of 2023

The 2023 U.S. banking crisis has been widely characterized as resulting from rapid depositor withdrawals triggered by unrealized securities losses and high levels of uninsured deposits, particularly at Silicon Valley Bank (SVB). This paper challenges this prevailing narrative by presenting an analysis emphasizing bank business models and their clients as an important source of instability. Specifically, banks that failed, such as Silvergate, SVB, Signature Bank, and First Republic, or those that faced severe distress, had concentrated their services toward the venture capital and crypto-asset sectors experiencing substantial economic pressure since 2022. The paper argues that the timing, severity, and geographic concentration of the crisis are best explained with inclusion of this factor, with the implication that bank supervisors should prioritize risks associated with banks' business models and their institutional deposit bases.  

Rushing to Judgment and the Banking Crisis of 2023

Effects of Shadow Bank Competition on Bank Strategies and Risk

A series of large, annual increases in the conforming loan limit after 2018 enabled nonbank mortgage originators (that originate agency-backed mortgages for securitization) to compete for a larger share of the residential mortgage market. This heightened competition affected traditional banks that had been active in jumbo mortgage lending. This paper examines how the affected banks have responded strategically and operationally. The analysis reveals shifts away from traditional mortgage lending toward investments in long-term securities, notably Treasury bonds and mortgage-backed securities, alongside increasing reliance on less stable funding sources-higher-cost noncore deposits replacing core deposits. The analysis also finds that these banks experienced decreased profitability and deterioration in credit quality and various other unfavorable outcomes such as branch closings.  

Effects of Shadow Bank Competition on Bank Strategies and Risk

Predicting Credit Card Delinquency Rates

U.S. consumer credit card delinquency rates, after declining during the pandemic, have risen sharply since the end of 2021. This note explores whether this rise is consistent with historical relationships to observable economic factors or whether repayment performance is worse than expected due to deterioration in household financial conditions not reflected in conventional indicators. The analysis relies on a statistical model of repayment performance estimated on pre-pandemic data applied to predict post-pandemic performance. Traditional predictors-primarily increased credit availability to riskier/nonprime borrowers and rising real revolving debt-are found to largely account for the post-pandemic delinquency rise, but the model leaves a substantial share of the rise unexplained. The note argues that that the underprediction may be mostly attributable to upward "credit score migration" during the pandemic, whereby consumer credit scores improved but possibly without corresponding changes in underlying risk. The paper concludes by noting that these findings reduce, but do not eliminate, the possibility of unobserved factors contributing to broader household financial fragility.

Predicting Credit Card Delinquency Rates

Credit Card Entrepreneurs

Using detailed transaction data from over 1.6 million small businesses via QuickBooks and targeted surveys, this study examines the role of credit card financing of small businesses during 2021 through 2023. The analysis finds that credit cards were a dominant source of credit, as evidenced by monthly credit card payments as much as three times larger than traditional loan payments. The study also documents the use of credit cards by small businesses to meet liquidity needs in response to overdue invoice payments, uncertain cash flows, or other adverse shocks. Examining the consequences of the Federal Reserve's rate increases in early 2022, the analysis finds that banks significantly reduced credit card availability, causing small business credit balances to decline by 15.75%, revenue growth to fall by 10%, and small business employment growth to slow by 1.5%. The higher rates also contributed to a rise in small business credit card delinquencies.

Credit Card Entrepreneurs

Mortgage-Backed Securities

Mortgage-backed securities (MBS) play a critical role in housing finance by allowing mortgages-which in the absence of a securities market would be limited to illiquid, bank-held assets-to be actively traded and broadly held by investors. This paper provides a comprehensive overview of the MBS market, discussing institutional structure, security design, MBS risks and asset pricing, and economic impacts of mortgage securitization, with particular focus on agency residential MBS. The paper documents substantial variability across securities in terms of prepayment and trading behavior, emphasizing the role of borrower refinancing decisions. Additionally, the influence of Federal Reserve quantitative easing programs is examined, revealing significant reductions in yields and market volatility. The discussion concludes with evaluating securitization's broader economic effects, which include enhancing liquidity and credit availability. Potential limitations of securitization are also noted, which include procyclicality of funding, reduced credit quality due to moral hazard, and misaligned incentives to provide loan modifications to troubled borrowers.

Mortgage-Backed Securities

How US Bank Regulation Failed SVB and its Supervisors

The failure of Silicon Valley Bank (SVB) in March 2023 forced regulators into extraordinary interventions, triggering a debate over the adequacy of existing regulatory safeguards. This paper argues that the bank's collapse could have been avoided had U.S. regulators implemented two key international standards established by the Basel Committee, highlighting three main issues. First, the interest-rate risk in the banking book (IRR-BB) standard, never fully adopted in the U.S., would have highlighted and required remedy for SVB's risky asset-liability management strategy around two and a half years prior to its failure. Second, SVB had been allowed to operate with drastically insufficient liquidity, worsening its vulnerabilities months before it collapsed, because regional banks in the U.S. had been exempted from Liquidity Coverage Ratio (LCR) standard. Finally, had SVB been subject to Total Loss Absorbing Capacity (TLAC) requirements mandating convertible debt issuance, the Federal Deposit Insurance Corporation could have saved billions in losses. Altogether, the findings emphasize the importance of implementing regulatory standards on interest-rate risk, liquidity risk, and loss absorption more broadly across U.S. banks.

How US Bank Regulation Failed SVB and its Supervisors

Tail Sensitivity of US Bank Net Interest Margins: A Bayesian Penalized Quantile Regression Approach

Historically stable, U.S. bank net interest margins (NIMs) have become notably volatile since 2020, especially at the extremes ("tails") of their distribution. This paper records substantial heterogeneity in NIM sensitivity to market interest rates and credit risk factors across different segments of the NIM distribution. It also identifies significantly increased sensitivity to interest rate fluctuations in the tails of the NIM distribution post-2020, driven primarily by increased sensitivity of bank loan income and demand deposit expense. This heightened tail sensitivity is seen as economically meaningful, posing risk to banks' profitability. These findings suggest that regulators and bank supervisors should closely monitor distributional heterogeneity and tail risk in assessing banks' vulnerability to macroeconomic shocks, rather than relying solely on average measures of sensitivity.

Tail Sensitivity of US Bank Net Interest Margins: A Bayesian Penalized Quantile Regression Approach

Chart of the Month

Recently, all the estimates of the term premium have trended up, perhaps reflecting rising uncertainty about the future path of Treasury rates.

Featured BPI Research

Bank Term Funding Program: Experience and Lessons Learned

The Federal Reserve established the Bank Term Funding Program (BTFP) to address liquidity stress following the failures of Silicon Valley Bank and Signature Bank. While the program broadly met its goal of stabilizing depositor confidence, analysis reveals critical design flaws. Notably, loans issued through the BTFP were significantly undercollateralized-totaling over $20 billion-effectively transferring risk from banks to taxpayers. Additionally, an unintended arbitrage emerged when borrowing costs fell below the Fed's deposit rate, encouraging excessive borrowing unrelated to genuine liquidity needs. Moving forward, regulators should ensure banks have sufficient collateral and encourage greater use of the traditional discount window, thereby reducing reliance on extraordinary emergency lending facilities and limiting future taxpayer exposure.

Bank Term Funding Program: Experience and Lessons Learned

BPI, Columbia Co-Host 9th Annual Conference on Bank Regulation

The Ninth Annual Conference on Bank Regulation, jointly hosted by the Bank Policy Institute and Columbia University's School of International and Public Affairs, took place on Feb. 27. The conference covered interconnectedness between banks and nonbank financial intermediaries (NBFIs), monitoring and early warning around bank runs, and takeaways from the 2023 regional bank failures. A keynote address by Beth Hammack, President of the Federal Reserve Bank of Cleveland, acknowledged regulatory challenges posed by the rise in private credit markets and hedge fund leverage, and the need for enhanced monitoring and transparency.

BPI, Columbia Co-Host 9th Annual Conference on Bank Regulation

Why Discard the Traditional Assessment Area Approach to CRA Regulation?

Consumers can access banking services from far beyond their neighborhood branch because of the growth of digital banking. Some have suggested that because of this factor, regulators' approach to evaluating how banks fulfill their responsibilities under the Community Reinvestment Act to meet the credit and banking needs of their local communities should be broadened beyond the traditional focus on physical branches. The U.S. banking agencies in 2023 adopted a new CRA rule reflecting this broader approach. This blog post argues that empirical evidence does not support this more expansive view. Moreover, any kind of revised rule that pushes banks to focus more on the composition of their lending outside of their traditional assessment areas could prove counterproductive.

Why Discard the Traditional Assessment Area Approach to CRA Regulation?

Regulatory Overreach: Impacts on Access to Banking Products and Services

This blog post examines recent U.S. regulatory proposals aimed at consumer protection and banking stability, focusing on potential negative effects on financial access for low-to-moderate-income households and communities. The discussion addresses the Basel III Endgame capital requirements, proposed reductions in allowable debit interchange fee under Regulation II, and the newly introduced Consumer Financial Protection Bureau (CFPB) rules limiting overdraft fees and credit card late fees. For instance, reduced interchange fees could indirectly increase checking account costs, potentially pushing vulnerable consumers towards becoming unbanked and restrictive rules on overdraft fees may compel banks to limit access to overdraft services. The post calls for balanced regulatory approaches that consider impacts on financial inclusion and credit accessibility.

Regulatory Overreach: Impacts on Access to Banking Products and Services

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