Knowledge that Transforms

We investigate how investors perceive the adoption of the expected-loss model (ELM) for impairment incorporated in IFRS 9. Using a sample of European listed banks covering the period of the standard-setting process of IFRS 9, we examine whether the market perceives the new regulation to increase shareholder wealth. First, we document a positive market reaction to the ELM adoption events. Second, we find that investors perceive that the potential benefits of ELM are more pronounced for larger banks, banks with lower profitability and higher systemic risk, and for those that received a public bailout and with more positively skewed returns. Overall, these results support a “monitoring” channel suggesting that ELM may lead to greater bank transparency and more effective market discipline, fundamental for improving financial stability.

This study explores the effect of an investment system reform (deregulation) on the innovation performance of private firms in China. Using a difference-in-differences approach on the data on patent applications of private firms from 1998 to 2009, this study confirms the positive relationship between investment deregulation and innovation performance. We also find that the positive relationship is moderated by types of innovation, firm size and international orientation, and regional patent promotion policy. The study further finds evidence that investment deregulation stimulates innovation performance through two mechanisms, the escaping competition effect, and the preemptive patenting effect. Moreover, investment deregulation may improve the innovation performance of private firms by encouraging investment in fixed capital.

This paper uses a stylized simulation model to assess the potential impact of climate transition risk on banks' balance sheets in a climate-stress-testing (i.e. short-run) framework. We show that a moderate to high transition risk increases overall bank losses only relatively modestly if the baseline is a stressed macroeconomic scenario. However, even in a benign macroeconomic scenario, if high-carbon assets are at least 13% riskier than comparable assets a fire sale mechanism could amplify an initially contained shock into a systemic crisis, resulting in significant losses for the EU banking sector. We show that transition risks are concentrated, and find that an additional capital buffer of 0.9% risk-weighted assets on average would be sufficient to protect the system.

We examine how climate risk influences analyst forecast accuracy proxied by forecast error and dispersion. Using country-level climate risk estimated with time trends in droughts, we find that analyst forecasts are less accurate for firms in drought-prone countries. This effect of climate risk is stronger when climate risks are denoted in earnings forecasts, and when firms’ home countries have greater reliance on hydroelectric sources in electricity generation, more important agricultural and food industries, and active stances concerning climate change. Overall, our findings suggest noteworthy implications of climate risk on the financial markets via analyst forecast accuracy.

In this study, we examine the relationship between firm-level political risk and stock price crash risk. Using a broad dataset of 4230 U.S. firms, 38,097 firm-year observations from 2002 to 2019, we reveal a positive association between political risk and stock price crash risk. These findings are robust to several model specifications and endogeneity checks. By using the Brexit referendum as a quasi-natural experiment, we provide evidence of a causal relationship between political risk and crash risk. Through channel analysis, we identify that this relationship is mediated via higher idiosyncratic volatility, lower price informativeness, and higher distress risk. We also find that our results are more pronounced in intangible-intensive firms. Interestingly, we show that managers of these firms respond to political risk by engaging in bad news hoarding. Finally, strong (external or internal) corporate governance mechanisms can moderate the positive relationship between political risk and stock price crash risk.

In this paper we present a methodology of model-based calibration of additional capital needed in an interconnected financial system to minimize potential contagion losses. Building on ideas from combinatorial optimization tailored to controlling contagion in case of complete information about an interbank network, we augment the model with three plausible types of fire sale mechanisms. We then demonstrate the power of the methodology on the euro area banking system based on a network of 373 banks. On the basis of an exogenous shock leading to defaults of some banks in the network, we find that the contagion losses and the policy authority’s ability to control them depend on the assumed fire sale mechanism and the fiscal budget constraint that may or may not restrain the policy authorities from infusing money to halt the contagion. The modelling framework could be used both as a crisis management tool to help inform decisions on capital/liquidity infusions in the context of resolutions and precautionary recapitalizations or as a crisis prevention tool to help calibrate capital buffer requirements to address systemic risks due to interconnectedness.

Charge-offs provide critical insights into the risk level of loan portfolios within the banking system, signaling potential systemic risks that could lead to deep recessions. Utilizing consolidated financial statements, we have compiled the net charge-off rate (COR) data from the 10 largest U.S. bank holding companies (BHCs) for disaggregated loans, including business loans, real estate loans, and consumer loans, as well as the average COR for each loan category among these top 10 banks. We propose factor-augmented forecasting models for CORs that incorporate latent common factor estimates, including targeted factors, via an array of data dimensionality reduction methods for a large panel of macroeconomic predictors. Our models have demonstrated superior performance compared with benchmark forecasting models, particularly well for business loan and real estate loan CORs, while predicting consumer loan CORs remains challenging especially at short horizons. Notably, real activity factors improve the out-of-sample predictability over the benchmarks for business loan CORs even when financial sector factors are excluded.

We study the impact of higher capital buffers on bank lending and risk-taking behaviour, at different time horizons following the initial policy decision. Employing a regression discontinuity design and confidential centralised supervisory data for euro area banks from 2014 to 2017, our research uniquely explores the effects of the EU policy on other systemically important institutions (O-SIIs) through a quasi-randomised experiment, exploiting the induced policy change and discontinuity of the O-SII identification process. Our findings show that the introduction of the O-SII buffers resulted in a short-term reduction in credit supply to households and financial sector, followed by a medium-term shift towards less risky borrowers, particularly in the household sector. We find a temporary cut in loan growth post-capital hikes, succeeded by a rebound in the medium-term. Our results substantiate the hypothesis that higher capital buffers can positively discipline banks by reducing risk-taking in the medium-term. At the same time, evidence suggests a limited adverse impact on the real economy, characterised by a temporary reduction in credit supply restricted to instances of macroprudential policy tightening.

This paper investigates the crucial role of capital controls in maintaining macroeconomic stability in China. We develop an open macroeconomic model integrating capital controls within a managed floating exchange rate system. Our model shows that capital controls enhance the effectiveness of foreign exchange interventions by restricting capital outflows and providing a broader array of policy options, though they may also create discrepancies between domestic and foreign asset holdings. Simulations using quarterly time-series data reveal that capital controls are essential for the success of both sterilized and non-sterilized interventions. These results indicate that the combined use of capital controls and foreign exchange interventions can reduce macroeconomic volatility in China. Moreover, our analysis of fixed versus floating exchange rate regimes suggests that an inappropriate regime choice can increase volatility in capital flows. Therefore, China should adopt a balanced financial approach within its managed floating system to stabilize the macroeconomy.

We employ the green revenue factors of firms, used in the computation of the FTSE Russell 1000 Green Revenues index to create corresponding green-adjusted share prices. We compute the firm betas, under both the standard and the green-adjusted share pricing. Our findings suggest that tilting of firm stock returns towards green finance could change temporarily asset pricing views. The Fama-French risk factors display very high correlations between the two settings. Nevertheless, there are some significant differences between standard and green-adjusted betas during periods associated with green activism and positive political decisions of financially supporting the global climate action. • Employ green revenues as measured by FTSE Russell. • Construct green revenues adjusted share prices. • Compare betas for green and standard investors. • Differences in asset pricing for green investors only temporary. • Fama-French factors for green versus standard highly correlated.