Knowledge that Transforms

What drives macro-financial vulnerabilities? Inspired by Minsky–Kindleberger narratives, one prominent view emphasizes that lending standards repeatedly deteriorate in good times, creating exposure to widespread reassessments of risk. Another emphasizes that leverage amplifies negative shocks. This paper constructs panel data on lending standards and uses it to show that Minsky–Kindleberger dynamics interact with leverage. Standards erode with improving economic performance, but do not always co-move with aggregate leverage. The combination of deteriorating standards and leverage—above and beyond leverage alone—signals poor subsequent macroeconomic performance. Inconsistent with models incorporating rational expectations, this poor subsequent performance is systematically reflected in forecast errors.

In this study, we examine the impact of liquidity support from the Federal Reserve on the capital structures of firms of varying sizes. Our findings suggest that large firms tend to increase their debt financing and leverage ratios in response to significant shocks triggered by the large-scale asset purchases (LSAPs) of the US Federal Reserve. By contrast, small firms with preexisting banking relationships are more likely to receive liquidity support. Notably, small firms associated with smaller banks exhibit increased default risks. Furthermore, large firms exhibited weaker operating performance but received greater managerial compensation following the LSAP. This trend indicates potential inefficiencies in the distribution of funding facilitated by unconventional monetary policies.

The 2023 banking turmoil highlighted how technological advancements have significantly accelerated the speed of bank runs. This paper investigates the impact of these faster bank runs on the effectiveness of policy interventions by interpreting them as a constraint on the relative speed of policy responses. Using a model of bank runs and ex-post policy responses, we examine how delays caused by this constraint affect financial fragility and welfare. We find that while delays exacerbate welfare loss by distorting allocations, they may also decrease fragility by making banks more cautious. We study the optimal level of structural delay, balancing the trade-off between distributional distortions and financial fragility. Furthermore, we extend this model to explore the roles of liquidity regulations and capital injections given such a delay. We show that regulation may be more desirable than a capital injection if the delay is substantial because the benefit of decreased fragility is particularly potent.

This study aims to empirically identify the state of the US housing market. I do so by estimating a Markov switching model of housing prices, in which mortgage debt affects house prices nonlinearly and drives state transition probabilities. Second, I compute a state-contingent housing risk measure fed with the probability of being in each state. Finally, I show that such risk measure contains early warning information in a forecasting exercise to predict the charge-off rates of real estate residential loans and a financial stress index. The significance of this study is that it informs economic agents and policymakers about the state of the housing market mechanically.

The regulatory dialectic describes the dynamic process of banks and regulators continuously acting and reacting to one another. We provide empirical evidence of the regulatory dialectic in the prime institutional money market fund (PI-MMF) industry. Regulations on commercial deposits fueled growth in bank-sponsored PI-MMFs as a form of shadow banking in a relatively less regulated market. Re-regulation following the 2008 financial crisis halted this rapid growth, and the industry shifted from PI-MMFs to government institutional MMFs. We conjecture that this dialectical process will continue, and the decline of the PI-MMF may engender a shift toward structurally similar products, like stablecoins.

Compared with the previous literature on external FinTech, this paper is more interested in the role played by bank FinTech. On the basis of panel data from Chinese commercial banks spanning 2010–2021, this paper investigates the impact of digital transformation on bank soundness and its potential mechanisms. The empirical findings demonstrate a positive association between digital transformation and bank soundness, driven primarily by strategic and management digitization. Mechanistic analysis indicates that digital transformation improves bank soundness by mitigating risk-taking behavior and promoting diversification. The positive effect of digital transformation is more pronounced in state-owned and joint-stock banks, banks with higher liquidity mismatch and in the subsamples with greater levels of external FinTech development and economic policy uncertainty. Additional analysis suggests that digital transformation can still enhance bank soundness even in the presence of relatively lenient monetary and macroprudential policies, highlighting the harmonization and complementarity between internal innovation from digital transformation and external regulatory policies in maintaining banking stability. Overall, this paper contributes to the literature on bank FinTech, which focuses on the factors influencing bank stability. This study also provides a novel explanation for the relationship between financial innovation and financial stability.

This paper investigates whether the design of the banking supervisory architecture impacts sovereign risk. Exploiting the implementation of the Single Supervisory Mechanism (SSM) in Europe, we provide evidence that sovereign risk – measured by sovereign ratings – is lower after the largest banks shift from national to supranational supervision. The impact of SSM implementation is shaped by the characteristics of the banking sector and the country’s institutional setting. Using specific bank-level data, we also find that increased bank resilience (banking stability) and reduced volatility of bank credit (credit stability) in the economy underlie the relationship between banking supervision and sovereign risk. The results hold when considering CDS spreads as an alternative measure of sovereign risk and after conducting several robustness tests.

How do banks react to firms’ climate risks? Using almost 80,000 global syndicated loans originated from 2001 to 2021, we study bank lending to fossil fuel firms vis-à-vis other firms. We find that loans to fossil fuel firms are at least 7 % more costly compared to other firms, and even more so toward the end of our sample. However, loan amounts to fossil fuel firms are approximately 22 % larger, implying heavy financing of brown activities. We show that the pricing effects are even stronger for banks with higher reliance on ESG considerations, consistent with the shifts driven by the supply side (bank behaviour). Overall, our findings corroborate the view that banks price in climate risks but continue to heavily lend to polluting firms in the medium term (with an average maturity of four and one quarter years).

Despite the rising number of green finance policies, the socioeconomic determinants shaping them remain largely unexamined. Drawing from the literature analysing the relationship between regulation, market development and institutional economics , we contend that green finance policy adoption is driven by both market-based and institutional factors. Using a survival analysis approach to understand the levers influencing green finance policy adoption across 188 countries from 2000 to 2019, we find that exposure to the fossil fuel industry predominantly drives the initial issuance of green finance policies. The positive effect of fossil fuel commercial financing on the adoption of green finance policies exists in countries with high and medium climate change awareness levels. Meanwhile, in countries with a low climate change awareness level, fossil fuel government subsidies drive green finance policy adoption. Our study also highlights the role of the financial industry as one of the key actors in the policy cycle of green finance policies via two pathways: (i) affecting financial stability through financing oil and gas companies on primary financial markets and (ii) developing a market for sustainable finance products.

This paper examines the return spillovers between Exchange-Traded Funds (ETFs) and stocks. While traditional approaches focus on proportional relationships between ETFs and their underlying assets, we develop a high-dimensional network framework that captures spillover effects between any ETF-stock pair, regardless of their compositional relationship. By separating idiosyncratic and systematic risks, we investigate potential drivers of contagion. We document substantial heterogeneity in spillover patterns across sectors, which is previously unaddressed in the literature. Sectors such as Utilities and Real Estate exhibit robust spillovers to both their component stocks and assets in other sectors. Conversely, in sectors such as Consumer Discretionary and Finance , cross-sector influences dominate intra-sector ETF-constituent linkages. Our results also highlight that during periods of high market volatility, sources of idiosyncratic contagion become more diverse, suggesting the need for broader market surveillance beyond the few most influential ETFs.