Nicholas Fritsch

Understanding banks’ responses to capital regulation is essential for regulators to use this key tool of modern banking regulation effectively. We study how and when US banks responded to changes to the way capital ratios are measured, changes that were introduced as part of the adoption of Basel III. We find that small banks — those below USD 10bn — responded neither before nor after the release of the new rules to the change in measured capital they experienced under the new rules. In contrast, we show that regional banks — those with total assets between USD 10bn and USD 50bn — adjusted their capital ratios to partially compensate for the changes resulting from the new rules: On average, if a bank’s capital ratio when measured under the new rules was lower than under the old rules, then the bank took steps to increase its capital ratio, compared to a bank whose capital ratio did not change with the new rules. This adjustment took place prior to the publication of the specific language applicable to US banks, suggesting that the changes were largely expected by that time. Both groups of banks responded in the periods following the release of the new US rules in relation to their exposure to mortgage servicing rights, suggesting that the severe treatment of this asset class was not expected. The bank responses we estimate take place well before the Basel III rules started to come into force after 2014, emphasizing the importance of policy announcements in shaping bank behavior.

Municipal bond markets experienced a significant amount of strain in response to the COVID-19 crisis, creating liquidity and credit concerns among market participants. During the economic shutdown resulting from the pandemic, income tax revenues were deferred and sales tax revenues decreased beginning in spring 2020, while the cost of borrowing significantly increased for municipal issuers. To aid municipal borrowing needs, the Federal Reserve implemented the Municipal Liquidity Facility (MLF) on April 9, 2020. In this analysis we describe the municipal market conditions as they evolved during 2020, we document the response by the Federal Reserve to municipal market distress with a focus on the MLF, and we conduct an event study to examine MLF-related impacts on market index yield spreads. We detail two case studies that compare yield spreads for two issuers that had sold debt to the MLF and find that yield spreads in secondary market transactions for these two issuers were notably reduced after a public announcement of intent to sell debt to the MLF. Our results present additional evidence that the MLF had a positive impact on municipal market functioning during the pandemic period.

Rates of US homeownership have declined in the past two decades, and the decline has been especially pronounced for young adults. Motivated by recent research that explores the ways in which personal experiences can affect financial attitudes and beliefs, we explore whether the negative homeownership experiences of parents during the 2008 financial crisis could have caused their children to view homeownership less favorably. We find that parental mortgage distress negatively correlates with the probability that a child will purchase a home, and we explore various channels through which this link may occur.

One potential threat to a stable financial system is the phenomenon of contagion, where a risk that is ordinarily small becomes a problem because of the way it spreads to other institutions. Researchers have investigated multiple channels through which contagion might occur. We look at two--banks borrowing from each other and banks holding similar types of assets--and argue that the latter is a potential source of systemic risk. We review recent data on asset concentrations and capitalization levels of the largest US banks and conclude that the overall risk from this particular contagion channel is at present likely limited.