GAËTAN LE QUANG

Sustainable economic policies: exploring the effects of ecosystemic macroprudential regulations

Thomas Lagoarde Segot, Gaëtan Le Quang, Laurence Scialom

Abstract

This paper explores the implications of ecosystemic macroprudential regulations on sustainability in an ecological PK-SFC framework. We first discuss the link between banks and global warming; and present the case for connecting prudential regulation with planetary boundaries. We then report a set of simulations suggesting that in the short run, such ecosystemic prudential regulations could effectively green banks’ balance sheets, credit flows, and curtail brown investment, at the cost, however, of significant short-run losses. In the longer run, the induced green transition appears to set the economy on a more sustainable pathway, to decrease inflationary pressures, and to maintain real GDP at the baseline level, with distributional effects favourable to wage-earners. These results highlight the relevance of ecosystemic prudential regulation to tackle climate change and call for adopting a holistic approach to sustainability policies.

Mot(s) clé(s)

ecological finance, SFC modelling

Shaky foundations Central bank independence in the 21st century

Jérôme Deyris, Gaëtan Le Quang, Laurence Scialom

Abstract

Central bank independence (CBI) has often been presented as a superior institutional arrangement demonstrated by economists in the 1980s for achieving a common good in a non-partisan manner. In this article, we argue that this view must be challenged. First, research in the history of economic facts and thought shows that the idea of CBI is not new, and was adopted under peculiar socio-historical conditions, in response to particular interests. Rather than an indisputable progress in economic science, CBI is the foundation for a particular configuration of the monetary regime, perishable like its predecessors. Secondly, we argue that the simplistic case imagined by the CBI theory (the setting of a single interest rate disconnected from political pressures) is long overdue. For nearly two decades, central banks have been increasing their footprint on the economy, embarking on large asset purchase programs and adopting macroprudential policies. This pro-activism forces independent central banks to constantly address new distributional - and therefore political - issues, leading to a growing number of criticisms of their actions with regard to inequality or climate change. This growing gap between theory and practices makes plausible a further shift of the institutional arrangement towards a democratization of monetary policy.

Mot(s) clé(s)

central bank independence, monetary policy, macroprudential policy

What do bankrupcty prediction models tell us about banking regulation? Evidence from statistical and learning approaches

Pierre Durand, Gaëtan Le Quang

Abstract

Prudential regulation is supposed to strengthen financial stability and banks' resilience to new economic shocks. We tackle this issue by evaluating the impact of leverage, capital, and liquidity ratios on banks default probability. To this aim, we use logistic regression, random forest classification, and artificial neural networks applied on the United-States and European samples over the 2000-2018 period. Our results are based on 4707 banks in the US and 3529 banks in Europe, among which 454 and 205 defaults respectively. We show that, in the US sample, capital and equity ratios have strong negative impact on default probability. Liquidity ratio has a positive effect which can be justified by the low returns associated with liquid assets. Overall, our investigation suggests that fewer prudential rules and higher leverage ratio should reinforce the banking system's resilience. Because of the lack of official failed banks list in Europe, our findings on this sample are more delicate to interpret.

Mot(s) clé(s)

Banking regulation ; Capital requirements ; Basel III ; Logistic ; Statistical learning classification ; Bankruptcy prediction models.

Banks to basics! Why banking regulation should focus on equity

Pierre Durand, Gaëtan Le Quang

Abstract

Banking regulation faces multiple challenges that call for rethinking the way it is designed in order to tackle the specific risks associated with banking activities. In this paper, we argue that regulators should focus on designing strong equity requirements instead of implementing several complex rules. Such a constraint in equity is however opposed by the banking industry because of its presumed adverse impact on banks' performance. Resorting to Random Forest regressions on a large dataset of banks balance sheet variables, we show that the ratio of equity over total assets has a clear positive effect on banks' performance, as measured by the return on assets. On the contrary, the impact of this ratio on the shareholder value, as measured by the return on equity, is most of the time weakly negative. Strong equity requirements do not, therefore, impede banks' performance but do reduce the shareholder value. This may be the reason why the banking industry so fiercely opposes strong equity requirements.

Mot(s) clé(s)

Banking regulation ; Capital requirements ; Basel III ; Random Forest Regression

Mind the Conversion Risk: a Theoretical Assessment of Contingent Convertible Bonds

Gaëtan Le Quang

Abstract

We develop a theoretical model to assess the merits of principal-write down contingent convertible (CoCo) bonds. The conversion risk is the key feature of CoCo bonds. Because of this conversion risk, CoCo bonds are hard to price and an equilibrium price does not necessarily exist. In our model, for such a price to exist, the bank needs to hold a minimum amount of equity and/or the expected return associated with its asset portfolio needs to be large enough. When an equilibrium price exists, it is a decreasing function in the amount of equity held by the bank. Well-capitalized banks can thus issue CoCo bonds at a lower price than least-capitalized banks. This is the reason why CoCo bonds are to be thought of more as a complement to equity than as a substitute. In addition, because of the conversion risk, self-fulfilling panics may occur in the CoCo bonds' market. We indeed define a game between CoCo bonds' holders and the Central Bank that allows us to exhibit situations where a panic occurs in the CoCo bonds' market. Using the global game technique, we show that the probability of crisis can be expressed as a function of the return associated with the asset portfolio of the bank. The probability of crisis is shown to be sensitive to the precision of the information available to CoCo bonds' holders. Taken together, our results call for cautiousness when assessing the relevance of regulatory requirements in CoCo bonds, especially concerning their systemic impact.

Mot(s) clé(s)

convertible contingent bonds; conversion risk; equity; banks; systemic risk

"Taking Diversity into Account": Real Effects of Accounting Measurement on Asset Allocation

Gaëtan Le Quang

Abstract

Following a request made by the G20, the IASB begins to work in 2009 on a new accounting standard meant to replace IAS 39: IFRS 9. Among other things, IFRS 9 puts forward a new way of classifying financial instruments that rests on a two-step procedure: a business model assessment and a contractual cash flow characteristics test. We develop a theoretical model that assesses the relevance of this procedure, specifically that of the business model assessment. We show that a mixed accounting regime where financial institutions whose time horizon is short resort to fair value accounting while those whose time horizon is longer resort to historical cost accounting provides a better asset allocation than a pure accounting regime where all FIs resort to the same accounting rule. In other words, business models are worth being taken into consideration when deciding whether an asset should be evaluated at its fair value or at its historical cost, which is in line with the framework presented in IFRS 9.

Mot(s) clé(s)

IFRS 9; Fair Value Accounting, Historical Cost Accounting; Asset Allocation; Real Effects of Accounting; Banks; Insurers

Taking Diversity into Account: the Diversity of Financial Institutions and Accounting Regulation

Gaëtan Le Quang

Abstract

The global financial crisis and what followed point out at least two major failures of the financial system: its inability to contain liquidity risk and its inability to fund long term investments. We think that these two problems come from the setting up of rules and practices that tend to homogenize market participants’ incentives and behaviors. Fair value accounting is one element of this set of practices and rules. If the rationale behind fair value accounting – that is enhancing transparency in order to limit unreported losses and manipulations – can justify its use in the case of short-term financial institutions (meaning institutions whose time horizon is short because of the maturity of their liabilities) that constantly face the risk of a sudden liquidity need, it seems totally irrelevant when it comes to long-term financial institutions that will not face liquidity needs before ten or twenty years. In this perspective, we develop a model that shows that an accounting regulation that takes the diversity of financial institutions into account offers better results both in terms of liquidity and in terms of efficiency than a regulation that ignores this diversity.

Mot(s) clé(s)

Fair value; Banks; Insurers; Diversity