What’s Different about Bank Holding Companies?

IMF Working Papers, February 10, 2017

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Bibliographic details

• Authors: Ralph Chami, Thomas F. Cosimano, Jun Ma, Celine Rochon
• Published: February 10, 2017
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781475577556.001

Summary

• The recent fnancial crisis highlighted the role of Bank Holding Companies (BHCs) in exacerbating the crisis and in transmitting monetary policy beyond the local economy to global markets.
• Most models of banking typically focus on banks with a loan desk; this work develops a dynamic model of a BHC that encompasses both a trading desk and a loan desk.
• The paper explores the role of risk attitude and overleveraging by the trading desk, and traces the impact of monetary policy and market innovations on bank behavior in the presence of Basel III type regulations.
• The authors state this is, to their knowledge, a first such exercise examining both desks within a BHC framework.
• The paper shows that the value of the BHC is enhanced by operating both desks, even if they both are subject to common market shocks.
• Alternative regulatory remedies are explored, including efforts to ring-fence the proprietary trading business; regulations that target bank governance can mitigate possible rogue trading and the overleveraging problem.

Model, Mechanisms, and Findings

• Model features:
  • Dynamic model of a BHC with a trading desk and a loan desk.
  • Incorporates Basel III type regulations.
  • Accounts for common market shocks affecting both desks.
• Key behavioral insights:
  • Operating both trading and loan desks enhances BHC value.
  • Risk attitude and overleveraging by the trading desk are central to crisis amplification and policy transmission.
  • Monetary policy and market innovations influence bank behavior through interactions with regulatory constraints and internal governance.
• Regulatory experiment results:
  • Ring-fencing proprietary trading is analyzed as a regulatory remedy.
  • Governance-targeted regulations can reduce incidence of rogue trading and overleveraging.

Policy Recommendations and Implications

• Consider regulatory measures that target bank governance to mitigate rogue trading and overleveraging by trading desks.
• Evaluate ring-fencing proprietary trading as one policy option, but complement with governance-focused regulations.
• Incorporate interactions between monetary policy, market innovations, and Basel III type constraints when designing macroprudential and microprudential frameworks for BHCs.

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