Annex 1. Spillovers to Low Income Countries
1. Spillovers could be significant to a disparate group of mainly small economies that are heavily dependent on trade with the U.K, but for which model results are unavailable. Examples (with the share of their exports targeted at the U.K.) include
Former U.K. colonies (middle-income): Mauritius (32 percent), Seychelles (24 percent), and St Lucia (16 percent).
Former U.K. colonies (low-income): Gambia and Kenya (11 percent both).
2. Spillovers to low income countries (LICs) through remittance flows and aid from the U.K. are significant, particularly for Sub-Saharan Africa (SSA). This includes substantial remittances to Nigeria ($460 million, or 26 percent of the total), Uganda ($373 million, or 62 percent of the total), and Kenya ($254 million, or 59 percent). The U.K. also accounts for around 10 percent of aid flows to LICs, focused on the poorest countries. In contrast to many other donors, it has not cut aid flows in recessions, and plans to increase aid by 30 percent in real terms in next four years in spite of a major fiscal adjustment effort.
Like the companion FSSA, this report takes a broad definition of the U.K. financial sector, financial institutions based in the U.K.—whether U.K. owned or not—as well as the operations of subsidiaries and branches of U.K. banks abroad.
This includes non-dollar government bonds as well as Eurobonds of all currencies.
Owing to data limitations, this approach does not take into account the impact of the overseas activities of U.K. banks on global liquidity (see Supplement, Note IV for details).
See Understanding Financial Interconnectedness (2010) for further elaboration on the methodology. Espinosa-Vega and Sole (2010) illustrates how financial interconnections can amplify shocks through successive reductions in funding.
See Hoggarth, Mahadeva and Martin (2010).
Hoggarth et al (ibid).
Bank of England Quarterly Bulletin, 2009 Q3.
As suggested in the Bank of England Quarterly Bulletin (2009, Q4), this may be the result of Libor fixings being less indicative of actual transacted rates between banks and as such underestimating true cost of funding.
Adequate regulation and supervision of other critical pieces of market infrastructure is also essential to prevent adverse spillovers. This includes, for instance, CHAPS, the U.K.’s real-time gross settlement system, which provides settlement services for CLS (one of the key global clearers of forex payments).
Supervisors are also applying stress tests (using firm-specific and market-wide shocks) to review firms’ own assessments of liquidity needs.
See BCBS (2010).
BCBS (Ibid) estimates that a 2 percentage point increase in capital ratios in the U.S. or Euro-Area would lead to 2 percent reduction in the standard deviation of output.
The FPC will also analyze financial sector vulnerabilities more generally, and make proposals on information gathering or microprudential measures complementing macroprudential policies.
The U.K. authorities have, by contrast, full powers to resolve foreign subsidiaries.
A recent proposal from the European Commission could alleviate some of these concerns. It would harmonize EU Member States’ legal and institutional arrangements for managing banking crises, bringing closer an integrated framework for crisis prevention, management and resolution.
The U.K. authorities are aware of such risks, and are monitoring the possible consequences of, for instance, new funding products that comply with revised liquidity regulations, but could create sizable rollover risks just beyond regulatory horizons (See Bank of England Financial Stability Report (2010)).
See the location of financial activity and the euro (an EMU Study) “HM Treasury” (2003).
This paragraph should be read in conjunction with paragraph 50 of the Staff Report on the 2011 Article IV consultation with the U.K.
Prepared by Vanessa Le Lesle (MCM) for the 2011 U.K. Financial Sector Assessment Program Update.
For example, Santander U.K. is a U.K.-owned and incorporated bank, established via the acquisitions of U.K. banks Abbey National, Bradford and Bingley, and Alliance and Leicester. See also Box 1 in the Bank of England Financial Stability Report (London, June 2010).
Prepared by Manmohan Singh, Vanessa Le Leslé (both MCM), and Alvaro Piris (SPR).
Today LIFFE’s transactions are technically cleared by LCH Clearnet Limited.
Australian dollar, Canadian dollar, Swiss franc, Czech koruna, Danish kroner, Euro, Sterling, Hong Kong dollar, Hungarian forint, Icelandic króna, Japanese yen, Norwegian krone, New Zealand dollar, Polish zloty, Swedish krona, South African rand, and the U.S. dollar.
Prepared by Karim Youssef (SPR).
An omnibus account groups together individual client accounts (including those of other brokers, banks, institutional investors, and Funds). It is a unified account, which does not allow for the retention of information about the individual accounts. Omnibus accounts are seen as an efficient way to augment inter and intra-firm operations in different markets and countries. They also allow firms to offer clients the ability to transact via a single firm across markets and countries.
Prepared by Irena Asmundson, Chris Marsh, and Karim Youssef (all SPR).
This measure is a simple proxy, given data limitations. A more accurate measure would require a more complete dataset including both claims and liabilities of the consolidated and locational balance sheets of domestically chartered banks, as well as subsidiaries and branches of foreign banks for every jurisdiction. The proxy measure does not take into account the claims of the consolidated balance sheet of a given country’s banks on their own foreign subsidiaries, but captures any claims by the subsidiaries on the consolidated balance sheet.
Prepared by Manuela Goretti, Alvaro Piris, and Karim Youssef (all SPR), and Manmohan Singh (MCM).
Tobias Adrian & Hyun Song Shin: “Financial intermediary leverage and value at risk,” Federal Reserve Bank of New York, Staff Reports 338 (2008).
Throughout the analysis, leverage is defined as (Total assets) over (Total shareholders’ equity). Total capital rather than Tier I capital is used given lack of uniform and complete data on the latter. Banks’ coverage varies across charts due to different data availability for on- and off-balance sheet definitions, as specified in the relevant footnotes to the figures.
Recently released figures for 2010 for some of the banks in sample confirm these results.
See note III, “The Role of the U.K. in SIFI business models”.
Prepared by T. Bui and M. Goretti (SPR), based on Bayoumi, T. and Bui, T. (2010), Deconstructing the International Business Cycle: Why Does a U.S. Sneeze Give the Rest of the World a Cold? IMF WP/10/239, October.
The analysis builds on the identification method in Rigobon, R. (2003), Identification through Heteroskedasticity, The Review of Economics and Statistics, Vol. 85 (4), pp. 777-792.
Outward spillovers from the U.S. dominate the “great moderation” period, while they are comparable in size to spillovers from the U.K. once the global crisis time window is included, despite the different relative size of the two economies due to the amplified financial channel in the latter.
Prepared by Francis Vitek and Gavin Gray.
Vitek, F. (2010), Monetary policy analysis and forecasting in the Group of Twenty: A panel unobserved components approach, International Monetary Fund Working Paper, 152.
Prepared by Francis Vitek (SPR)
Vitek, F. (2010), Monetary policy analysis and forecasting in the Group of Twenty: A panel unobserved components approach, International Monetary Fund Working Paper, 152. The calibration of the impact of the sovereign debt shock on U.K. and other markets is based on empirical studies for the United States, scaled by the relative size of the relevant financial markets.
Prepared by Eugenio Cerutti (RES)
Prepared by Gavin Gray, Siret Dinc, Mohamed Norat, and Malika Pant.
The U.K. banks included in the model comprise Barclays, HSBC, Lloyds, RBS, and Standard Chartered.
The CoPoDs are estimated as in Segoviano (2006), “Consistent Information Multivariate Density Optimizing Methodology,” Financial Markets Group, London School of Economics, Discussion Paper 557, Segoviano (2006), “The Conditional Probability of Default Methodology,” Financial Markets Group, London School of Economics, Discussion Paper 557, and Segoviano and Goodhart (2009), “Banking Stability Measures,” IMF Working Paper, WP/09/04.
A credit event could be a default or a restructuring in which bondholders are forced to bear losses. The mapping from CDS spreads to probabilities of distress assumes a fixed recovery rate of 40 percent given distress.
Prepared by Silvia Sgherri (SPR).
The importance of risk commonalities varies over time, being greater at time of generalized stress in financial markets. On average, over the sample August 2007–February 2011, risk commonalities are found to explain about one-third of the total volatility for the portfolio considered.
Prepared by Karim Youssef (SPR).
Prepared by Alvaro Piris and Francis Vitek (SPR).
This follows the work reported by the Macroeconomic Assessment Group “Final report: Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements”, BIS, December 2010. FSA estimates for the U.K. are marginally lower (by less than one basis point).
Admati, A.R., P.M. De Marzo, M.F. Hellwig and P. Pfleiderer, “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why bank Equity is Not Expensive”, available at: http://www.gsb.stanford.edu/news/research/admati.etal.html
Francis, W. and M. Osborne, “Bank Regulation, Capital and Credit Supply: Measuring the Impact of Prudential Standards”, FSA Occasional Paper no. 36, September 2009.
See for example Angelini, P., L. Clerc, V. Cúrdia, L. Gambacorta, A. Gerali, A. Locarno, R. Motto, W. Roeger, S. Van den Heuvel and J. Vlček, “BASEL III: Long-term impact on economic performance and fluctuations”, BIS Working Paper no. 338, February 2011.