 policies going on in the markets and what should be done about it. Yesterday we listened to Olivier Blanchard on fiscal policy and so today financial markets. I will invite everyone to shoot questions via the chat button. You can just share them with everybody and I will then group them by topic and give them to Daryl so you don't have to multitask too much Daryl. It's difficult enough with this technology. So we're aiming for about a 45 minute presentation and then some Q&A at the end. So with that we go over to you Daryl and thank you so much for doing this. Luke, thank you so much. It's a great opportunity to engage with you and to find out what kinds of issues you're thinking about as well. So I hope this will be lively. I'm not going to present a paper but rather just a selection of issues that have come up in my policy conversations since the crisis began that might be relevant to what you're thinking. I'm not really sure. My focus is on US central bank policy. So what I'm going to do is share the screen in a moment, go through a list of the issues and then dive a little bit more deeply into each but not in extremely fine detail and invite a conversation about some of these issues. I'm actually making a related conversation this afternoon with the Fed. And so this will be a good chance for me to find out how central bankers are thinking about some of these issues. So at this point let me try to share my screen. Ana Maria was very helpful in teaching me how to do this. Can somebody verify that you're actually seeing my screen? Yes, of course. Okay, good. So there's one issue in here that I think you'll agree should be treated as confidential. So I mark these slides preliminary and confidential. So here's the issues that I think are worth discussing maybe in rank order of interest or importance. So the first one is a concern that's arisen in the United States with the exceptional growth in central bank deposits over the last month. Now over a trillion of additional reserves in the US Federal Reserve System. And what happens as the Fed continues to expand its balance sheet with the impact of the leverage ratio rule, those reserves will begin to crowd out credit provision and market making inventories unless something is done. And the Fed has already taken some actions to relieve this crowding out effect by relaxing the leverage ratio rule. But that's not necessarily going to work and I'm also wondering what other central banks may be doing in this area as they expand their own balance sheets. And central bank deposits start to impinge on commercial bank balance sheet space under the leverage ratio rule. So we'll come back to that. The second issue, and this is the one that I think should be treated as confidential, is the idea that as banks start to experience losses, they will tend by in order to maximize shareholder value they will tend to react to their leverage and risk based capital requirements by reducing their balance sheets rather than by expanding the amount of capital. In other words, if you think of a capital ratio requirement as having both a numerator capital and a denominator assets, banks can maintain their capital ratios by reducing assets rather than increasing capital as they start to lose money. And I want to discuss the possibility, and this is quite hypothetical, of adding a temporary floor on the quantity of capital in euros as opposed to a ratio based requirement. And I'm doing some modeling of this right now that I'll describe although the results are not quite ready yet. This started last weekend because of the interest in this topic. The third topic area is how to think about big bank credit spreads during a stress period like this as a gauge of bank quality. And I've been watching bank equity levels, at least to market value of equity levels are extremely low, but credit spreads are surprisingly muted. And in order to try to disentangle the implications for the solvency or risk of banks, we have to remove the effects of credit or assumptions about state support to try to take those out of the credit spreads and see what the credit spreads might be telling us. And I've been doing some work on this for the United States, but my work on this for your with on the European scene is in progress. I don't have any empirical results yet, but I want to tell you what I'm doing. And then time permitting, which may not happen. A couple of other issues that I've been thinking about policy issues. One is pro cyclical margin requirements. As yet, I've noticed in Europe, for example, sovereign credit spreads are also muted. But that leaves an opportunity for in the event that some sovereign credit spreads start to rise for some pro cyclicality in the assignment of haircuts and margins that could place that could magnify stresses. And then finally, I have some concerns on behalf of, you know, thinking about central bank policy makers as they face in the United States. The request from the government to fund corporations with subsidized loans in order to preserve jobs, which is a beneficial objective, but may cause some issues for the Federal Reserve in terms of its mission and its political independence. So I can come back to those last two issues, time permitting and interest permitting. And I'm going to go back to the very first issue now, which is the effect of crowding out of reserves by reserves of other market making inventories. And I would suggest as we walk into this, that rather than waiting to the very end, that maybe wish, if it's okay with you, Luke, to take comments after each of these topics because they're somewhat separable and people may lose track of what they wanted to ask or the topicality may decline as we go through this. Absolutely. I'm just collecting all the comments via the chat and then we'll pass them on to you. Okay. So on this first topic, the Federal Reserve has added about a trillion dollars of central bank deposits and it's using those newly created reserves to purchase assets, basically taking mostly treasuries, about 1.3 trillion in treasuries and some other assets. And now it's beginning to expand its emergency lending and will continue to use reserves mostly to purchase more assets or to make more loans. And as those reserves are being added, of course, the commercial banking system is a closed system. They have to be held by commercial banks. And those commercial banks are under capital requirements and one worries that there will be space left for banks to provide intermediation and credit provision. At the same time, the customers of banks are drawing on their credit lines and increasing their deposits, which further expands bank balance sheets and puts further pressure on their capital requirements. Now there's some overlap there because some of those deposits are being invested in reserves but not all of them. So as the crisis proceeds and central bank balance sheets get bigger and bigger, the headroom available under the leverage ratio rule is declining. Now one could say the same thing about tier one risk-based capital requirements, but there is something that can be done with respect to the leverage ratio rule, I think. For two reasons. Number one, that's the one that's the leverage ratio rule applies to reserves in the same way that it applies to any risky assets, but reserves are not risky. So there's some space to make adjustments there. Just to give you an example, I went to this week's first quarter report for JPMorgan Chase and their balance sheet is grown by 450 billion in assets in the first quarter, almost all of it due to crisis effects. And at the same time, the headroom that they have available under the supplementary leverage ratio has been reduced by 30 basis points, which is quite a bit. Those SLR numbers are not very volatile normally. They had, for JPMorgan Chase, there had been no change in the previous year and suddenly a 30 basis point reduction in capital according to the supplementary leverage ratio rule. At the same time, loan loss provisions jumped, for JPMorgan jumped up this quarter by 77 percent and they had been dead flat for the previous year. So to have no change four quarters in a row and then a 77 percent increase in one quarter suggests the degree of severity of this crisis on bank earnings. So it happens that JPMorgan Chase is one of those kinds of banks that can continue to earn money even in a crisis and so it doesn't have negative earnings, but maybe for other banks, these losses will further reduce headroom available under capital ratios and something may need to be done about that, which I'll get to later. The Fed was not unaware of this problem and on April 1st it temporarily exempted treasuries and reserves from the supplementary leverage ratio rule for bank holding companies and it hinted that it may exempt treasury repos and we can talk about that hinting. If you're interested, it's quite a nice little back story there and the Fed was very explicit in its temporary revision of regulation Q by saying that they are indeed concerned that as banks accumulate treasuries and reserves due to the crisis, that their incentives and ability to continue providing intermediation to the economy may be cramped. Unfortunately, two other regulators have to sign off for the bank subsidiaries, which are the holders of the reserves. So the FDIC and the OCC, which are the two other large bank regulators in the US, have not allowed exemptions under the leverage ratio rules for the banks themselves. So even though the Fed has mitigated the problem at the holding company level, which includes the dealers, the banks themselves, which also hold the dealers' reserves, continue to accumulate reserves with no relief under the supplementary leverage ratio rule. In my Bafi lecture, I spoke about the fact that this imposing the SLR on things like reserves and treasury repos is counterproductive because these are extremely safe assets and imposing those leverage-based rules on extremely safe assets will have the effect of crowding out intermediation of other sorts. And now the general reasoning that I provided has become kind of exigent. The Fed has only done this temporarily. That's one year. And market commenters are asking, well, how will the Fed exit this temporary relief? I would suggest that it doesn't exit it. And I know this, for some people in the policy community, this is heresy because there are good reasons to have leverage ratio rules. I just think that they are dominated by the bad reasons to have them, the damage that they're causing to intermediation. And I'd be happy to discuss that further. Now, I'm assuming that banks won't issue new equity. I'm going to discuss in a moment the possibility of mitigating that problem, but assuming that banks will not issue new equity, unexempted reserves will eventually crowd out the incentives for banks to offer robust credit provision and market making. I'm not sure that's true in Europe, but I'm pretty sure it's true in the United States where the SLR is bigger for GSIBs, quite a bit bigger. If a central bank or a bank regulator were to say, well, we don't want to exempt reserves because then bank capital levels will go down, I describe in my Bafi lecture how that can be sterilized by increasing other capital requirements and still maintaining the objective of the leverage ratio rule on a system-wide basis. The idea being one calculates how much capital in the system should be based on the leverage ratio rule, but one does not apply the leverage ratio rule to each bank. One simply adds other capital requirements until the objectives of the leverage ratio rule are met on a system-wide basis. This effect can be sterilized. When the Bank of England exempted reserves a few years ago, they did sterilize it by increasing other capital requirements, which I thought was a prudent move, although I noticed that some in the central banking community didn't like the idea that one central bank would depart from the norm set in Basel, and I think there are good reasons for Basel to revisit the whole issue of leverage ratio rules, but that's a longer story. Okay, I'm going to move to the issue of enhancing capital requirements in a moment, but Luke, if anybody wants to comment on this or if there's chat about this issue, we could do that now. Well, there is sort of a more general question, Bero, from Simone Manganelli. How do you, how should we deal with cliff effects related to rating downgrades? So this you may talk about later on prosyclicality issues, but it's a pertinent issue for discussion in Europe, sort of these cliff effects from rating downgrades. That's a very apt question under this issue of prosyclicality, and just for sake of clarity, until two years ago, I had been on the board of Moody's Corporation, the board of directors for ten years, and this issue of prosyclicality comes up all the time, and credit rating agencies are under quite a lot of pressure, because on the one hand, as they were recently advised by Stephen Mayor, the head of ESMA, their ratings downgrades recently have been adding prosyclicality. But on the other hand, the rating agencies are not policy, they don't have policy objectives, they have the objective of providing guidance on credit quality. So I would not suggest, and actually the chair of ESMA did not actually suggest calling on rating agencies to do that, but rather to have them thinking about it. But I would not suggest that rating agencies be prevented from providing downgrades whenever they are reasonable. However, policymakers will have to make a judgment about how to mitigate that prosyclicality. I had a discussion earlier this week with a senior executive at a large central counterparty about the issue of counter-syclicality, and this issue of credit rating downgrades came up in that discussion as well. And if we get to prosyclicality, maybe we could raise it again there. But it is true, as the question suggests, that ratings downgrades are prosyclical, in some cases they automatically trigger haircut increases or higher margin requirements or preclude certain types of collateral from being used as margin, and that is an accelerator that needs to be dealt with. And there's also a question, Darryl, from Isabel Schnabel, more on the topic of the leverage ratio. What do you think about designing leverage ratios in a macro-potential way similar to the counter-syclical capital buffer? I think that's a very good idea. I'm a fan of counter-syclical buffers. I would suggest again applying it on a system-wide basis. So just to repeat the formula, every bank reports its assets just as under the leverage ratio rule. The regulator and reports what its capital would be required under that rule, but that's not the binding constraint on that particular bank. Rather, the regulator adds up all of those capital requirements, determines how much capital would be needed in the system or large bank system based on that rule, and then increases other capital requirements to meet that level, if that's the binding constraint. In that way, you get the effect of the leverage ratio rule, but no individual bank is causing distortions because it doesn't internalize very much the purchase of its own asset balance sheet with respect to this leverage ratio rule. And that could be done on a counter-syclical way, and I think it's a great idea to do that. And then there is the last question from Klaus Massot on this. You get the example of J.P. Morgan in the US, which is reasonably well-capitalized. Unfortunately, in Europe, many capital ratios of banks are somewhat lower, and especially market to book ratios are low. So you making the assumption of no issuance of new bank equity, but in the case of Europe, should we be thinking of recapitalizing banks more up from? My answer to that is yes, and it's the next topic. So whenever you like, we can move on to that. Okay, so let me move ahead to that topic, and that doesn't rule out coming back to the topic of the leverage ratio rule. So this, just to, maybe I'll go back to where this came up at a conversation with Tim Geithner in the Federal Reserve in 2007. Jeremy Stein and I got into a discussion about this issue of banks will simply meet their capital requirements by reducing the sizes of their balance sheets so that they don't need to raise equity. And Jeremy made the astute point, well, during a period of concern, perhaps the banks could be required to maintain the numerator dollars of capital. And so it won't do them any good to reduce the denominator, they simply have to maintain the numerator or dollars of capital. And so I decided, I actually have been suggesting this in my recent policy discussions over the last few weeks, because I'm concerned by this same issue. So this is, so last weekend, my student Tim, or Sobolev, who's because of the social distancing measures is at home in Moscow, I invited him to work with me on modeling this effect. So let me outline the policy and then how the model works if we have time. But unfortunately, Timor is still coding up the results, so I don't have output yet to show you. I will in a few days. So here's how the rule goes. Well, first, just to remind when a bank's loan default rates or NPLs are expected to be high for some period of time, like during a crisis that we're experiencing, the capital regulation, which says that capital over assets has to be at least a given ratio, could incite reduced lending and reduce market making. And the reason is that the banks will not issue equity unless forced to, because it's bad for their legacy shareholders. It will reduce return on equity. It's better for the bank to avoid making its balance sheets safer and transferring value to creditors. The bank would rather just simply reduce assets, selectively provide less intermediation. There is, however, an idea, which is during this crisis period, however long it lasts, telling banks, whatever your assets are, it doesn't matter. You must have at least a certain number of euros of capital in excess of some floor, which would be around where capital is right now or possibly a bit higher or possibly a bit lower, depending on the impact that you're willing to create with this, because this would be extremely unpopular, to say the least. First, bank executives would scream about it, because it would really reduce the market value of their equity, given the inability of banks to meet their capital requirements by reducing assets. This is quite expensive for bank shareholders. So why do it? Well, there's two reasons to do it. One is, I think it was in the premise of the question, to keep banks a source of strength to the economy, not to let their solvency come into question, and so maintain capital from a financial stability viewpoint. The other one, which is the one that I think is more fun to model, at least, and more interesting for credit and loan provision, is that when this floor is binding and assets are strictly below regulatory requirements, the bank will have a positive incentive to increase its assets and retain the earnings. And that's an outcome of the model, but it's kind of intuitively obvious that if you have headroom under your capital requirements based on the size of your balance sheet, you might as well use that headroom while this floor on capital is binding. Then the floor could be removed at the end of the crisis. The bad news, as I mentioned, is that announcing a floor will reduce the market price of a bank's equity, and certainly if it's done too late or too early, it'll be worse. Too early meaning you, well, that is too aggressively, if you put a floor that's much, much higher than current bank capital, then that's going to reduce the current share price of bank equity a lot. It will make the system safer. It will provide incentives for intermediation that are stronger, but legacy share prices of bank equity will drop, and it's possible the market will get confused about what that means. This is a debt overhang effect. It's pure debt overhang. So one needs to be careful about how it's announced. And if I were you, I wouldn't talk about it externally unless and until you know what you're going to do about it, and then be very cautious about communicating it. And I would advise any policymaker to do the same. Another concern is that if it's done too late, under stress, rights offering would be required at a deep discount. Winnie Credit had one of those about five years ago that during now it's seven years ago, I think during the sovereign crisis, and it almost didn't get the rights offering off because even though it was at a deep discount, the market was spooked by the steep discount and the weak demand. So these, if it's done during a stress period where there's actually concern about the bank's solvency, the underwriting of these of the share of issuances that might be necessary, I should have a government backstop. And so that requires that's not a central bank issue. That's a finance ministry issue. But that's to ensure that there's confidence that the banks will be able to recapitalize rather than having a failed rights offering. So that's that's the idea. I think I'm going to in the interest of time, I'm going to skip over the modeling of it which is on the next slide. And which is a simple model that demonstrates the the effect of applying this floor on improving the incentives of banks to make markets and to provide credit to the economy. And maybe if there's any discussion, we could do that now, Luke. Without further questions at this moment. Yeah, okay, very good. Oh, this is just to make the point in reverse. About the incentives associated with capital requirements for growing assets. So this is the perverse effect of the same phenomenon, which is showing the total assets on this slide of large US banks leading up to the financial crisis and then afterwards and it is quite dramatically clear from the slides. Then when capital requirements were not tight, banks were very happy to expand their balance sheets and provide aggressive market making and credit provision, which is what policymakers would like to see except that they didn't they didn't realize at the time in the US at least, that the low capital requirements were also causing extreme financial instability. Post crisis, capital requirements are much tighter. And correspondingly, the rate of growth of assets of banks is muted, despite reasonable economic growth in the United States. So again, the lesson of this is if banks have loose capital requirements, they're going to expand their balance sheets, but you don't need to make loose capital requirements and have financial instability. You can impose a floor on capital. And then when assets fall below the ratio based capital requirements, there will be an incentive to grow assets back up again, just as existed in the US before the financial crisis. So this is a good anti cyclical capital requirement to apply during a period over which bank earnings are expected to be low and bank capital might might might be insufficient. Definitely, I would not advise just lowering capital requirements, except in so far as removing counter cyclical buffers, which is what they're there for. That's the model I'm going to skip. There's two figures that are being plotted based on that model. And I'm going to go to the last topic. The last topic that I want to mention, which is how to interpret bank credit spreads for the effect of too big to fail. And I actually spoke about this, Luke, I don't know if you remember, and a very preliminary version at the ECB over a year ago. But I'm just going to review what I did with my collaborators on Tia Berent and Ichao Zhu. So what we did is we tried to estimate how much too big to fail presumption of creditors has disappeared since the financial crisis, the idea being that after the financial crisis, with both the failure of Lehman and failure new bail in based failure resolution requirements, creditors began to believe that the state support would decline, would not be there as it was before the financial crisis. And the credit spreads of large US banks actually went up despite those banks being much better capitalized. In our empirical analysis, we estimated that effect for US GSIBs, and for US domestically systemically important banks that are shown on this slide. And I'm just going to give you the bottom line in terms of how to interpret the credit spreads. Before I do that, let me just give you an idea of what heightened credit spreads and improved capital, how those can be resolved. Again, it sounds strange, banks are much better capitalized, and yet they have much higher credit spreads. The only way to resolve it is to lower the probability that creditors assigned that they'll get bailed out. And this slide shows the implication of that. What is plotted here is the credit spread at five years in the form of a CDS rate, fitted to from the data for all US operating companies and large banks, fitted to a large bank that's always got a two standard deviation capital buffer. And let me interpret the slide. This is the blue line. Before the failure of Lehman, a bank with a two standard deviation capital buffer had a credit spread of between 50 and 100 basis points. After the failure of Lehman, and actually the same thing is through 2018 now, the bank of the same quality, still two standard deviation capital buffer, has a credit spread that's on the order of 200 to 250 basis points. So around 150 basis points more. And why is that? Well, one reason is that default risk premium had generally risen. So some of the effect is accounted for by that. But most of the effect is a presumption by creditors that they won't get bailed out after the crisis. And the data are remarkably speak remarkably strongly on this point. So no matter how we shake the model and look at the data, it always comes out that the implied the market implied probability of a bailout goes way down. So for example, if the probability of a bailout were 0.65 in the US before the financial crisis, then it's dropped to about 0.2 on a market implied basis. The red dotted line shows what those credit spreads would be. If the battle days were still present and creditors still believe that they're going to get bailed out with probability 0.65. So those credit spreads would be much smaller, or between 100 and 150 basis points, which is typical of some large banks today. Now, why am I telling you, why am I explaining this in the context of the COVID-19 crisis? Well, I'm going through this because when I look at large bank credit spreads around the world, I'm wondering, well, is this bank really okay? It only has a credit spread of 150 basis points. That's not bad. Or is it the case that in this jurisdiction, creditors still presume that there's state support? Now, I'm not saying anything about what state support actually exists, or whether a bail in could be successfully conducted. This is not about what governments intend to do or regulators intend to do with respect to triggering a resolution. This is about what creditors believe that the official sector will do. If creditors believe that they're still getting state support, then the cost of credit to banks will be bid down. The spreads that we're looking at may not be representative of the actual solvency of those banks. Now, I know you have independent sources of information on bank solvency, but market prices are usually quite helpful. The market equity prices of European banks, as was mentioned earlier, are extremely low to the point of being for two of the largest banks in the Eurozone on the order of 1% or less of total assets on the balance sheet, which is a very, very low credit spread. On the other hand, equity prices also have to be interpreted. It's not all in solvency risk. Some of it is expectations of declines in earnings or negative earnings. So, basically, the incentives of the bank manager are to keep the banks going, even if shareholders might be better off if the banks were liquidated or encouraged to create healthier banks in the Eurozone. So, that was kind of a, again, my reactions, and I'm still learning, to how to interpret market prices of debt and equity in light of bailouts and low earnings. The study that I just described here, the United States, I'm now collaborating with the same co-authors and one additional co-author to do for Europe. Europe is a bit more challenging because the largest banks in Europe are split across different jurisdictions. They have somewhat different conditions. It's not as a uniform a situation as in the U.S. But we hope to have data, we already have data of what we're working on the empirics. We hope to have empirical estimates of how much to beat the fail has declined in Europe since the financial crisis within a few months. And I hope you'll invite me back, Luke, to talk about that when the numbers are ready. So, with that, I would turn it back to you for any discussion. Yes, there was one question still on the previous topic of enhancing banking capital, where you were advocating a floor on the level of capital. Florian Haider is wondering whether it would not be more effective to instead forbid dividends or share repurchases. Would that go a long way and would that not be easier to implement? Yeah, so definitely that is moving in the same direction because that will at least prevent the capital available from going down with discretion. So it will mitigate the problem that I just described. Two were actually several caveats. Number one in the United States banks are not being prevented from paying dividends. In fact, I was a bit surprised that Chair Powell said last week that he sees no reasons for banks to be asked to reduce their dividend payments. I wouldn't probably have said that, it's not necessarily because it isn't true but rather that if things turn out badly, it would have been better not to open the gates on that. The other issue is, I know in Europe that banks have undertaken that they won't pay dividends and nor makes their repurchases, but that doesn't necessarily imply that they will meet a floor if they have negative earnings. Moreover, some banks, the effect of a floor on capital may be different across different banks. So for some banks, not paying out dividends may be excessively onerous if they're exceeding a natural floor and for other banks, not paying out dividends might not be enough of a floor. If the objective is that banks have a given level of capital, then it's more effective to impose a floor. Now it's a different issue politically because politically it's easy to explain that banks shouldn't needlessly pay out cash that they may need. It's harder to tell banks, well you've done such a great job on your risk-based capital requirements, now we're going to slap another one on you, cause your share price to go down and and and then suffer the communication challenge associated with that. So this is, this would be viewed as a heavy-handed requirement. Well from a policy viewpoint though, I think it makes that makes a lot of sense because it enhances financial stability and it enhances credit provision and intermediation in a way that would be hard to do without something like this, although again dividend pay, so restricting dividend and share repurchases is definitely going in the same direction Florian, thanks. And there is another question from Klaus Masouk the statement earlier that you made that legacy shareholders will not call for an increase in capital because their share prices will go down, but everyone sort of takes this from a welfare standpoint, would not this also simply reflect the decline in taxpayer costs to future bailouts of banks? Absolutely and in fact the analysis that I showed you on Too Big to Fail clearly shows that undercapitalization of banks with a prospect of bailouts is a generates a large subsidy so we get the fact that before the financial crisis 29% of total large bank equity was in the form of implicit subsidies associated with bailout and this also elevates the causes a distorted view of the health of banks from looking at their equity share prices because those are elevated when there's a prospect of bailout those are elevated by those subsidies to debt that are coming in the form of cheap credit spreads so I completely agree with that question the premise of that question. And then the last question is from Klaus Maslup in this section so his question is whether the public support that you are estimating here whether this could also reflect central bank support? Well there's two ways that that could happen number one central bank support provides liquidity and banks can fail for two reasons insolvency and lack of liquidity and so if central banks are providing less liquidity then credit spreads should rise. I don't think in the United States that the blue line in the chart shows that the Fed is supplying less liquidity and therefore credit spreads are higher rather I think it's a reflection of the disappearance of too big to fail. The other way that central bank liquidity can support banks is that in some cases it's not actually just liquidity in some cases central banks can do whatever it takes and sometimes that implies more than providing liquidity. Okay then there is a comment coming in from Jerome Henry he's referring to a study by Glassamann and co-authors they found that indeed consistent with just story that after the creation of the single supervisory mechanism in the EUR area the measurement of potential state support has declined and this is also consistent with not just single supervision but also the adoption of new bail-in rules but then later on again increased more recently due to some bailout decisions in some countries. So the question is would you also expect such indicators to fluctuate a little more in Europe than in the US? Oh that's a great question very perceptive yeah the paper by Glassamann has a very nice experiment because in 2014 there was a change in the coverage of credit default swaps one flavor covered bail ins and a legacy flavor which still traded did not cover bail ins and so the difference between the two revealed to the market the likelihood of a bail in on a market implied basis and indeed the likelihood of a bail in increased with the single stability mechanism and then it dropped back again with the bailout of Monte De Paschi di Siena so yeah this the the intentions for bail in versus not bail in can be detected to some extent for market prices and as I mentioned I'm interested in what the case is in Europe I do have I might even speculate about the situation in Europe versus the US but I don't have the results of our empirical analysis yet so I'm a bit hesitant to to tell you my bias which is that at least in some jurisdictions in Europe there is still a high presumption of bail in by the way when I gave my talk about this topic last week to 500 economists it's the wonderful thing about being in a crisis you get a lot you get a bigger audience because there's people watching all over the world I asked for a poll of all the economists watching on the probability of a bail in in Europe now going forward and the median the median probability assigned by 370 economists who took the poll was 80 percent that is the median probability assignment that an official sector in Europe would bail out a large a large European bank was 80 percent state support is still assumed to be very high in Europe I was also surprised to see that the assumption of state support is very high in the US so maybe maybe the decline in the US is coming from maybe a probability one of a pre-crisis a bail in down to more like 75 percent I don't know we'll see but in Europe in Europe yeah I think most commentators are saying that in some jurisdictions there's more likelihood of a government support than there is in the United States at this point so directly speaking to this there's a question from Isabelle Schnabel because of course things may now have rapidly changed in terms of these dynamics that you talk about since we are in the middle of a crisis so I mean how likely do you think it is to have a bail in in the midst of a crisis like the one we have today and if not would this not naturally raise the probability of a bailout well first of all I think from a policy viewpoint it's more justified to have a bailout in a systemic crisis the reason being is that it's a transfer it's a government transfer with moral hazard but not as much moral hazard as there would be outside of a crisis especially a crisis caused by a virus and that if there's ever a time to do a bailout it would be in a system-wide banking crisis where you're worried that bail in might not be extremely effective that said my sense is that in Europe there's no system-wide banking crisis and if banks start to reach the point of insolvency one at a time then I would you know my policy viewpoint would be to stick to your guns and stay the regime of bail in and I think that will have a create significant benefits the only reason I would hesitate is if you're not confident that the bail in process will actually work and you're more experts you have more experts than me on knowing whether your bail in process will work I've written a lot about this but it's getting the quality of the process is getting better and better especially with the treatment of central counterparties derivatives and repos there's still there are still issues as you know and just the fact that you're able to conduct a bail in without a failure doesn't mean that the financial institution that's left will be a significant provider of credit to the economy it could be that counterparties will shun that financial institution it will successfully get bailed in but shrink dramatically and if you do that to more than one or two banks during a stress period that's not good for the economy for sure thank you Daryl you have two more topics to cover right yeah if you're interested I can we're definitely interested in the margins maybe to close the topic on capital there was one question that I skipped that would like to come back to by Philip Hartman when you spoke about the capital lower proposal doesn't the the benefit of the effect of a capital floor depends on high on how high the riskiness of lending opportunities rises um okay so well there's a couple of issues yeah the couple of points in that question so if the if bank if the risks of bank lending going forward are high then that can be priced into bank loans and so from the viewpoint of the health of the bank the new loans that are made uh will be made on better market terms because of more aggressive bidding by banks and not cause losses for banks um because banks won't involuntarily head in for losses the their the flip side of that is that if the riskiness of bank loans goes up then the legacy loans already on the balance sheet or would be expected to experience higher um uh non-performance losses will accumulate the banks capital will decline maybe the accounting won't keep up with that but the banks will have an incentive without a floor on capital uh to simply because they're declining capital uh to provide fewer loans the alternative being to issue new equity which they're which they're loathe to do in normal circumstances you almost never see a bank doing a secondary equity offering uh when it's under stress except in the most extreme cases like uh uh well they have come up and during the financial crisis here in the united states the largest banks were forced to recapitalize uh with a tarp backstop and uh there was a beneficial effect there actually the increased confidence in the u.s economy and in the banking sector entirely uh actually improved bank capitalization or improved share prices of banks uh coming on the uh coming on the market-wide effect of that confidence but normally it should uh it would not be good news for a legacy shareholder to to be forced to raise capital okay so in the remaining five minutes maybe you could speak to uh to margining which is a topic of great interest to the colleagues here yeah so there uh several things have come up in the last few weeks um the volatility is in the equities market has been around four times normal at points much higher even than during the financial crisis uh volatility in treasury u.s treasury markets has been exceptional all asset classes have been extremely um the the the effective margin requirements has been extremely pro cyclical because central counterparties and uh prime brokers and everybody else almost that's handling margin setting has been aggressively uh taking margins both through reduced valuation of collateral and through higher initial margin or haircuts and this has been really hard especially in the market for mortgage related securities and you you probably saw that um Ronin capital which had been speculating on equity volatility was uh was uh liquidated at uh two at two large clearinghouses in the u.s the FICC and the CME um the as far as I understand it the LCH has not increased its margin requirements because it already had reasonably significant margin requirements and haircuts but going forward um if I were in in the eurozone I would be thinking about asset classes that are systemically important um that could if the stress continues uh continue to uh could deteriorate and their pro cyclical effect could be set in there have been cases in the past as everyone uh listening today or watching today knows in which um BTPs the Italian sovereign bonds have been caught in an adverse margin spiral causing a lot of concern currently uh BTPs are out of spread to buttons of the last time I looked a few days ago it was 200 basis points which uh what I actually think is not alarming but uh uh if if uh conditions were to worsen fiscal conditions were to worsen in Italy where the european situation were to worsen and uh uh there's a uh risk off period uh it's quite possible that a pro cyclical effect could set in on that type of an asset that I'm not singling out that particular asset but that's an example that's come up before that's on my mind uh so what can be done well um try to have margins that are already sufficient uh for extreme events or at least moderately extreme events uh some central counterparty set their margin requirements based on something like a thousand-day look-back period which hasn't included enormous amounts of stress and so I would tend to ensure that margins are set um aggressively going right through back through to the last financial crisis or to scenarios that that uh would incorporate um extreme moves and then be ready um with lending of last resort uh to those that are suffering from a short-term extreme margin calls but remain solvent and uh I'm not sure exactly how you reach the non-bank uh players in that market but um I guess that's a subject for another discussion thank you very much Daryl for your interesting presentation um my last question for you is um you spoke now about margins uh bank capital um predator support what do you what do you see is the biggest financial risk also when you compare the current crisis to the global financial crisis what where should we have our eyes on is it what you just ended with the normal banks and where where do you see the concentration of risk I um I see the concentration of risk in the corporate balance sheets um there they tend to be um not part of the financial system I'm not as worried about the shadow banking system as a amplifier of uh systemic risk at least in US markets the ETFs the mutual funds the hedge funds the private equity firms are they're often viewed as significant sources of um of uh financial risk so far at least in the US the banks are also holding up well and that's why I think I think this is a good time to impose um capital requirements or restrict dividends and show repurchases uh to to ensure that they remain a source of strength I view this crisis as remarkably different than the the great financial crisis of 2007 and 2008 because that was a moderate macro shock that was dramatically amplified by fragilities in the financial sector this one is just the opposite it's a massive macro shock that has so far not been amplified significantly in my view by weaknesses uh in uh in financial intermediaries uh and I would just uh I would just want to keep it that way by keeping the financial sector a source of strength I am much less familiar with the situation in Europe I already mentioned my concerns about um a small number of very large banks in Europe and if I were in the European official sector and concerned about risk managing the financial sector I would probably start start there and also consider the potential for um a a pro cyclical the change in credit spreads of a very large sovereign issuer as a as another potential amplifier coming out of finance terrific thanks so much Darrow um I um wish you uh uh that you stay healthy and uh please share those results with us when they're ready so thanks to everyone for joining um tomorrow is uh another webinar a big shift of gears uh there will be Mark Lipschitz from Harvard University will be talking some uh on epidemiology uh probably more important than the economists um and uh that's it for today