Oliver Burrows Financial Stability, Bank of England Discussion for session 4 24 February 2014 ESRC Conference on Diversity in Macro

Credit by type: purchasing existing assets vs financing activity UK-resident banks’ sterling lending to UK residents, % of GDP

Credit by type: purchasing existing assets vs financing activity UK-resident banks’ sterling lending to UK residents, % of GDP

The UK financial system (stripped down)

The UK financial system, with cross-border inter- bank connections

The UK financial system, with cross-border inter- bank connections and derivatives

As a per cent of GDP in 1978

As a per cent of GDP in 2012

Growth of savings vs asset price inflation: insurance companies and pension funds

MPC/FPC awayday on credit System-wide network effects / liquidity risk Monetary circuits

MPC/FPC awayday on credit System-wide network effects / liquidity risk Monetary circuits

MPC/FPC awayday on credit System-wide network effects / liquidity risk Monetary circuits

MPC/FPC awayday on credit System-wide network effects / liquidity risk Monetary circuits

If demand for household and PNFC deposits grows in line with income, then lending can be accommodated out of deposit growth… MPC/FPC awayday on credit System-wide network effects / liquidity risk Monetary circuits

If demand for household and PNFC deposits grows in line with income, then lending can be accommodated out of deposit growth…...but if it grows faster, the financial network can become larger and more fragile MPC/FPC awayday on credit System-wide network effects / liquidity risk

The balance sheets (maroon is cash, blue is debt, orange is loans, green is equity, purple is contingent claims and red is other)

Leverage

Maturity Transformation

Network risks: concentration

The UK financial system (stripped down)

END

Side issue 1: the size of the UK banking system UK-resident bank assets are large by international comparison......in part because of the UK’s role as a financial sector which means there are lots of foreign-owned banks in the UK......and that UK-owned banks’ global balance sheets are large. Banking sectors by residency Sources: BIS, national central banks

Side issue 1: the size of the UK banking system UK-resident bank assets are large by international comparison......in part because of the UK’s role as a financial sector which means there are lots of foreign-owned banks in the UK......and that UK-owned banks’ global balance sheets are large. London’s share of selected global markets Sources: BIS, national central banks

Side issue 1: the size of the UK banking system UK-resident bank assets are large by international comparison......in part because of the UK’s role as a financial sector which means there are lots of foreign-owned banks in the UK......and that UK-owned banks’ global balance sheets are large. Resident banks by ownership Sources: BIS, national central banks

Side issue 1: the size of the UK banking system UK-resident bank assets are large by international comparison......in part because of the UK’s role as a financial sector which means there are lots of foreign-owned banks in the UK......and that UK-owned banks’ global balance sheets are large. Global balance sheets by country of ownership Sources: BIS, national central banks

The UK financial system, with cross-border inter- bank connections

UK-resident banks’ derivatives-book breakdown 27

UK-resident banks’ derivatives-book breakdown 28

UK-resident banks’ derivatives-book breakdown 29

Bank A Corporate Hedging example Tailored IR + FX hedge

Bank A Corporate Bank B FX risk Tailored IR + FX hedge IR risk Hedging example

Bank A Corporate Bank B FX risk IR risk +10 Hedging example Tailored IR + FX hedge

Bank A Corporate Bank B FX risk IR risk +10 Bank C IR risk FX risk Hedging example Tailored IR + FX hedge

Bank A Corporate Bank B FX risk IR risk Bank C IR risk FX risk +5 Hedging example Tailored IR + FX hedge

Bank A Corporate Bank B FX risk IR risk Bank C IR risk FX risk +5 Hedging example Tailored IR + FX hedge

Bank A Corporate Bank B FX risk IR risk Bank C IR risk FX risk +5 = Hedging example Tailored IR + FX hedge

Bank A Corporate Bank B FX risk IR risk Bank C IR risk FX risk +5 = Gross MV = 6020 Hedging example Tailored IR + FX hedge

The UK financial system base case

As a per cent of GDP in 2012

As a per cent of GDP in 1959

As a per cent of GDP in 1978

As a per cent of GDP in 2012

Flow of funds Access to payment systemsMitigate risksProvision of credit

The balance sheets (maroon is cash, blue is debt, orange is loans, green is equity, purple is contingent claims and red is other)

Risk metrics

Leverage

Maturity Transformation

Network risks: concentration

Network risks: interconnections ?

? Chart 1: Stylised map of UK-resident banks’ £3.1 trillion repo market activity as of end-2011 From Paul Baverstock’s note on Mapping UK- resident banks’ repo activity Chart 8: Contagious links (orange arrows) and exposed banks (red dots) From Tomo Ota’s note on Mapping the UK interbank system – some insights from a new dataset

UK-resident deposit-takers 51

UK-resident deposit-takers 52

UK-resident deposit-takers 53

Example of further work on repo Breakdown balance sheets further by underlying collateral- type Use this to assess the impact of - increased hair-cuts - falls in asset prices (e.g. due to a snap-back in yields) on the value of sectors’ repo books and resultant collateral shortfalls (to maintain current levels of funding via repo).

Network risks: research agenda Gabaix (2011): The granular origins of aggregate fluctuations – heavy-tailed distributions of firm size invalidate usual assumptions on idiosyncratic shocks to firms not affecting aggregate output Acemoglu et al (2012): The network origins of aggregate fluctuations – network structure of the real economy affects aggregate output => How does the network structure of the financial system propagate real and financial shocks?

Disaggregate data

UK Private Sector 4,794,105 UK Private Sector 4,794,105 Companies 1,341,115 Companies 1,341,115 Partnerships 448,020 Partnerships 448,020 Sole Proprietors 3,004,970 Sole Proprietors 3,004,970 Large 6,390 Large 6,390 Small and Medium 1,334,725 Small and Medium 1,334,725 Private 1,334,258 Private 1,334,258 Public 467 Public 467 Private 5,705 Private 5,705 Public 685 Public 685 Bond Issuers 36 Bond Issuers 36 Non-Bond Issuers 5669 Non-Bond Issuers 5669 Bond Issuers 175 Bond Issuers 175 Non-Bond Issuers 510 Non-Bond Issuers 510 Breakdown of the UK corporate sector

Data issues

Back to today - Data quality (green=good ONS data, amber=made-up ONS data, and white=no ONS data)

Divisional coverage of the financial system

Key takeaways and questions In principle, the maps are very useful for understanding and assessing risk across the system has thrown up some interesting issues – such as differences within the PNFC sector (public/private; PE-owned; property/non-property) has been used in PE and CRE analysis – see QBs if interested is being used in work on cumulative impact of regulation But very serious data issues quality of much of the ONS data is very poor – care needed interpreting PNFC and OFI accounts in particular coverage is too narrow – work ongoing with ONS to improve and very little data on interconnections between sectors (“who-to- whom” data)