FIIE-12: Empirical banking and insurance
Seeking My Supervisor: Evidence from the Centralization of Banking Supervision in Europe
1University of Rome III, Italy; 2European Central Bank; 3The Ohio State University and NBER; 4National Research Council of Italy
We study the behavior of banks around the announcement of the centralization of banking supervision in Europe. On December 2012, European authorities announced that within a year the supervisory responsibilities for mid-size and large banks would be transferred to the European Central Bank. We document that following the announcement banks around the size threshold shrank their assets by contracting their credit book and liquid assets. Then, we use the size threshold to measure the effects of central supervision on banks. After accounting for banks’ strategic behavior, the effects of central supervision are materially larger than previously-thought.
Regulatory Limits to Risk Management
London Business School, United Kingdom
I construct a long history of risk exposures from derivatives using detailed position-level data on interest rate and equity instruments to show that inconsistencies in regulation distort the hedging choices of US life insurers. I exploit a shift in the regulation that provides inconsistent incentives to hedge economically similar products due to differences in the sensitivity of regulatory capital to movements in interest rates. I show that hedging increases and becomes more sensitive to interest rate fluctuations for insurers that underwrite products that became risk sensitive under the new regulation. However, insurers that underwrite products that have similar economic exposures but no regulatory sensitivity to interest rates do not increase hedging but instead increase off-balance sheet transfers through reinsurance. Consistent with regulation limiting hedging choices, tighter regulatory constraints lead to lower hedging. Using actual data on collateral posted to counter-parties, I show that lower hedging is not due to collateral constraints. My findings have implications for the fragility of life insurers going forward as regulation interacts with monetary policy in a way that makes the framework insensitive when interest rates rise.
Can Risk be Shared Across Investor Cohorts? Evidence from a Popular Savings Product
1Ohio State University, United States of America; 2HEC Paris, France
This paper shows how one of the most popular savings products in Europe – life insurance financial products – shares market risk across investor cohorts. Insurers smooth returns by varying reserves in order to offset fluctuations in asset returns. Reserves are shared with new investors so changes in reserves imply changes in future returns, causing redistribution across investor cohorts. Using regulatory and survey data on the 1.4 trillion-euro French market, we estimate this redistribution to be quantitatively large: 1.4% of savings value per year on average, i.e., 17 billion euros or 0.8% of GDP. Even though returns smoothing creates predictability, investor flows barely react to predictable returns. These findings challenge a large theoretical literature that assumes cross-cohort risk sharing is impossible. We develop and provide evidence for a model in which the degree of competition determines the amount of risk sharing that is possible. We provide evidence that investors’ lack of sophistication explains the inelasticity of flows to predictable returns, sustaining the risk sharing mechanism.