Agent-based models and financial stability

David Aikman*Bank of England

12th April2013Complexity Models for Systemic Instabilities and Crises

Lorentz Centre

*The views expressed in this presentation are those of the presenter and not necessarily those of the Bank of England. Not for further distribution. 1

Outline

• What are the goals and policy levers of a macroprudential regime?

• What do policy institutions need to know to operationalise a macroprudential regime?– what models and tools are currently being used?

• Where might Agent Based Models fit in?

2

Macroprudential policy

3

Extraordinary Times

2004

Q2 2004

Q3 2004

Q4 2004

2005

2005

Q3 2005

Q4 2005

2006

Q2 2006

Q3 2006

Q4 2006

2007

Q2 2007

Q3 2007

Q4 2007

2008

Q2 2008

Q3 2008

Q4 2008

2009

Q2 2009

Q3 2009

Q4 2009

2010

Q2 2010

Q3 2010

Q4 2010

2011

Q2 2011

Q3 2011

Q4 2011

2012

Q2 2012

90

95

100

105

110

115

120

125

130

Index (2004=100)

15%

UK Euro area US

2004

Q2 2004

Q3 2004

Q4 2004

2005

2005

Q3 2005

Q4 2005

2006

Q2 2006

Q3 2006

Q4 2006

2007

Q2 2007

Q3 2007

Q4 2007

2008

Q2 2008

Q3 2008

Q4 2008

2009

Q2 2009

Q3 2009

Q4 2009

2010

Q2 2010

Q3 2010

Q4 2010

2011

Q2 2011

Q3 2011

Q4 2011

2012

Q2 2012

90

95

100

105

110

115

120

125

130

Index (2004=100)

11%

2004

Q2 2004

Q3 2004

Q4 2004

2005

2005

Q3 2005

Q4 2005

2006

Q2 2006

Q3 2006

Q4 2006

2007

Q2 2007

Q3 2007

Q4 2007

2008

Q2 2008

Q3 2008

Q4 2008

2009

Q2 2009

Q3 2009

Q4 2009

2010

Q2 2010

Q3 2010

Q4 2010

2011

Q2 2011

Q3 2011

Q4 2011

2012

Q2 2012

90

95

100

105

110

115

120

125

130

Index (2004=100)

8%

Source: Thomson Reuters

Simple linear trend used for pre-crisis trends

4

Crisis Cost

Only WWI was more costly

2005 2007 2009 2011 2013 2015 201770

80

90

100

110

120

130

140

IMF forecastGDPPre-crisis trendGreat DepressionWWIWWII

Index: March 2008 = 100

6

Extraordinary Times

Source: GFD

Short-term policy rates

16941695169616971698169917001701170217031704170517061707170817091710171117121713171417151716171717181719172017211722172317241725172617271728172917301731173217331734173517361737173817391740174117421743174417451746174717481749175017511752175317541755175617571758175917601761176217631764176517661767176817691770177117721773177417751776177717781779178017811782178317841785178617871788178917901791179217931794179517961797179817991800180118021803180418051806180718081809181018111812181318141815181618171818181918201821182218231824182518261827182818291830183118321833183418351836183718381839184018411842184318441845184618471848184918501851185218531854185518561857185818591860186118621863186418651866186718681869187018711872187318741875187618771878187918801881188218831884188518861887188818891890189118921893189418951896189718981899190019011902190319041905190619071908190919101911191219131914191519161917191819191920192119221923192419251926192719281929193019311932193319341935193619371938193919401941194219431944194519461947194819491950195119521953195419551956195719581959196019611962196319641965196619671968196919701971197219731974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120120

2

4

6

8

10

12

14

16

18UK US

Percentage Points

2012

7

Extraordinary Times

182118221823182418251826182718281829183018311832183318341835183618371838183918401841184218431844184518461847184818491850185118521853185418551856185718581859186018611862186318641865186618671868186918701871187218731874187518761877187818791880188118821883188418851886188718881889189018911892189318941895189618971898189919001901190219031904190519061907190819091910191119121913191419151916191719181919192019211922192319241925192619271928192919301931193219331934193519361937193819391940194119421943194419451946194719481949195019511952195319541955195619571958195919601961196219631964196519661967196819691970197119721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020110

5

10

15

20

25Percent of GDP

Bank of England balance sheet

What is macroprudential policy?

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• 2 components of systemic risk (Borio and Crockett, 2000)– Cyclical vs structural or time series vs cross section

• Cyclical risks = credit cycle– Upswing amplified by increasing leverage, maturity transformation,

intra-financial system activity, and looser terms and conditions in markets

– Factors go into reverse in downswing

• Structural risks– Systemically important financial institutions (“TBTF”)– Opacity, complexity

Medium-term cycle in real credit and GDP in the UK

9

Macroprudential policy in the UK

• Financial Policy Committee (FPC) set up to take a top-down macroprudential view

• Mandate to “protect and enhance the resilience of the UK financial system”- Subject to that, support

growth and employment

Financial Policy

Committee

Monetary Policy

Committee

Prudential Regulation Authority

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• Includes members of the BoE’s executive, microprudential heads, and externals:– Non-voting HM Treasury representative

Financial Policy Committee’s powers

General Recommendations

• eg to HM Treasury over regulatory perimeter

Comply or Explain Recommendations

• Better suited for tackling structural, cross-sectional risks

Directions

• Binding instructions

11

Microprudential regulators

• Directions carry greater statutory force – so which specific tools?

Which macroprudential tools?

12

• FPC will have immediate powers over – Countercyclical capital buffer (CCB)– Sectoral capital requirements (SCRs)

• Future candidates?– Leverage ratio (in 2018, subject to review in 2017)– Liquidity tool– Margining requirements– LTV / LTI restrictions

Policy Statement: The FPCs’ Powers to Supplement Capital Requirements (2013)

Countercyclical capital buffer (CCB)

• Part of Basel III• Level playing field:

– FPC sets CCB rate for UK lending

– Other countries set national CCB rate for overseas lending

– Mandatory reciprocity in EU up to 2.5% RWAs

13

Sectoral capital requirements (SCRs)• FPC sets temporary additional capital requirements on

– Residential mortgages– Commercial property exposures– Exposures to other financial sector entities

• More targeted/flexible than CCB– Could target risky sub-sectors

• High-LTV mortgages• Financial sector: institutions (eg exposures to SPVs) or

instruments (eg repos)– Could apply to stock of existing loans or just new lending

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What do we need to know to operationalise a macroprudential regime?

15

Risk assessment

process

FPC decisio

ns

Coordination

process

Implementatio

nImpact

16

Policy process

Measuring systemic risk

• What is the current level of systemic risk? How has risk changed in the last quarter?– What summary statistic indicators should we look at?– Should we run more/less stringent stress tests? – What does a “severe but plausible” stress look like?

• Where are the major structural fault-lines in the financial system?– Which institutions/markets/infrastructures are most

systemic?

17

Macroprudential indicators

18

19

Macroprudential indicators

Stress testing - RAMSI

Source: Aikman et al (2009) Source: Burrows, Learmonth and McKeown (2012)

Understanding the impact of policy

• What transmission mechanism would we expect a change in capital requirements to have?– On financial stability – On growth– On different segments of society

• Which tools are best suited to tackling a particular problem?

• How should we think about the interaction across tools? 21

Transmission map

22

Source: Bank of England (2013)

Nelson and Gabor (2013): DSGE framework

Simulating a credit boom under different capital requirements rules

• By leaning against the wind, countercyclical capital requirements can moderate credit cycles

quartersquartersquarters

Solid line: no interventionDashed line: fixed capital requirementDotted line: countercyclical capital requirement responding to credit imbalance

Bridges et al (2013): Estimating the sectoral impact of capital requirements

Impact of a 100 basis point increase in Pillar 2 requirements

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

01 2 3 4 5 6 7 8 9 10

Per cent

Quarters

HH UNSEC HH SECPNFC CRETotal

• Micro-econometric estimates of the impact of micro-prudential standards on credit volumes

Gai et al (2011): Haircuts and liquidity

Source: Gai, Haldane and Kapadia (2011)

Haircut vs frequency of liquidity hoarding in a geometric network

Gai et al (2011): Haircuts and liquidity

Source: Gai, Haldane and Kapadia (2011)

Haircut vs frequency of liquidity hoarding in a geometric network

• Raising liquidity requirements as haircuts fall reduces contagion risk

Where might ABMs fit in?

27

• We’re in exploring mode

• ABMs seem to offer major advantages– allow a more flexible characterisation of expectations

and instability– Allow modelling of detailed features of credit markets

• Caution too: – ABMs seem overparameterised; – question marks too over their story-telling power

How do ABMs fit in?

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• How different might recent macro history have been had we had a countercyclical macroprudential regime in place?

• Which policy lever would have been most potent in pricking the housing bubble? LTVs, LTIs, amortisation periods, capital requirements, interest rates etc

• How does banking market structure affect transmission mechanism of policy?

• Can one construct a simple model of procyclicality based on adaptive expectations? Or on strategic complementarities such as “keeping up with the Goldmans”?

Some concrete suggestions

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• What impact might the shift towards collateralised lending have for financial stability? For growth?

• Under what conditions might the insurance sector be a shock absorber?

• What are the financial stability implications of Vickers? Liikanen? Volcker?

• What are the implications of simple vs complex regulatory rules? Eg leverage vs risk-based capital requirements?

Some concrete suggestions (cont)

30