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

0%

20%

40%

60%

80%

100%

120%

140%

160%Other Financial InstitutionsSecured Household (banks)Unsecured HouseholdLBO targetsCommercial Real Estate'core' PNFC

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

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20%

40%

60%

80%

100%

120%

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180%Other Financial InstitutionsSecured Household (banks)Secured Household (BSocs)Unsecured HouseholdLBO targetsCommercial Real Estate'core' PNFC

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

-

500

1,000

1,500

2,000

2,500

1987 1992 1997 2002 2007 2012

revaluation

net purchases

MPC/FPC awayday on credit

A L

A L

A L

Household Sector

Household 1

Bank sector

Household 2

System-wide network effects / liquidity risk

Monetary circuits

MPC/FPC awayday on credit

A L

+ deposit + loan

A L

+ loan + depositA L

Household 2

Household 1

Household Sector

Bank sector

System-wide network effects / liquidity risk

Monetary circuits

MPC/FPC awayday on credit

A L

- deposit + loan+ house

A L

+ loan + deposit A L

+ deposit-house

Household Sector

Household 1

Bank sector

Household 2

System-wide network effects / liquidity risk

Monetary circuits

MPC/FPC awayday on credit

A L

+ loan

A L

+ loan + deposit A L

+ deposit

Household Sector

Household 1

Bank sector

Household 2

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

A L A L

+ loan + deposit + deposit + loan

Household SectorBank sector

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

A L A L

+/- 2* deposit + 2 * loan +/- deposit + annuity

+ RoW bond

A L

+ 2 * loan + deposit A L+ RMBS

+ deposit

+ annuity A L

+/- deposit + short-term paper

+ RMBS

Household Sector

Insurer

Bank sector

Households 2:N

SIV

RoW

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.

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Total assets

Credit to the domestic non-bank private sector

Per cent of annual GDP

(b)

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

0510

1520253035

404550

UK US

Japa

n

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y

Sing

ap.

H. K

ong

Cross-border bank lending

FX turnover

OTC derivative turnover

GDP

global share, %

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

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1,000

Icel

and

Net

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o A

rea

Spai

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UK

Ital

y US

Foreign-owned

Domestic-owned

Per cent of annual GDP

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

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Total bank assets

Largest three banks' assets

Largest five banks' assets

Per cent of annual GDP

Sources: BIS, national central banks

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

UK-resident banks’ derivatives-book breakdown

27

0

1,000

2,000

3,000

4,000

5,000

6,000

Liabilities Assets Liabilities Assets

Commodity & Equity SterlingCredit EuroFX USD & OtherInterest Rate

£bn

UK-resident banks’ derivatives-book breakdown

28

£bn Liabilities AssetsTotal Derivatives 5,383 5,414UK Resident:

UK banks 949 955

ICPFs 129 133

Other UK financial corporations 257 187

UK PNFCs 29 47

CCP - Swapclear 1,296 1,332

Foreign-Resident:

Foreign-resident offices 548 540

Foreign-resident Banks 1,498 1,585

Hedge Funds 243 241

Other foreign-residents 408 368

CCP - DTCC 26 26

UK-resident banks’ derivatives-book breakdown

29

£bn Liabilities AssetsTotal Derivatives 5,383 5,414UK Resident:

UK banks 949 955

ICPFs 129 133

Other UK financial corporations 257 187

UK PNFCs 29 47

CCP - Swapclear 1,296 1,332

Foreign-Resident:

Foreign-resident offices 548 540

Foreign-resident Banks 1,498 1,585

Hedge Funds 243 241

Other foreign-residents 408 368

CCP - DTCC 26 26

Bank A Corporate

Hedging exampleTailored IR + FX hedge

Bank A Corporate

Bank B

FX risk

Tailored IR + FX hedge

IR risk

Hedging example

Bank A Corporate

Bank B

FX riskIR risk

+10

+10

Hedging exampleTailored IR + FX hedge

Bank A Corporate

Bank B

FX riskIR risk

+10

+10

Bank C

IR risk

FX risk

Hedging exampleTailored IR + FX hedge

Bank A Corporate

Bank B

FX riskIR risk

+20

+15

Bank C

IR risk

FX risk

+5

Hedging exampleTailored IR + FX hedge

Bank A Corporate

Bank B

FX riskIR risk

+20

+15

Bank C

IR risk

FX risk

+5

Bank A Bank B Bank C CorporateA L A L A L A L20 15 5 20

515

Hedging exampleTailored IR + FX hedge

Bank A Corporate

Bank B

FX riskIR risk

+20

+15

Bank C

IR risk

FX risk

+5

Bank A Bank B Bank C CorporateA L A L A L A L20 15 5 20

515

Banks CorporateA L A L

40 20 20=

Hedging exampleTailored IR + FX hedge

Bank A Corporate

Bank B

FX riskIR risk

+20

+15

Bank C

IR risk

FX risk

+5

Bank A Bank B Bank C CorporateA L A L A L A L20 15 5 20

515

Banks CorporateA L A L

40 20 20=

Gross MV = 60 20

Hedging exampleTailored IR + FX hedge

The UK financial system base case

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

?

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

£bn Reverse Repo RepoTotal 1142 960

intra-group 191 191BoE 0 13UK-resident banks 68 62UK-resident non-banks 245 156

o/w CCP 148 116o/w other* 97 40

UK-PNFC and sovereign 3 9Non-residents: 635 531

Banks 409 345Non-banks 226 186o/w CCP 16 10o/w MMF's 0 54o/w Foreign CB's 0 8o/w other* 210 114

£bn Reverse Repo RepoOther Non-Banks* 308 154o/w Hedge Funds 74 37o/w Sovereigns 23o/w Corporates 10o/w ICPF's 11o/w Other AMs 6o/w Residual** 234 67

UK-resident deposit-takers

52

£bn Reverse Repo RepoTotal 1142 960

intra-group 191 191BoE 0 13UK-resident banks 68 62UK-resident non-banks 245 156

o/w CCP 148 116o/w other* 97 40

UK-PNFC and sovereign 3 9Non-residents: 635 531

Banks 409 345Non-banks 226 186o/w CCP 16 10o/w MMF's 0 54o/w Foreign CB's 0 8o/w other* 210 114

£bn Reverse Repo RepoOther Non-Banks* 308 154o/w Hedge Funds 74 37o/w Sovereigns 23o/w Corporates 10o/w ICPF's 11o/w Other AMs 6o/w Residual** 234 67

UK-resident deposit-takers

53

£bn Reverse Repo RepoTotal 1142 960

intra-group 191 191BoE 0 13UK-resident banks 68 62UK-resident non-banks 245 156

o/w CCP 148 116o/w other* 97 40

UK-PNFC and sovereign 3 9Non-residents: 635 531

Banks 409 345Non-banks 226 186o/w CCP 16 10o/w MMF's 0 54o/w Foreign CB's 0 8o/w other* 210 114

£bn Reverse Repo RepoOther Non-Banks* 308 154o/w Hedge Funds 74 37o/w Sovereigns 23o/w Corporates 10o/w ICPF's 11o/w Other AMs 6o/w Residual** 234 67

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).

Disaggregate data

UK Private Sector4,794,105

Companies1,341,115

Partnerships448,020

Sole Proprietors3,004,970

Large6,390

Small and Medium1,334,725

Private1,334,258

Public467

Private5,705

Public685

Bond Issuers36

Non-Bond Issuers5669

Bond Issuers175

Non-Bond Issuers510

investment

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investment

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investment

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employment

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investment

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employment

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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)