The project’s starting point and foundation was the development of a novel model to study the resolution of global banks that are “too-big-to-fail” so that their failure would impose significant costs on society, as exemplified by the collapse of Lehman Brothers in 2008. The article “Bank Resolution and the Structure of Global Banks” (Review of Financial Studies, 2019) shows that credible resolution regimes need to take into account the interests of national resolution authorities (for example, they may refuse to make large transfers to other jurisdictions during a resolution). Moreover, they need to reflect the organizational structure and risk profile of the global financial institution. In terms of concrete policy guidance, these results show that resolution is not “one-size-fits-all” and provides a taxonomy of which institutions can be resolved effectively under competing models, such as single-point-of-entry and multiple-point-of-entry resolution. Alongside the work on resolution, the research team developed a new model of the determinants of the debt structure chosen by firms and financial institutions (“A Theory of Multi-Period Debt Structure,” Review of Financial Studies 2019). This research shows how debt structure (i.e. the timing, number, and amount of the promised debt repayments) is determined by a simple trade-off between the termination threat required to make repayments incentive compatible and the desire to avoid early liquidation, helping us understand observed empirical patterns of debt maturity profiles.
Project research then turned to other ways financial regulators and market participants can address externalities generated by firms and financial institutions. One key finding in the article “A Theory of Socially Responsible Investment” (currently R&R at Review of Economics Studies) is that investors can indeed induce banks or firms to behave more responsibly. However, doing so requires that socially responsible investors who engage with a company are willing to make a financial sacrifice. This article also develops an investment criterion, the Social Profitability Index, to help guide the allocation of socially responsible capital. The article “Green Capital Requirements” turns to whether bank regulators can address risks and externalities resulting from climate change. The key finding of this research is that capital regulation can help the banking sector withstand financial risks resulting from climate change, such as extreme weather events, but is much less effective at addressing carbon emissions. Finally, the article “The Tragedy of Complexity” turns to the complexity of financial regulation (and other market outcomes). The setting reflects a typical situation for global banks: they deal with multiple regulators for different parts of their business (e.g. a bank capital regulator, a derivative markets regulator, etc.). This research shows that equilibrium regulation can become overly complex if each regulator considers only outcomes for its specific regulatory mandate. A more holistic view of the regulatory landscape could prevent this outcome.
The project’s research findings were disseminated via several channels, including seminar and conference presentations at academic institutions and presentations to policymakers (ECB, ESRB, Single Resolution Board, Bundesbank, Banque de France, Nederlandsche Bank, Federal Reserve, Office for Financial Research, etc.). To reach a broader audience, key research findings were also disseminated via several non-technical summaries (both written and video), some of which were geared towards interdisciplinary audiences (e.g. the Harvard Law School Forum). Some of the project’s research findings were presented to the ESRB General Board and summarized in an ESRB ASC Insight policy paper, reflecting that, as intended, the project’s research findings have already influenced policy. Finally, two project conferences were held at LSE to facilitate the dissemination and exchange of research findings and ideas.
