36  All speeches are available online at www.bankofengland.co.uk/speeches  36  (c) Models of Financial Stability: In a world of monetary, macroprudential and microprudential policy, all having an impact on the economy and on the financial system, there is an increased onus on developing quantitative frameworks which enable us to understand their impact, individually and collectively, and their interaction (Bank of England (2015b)). That calls for models able to capture quantitatively monetary, financial and regulatory channels of transmission and the feedback mechanisms between them. Progress has been made, in particular since the crisis, in developing macro-models with an explicit financial sector which can capture rich, two-way feedbacks between the economy and financial system (for example, Brunnermeier et al (2012), Brunnermeier and Sannikov (2014)). There has been progress, too, in developing models of systemic risk which assign macroeconomic factors, and within-system feedbacks, a prominent role (Greenwood et al (2014), Cont and Schaanning (2017)). Yet we are still probably in the foothills when developing a unified framework for bringing these factors together in one place, a framework that could capture the rich feedback and amplification mechanisms that operate in practice and a model which could then serve as a test-bed for each of the three arms of policy. Indeed, it could be that a single, Holy Grail, framework is infeasible or indeed undesirable. (d) Future of Stress-Testing: Bank stress testing has evolved considerably since the financial crisis and is now a cornerstone of the regulatory regime in many jurisdictions.
Here we adopt a somewhat different approach. Specifically, we consider how effective various combinations of regulatory constraints would have had been in identifying banks which subsequently failed during the crisis (the “hit rate”), while at the same time avoiding incorrectly signalling stress among banks which survived (the “false alarm rate”). To do this, we exploit a dataset on the pre-crisis balance sheet characteristics of global banks developed by Aikman et al (2014). The dataset includes almost all global banks which had more than $ billion in assets at end-2006 – 116 banks in total across 25 countries. A range of balance sheet metrics are proxied at consolidated (group) level for each of these banks at end-2006. Restricting attention to those banks for which data are available to compute all of risk-weighted capital ratios, leverage ratios and NSFRs reduces the sample to 76 banks. If we focus on risk-weighted capital ratios, leverage ratios and loan-to-deposit (LTD) ratios (as a simplified proxy for the NSFR which captures the ratio of retail loans to retail deposits) the sample size is 96 banks.20 These banks can be divided into those that ‘survived’ and those that ‘failed’ between 2007 and the end of 2009.