Economic Policy Review Advisory Board

Federal Reserve Bank of New York 2 2000 mber ly u u J N 6 e Economic m lu o V Policy Review 1 Listening to Loan Officers: The Impact of C rcial Credit Standards on Lending and Output Cara S. Lown, Donald P. Morgan, and Sonali Rohatgi 17 The Timing and Funding of Fedwire Funds Transfers James McAndrews and Samira Rajan 33 Capital Ratios as Predictors of Bank Failure Arturo Estrella, Sangkyun Park, and Stavros Peristiani 53 Support for Resistance: Technical Analysis and Intraday Exchange Rates Carol Osler ECONOMIC POLICY REVIEW ADVISORY BOARD EDITOR Andrew Abel Richard J. Herring Wharton, University of Pennsylvania Wharton, University of Pennsylvania Paul B. Bennett Ben Bernanke Robert J. Hodrick Princeton University Columbia University ASSOCIATE EDITORS Timothy Bollerslev R. Glenn Hubbard Duke University Columbia University Linda S. Goldberg Charles Calomiris Christopher M. James Kenneth N. Kuttner Columbia University University of Florida, Gainesville Hamid Mehran Stephen G. Cecchetti Kose John Philip E. Strahan Ohio State University New York University Richard Clarida Edward Kane Columbia University Boston College EDITORIAL STAF F Francis X. Diebold Deborah Lucas Valerie LaPorte New York University Northwestern University Mike De Mott Franklin Edwards Richard Lyons Columbia University University of California, Berkeley Susan Szarkowitz Henry S. Farber Frederic S. Mishkin Princeton University Columbia University PRODUCTION STAFF Mark Flannery Maurice Obstfeld Carol Perlmutter University of Florida, Gainesville University of California, Berkeley Mark Gertler Raghuram G. Rajan David Rosenberg New York University University of Chicago Jane Urry Gary Gorton Kenneth Rogoff Wharton, University of Pennsylvania Princeton University James D. Hamilton Christopher Sims University of California, San Diego Yale Universit y Bruce E. Hansen Kenneth D. West University of Wisconsin University of Wisconsin John Heaton Stephen Zeldes Northwestern University Columbia University The ECONOMIC POLICY REVIEW is published by the Research and Market Analysis Group of the Federal Reserve Bank of New York. Articles undergo a comprehensive refereeing process prior to their acceptance in the REVIEW. The views expressed in the articles are those of the individual authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. www.ny.frb.org/rmaghome Federal Reserve Bank of New York Economic Policy Review July 2000 Volume 6 Number 2 Contents Articles: 1 Listening to Loan Officers: The Impact of Commercial Credit Standards on Lending and Output Cara S. Lown, Donald P. Morgan, and Sonali Rohatgi Over most of the last thirty-three years, the Federal Reserve has polled a small number of bank loan officers about their moves to tighten or ease commercial credit standards. Although the Senior Loan Officer Opinion Survey uses a small sample and gathers only qualitative information, it proves to be a useful tool in predicting changes in commercial lending and output. The authors find a strong correlation between tighter credit standards and slower loan growth and ou tput, even after controlling for credit demand and other predictors of lending and output. The analysis also shows that the loan officer reports can help predict narrower measures of business activity, including inventory investment and industrial production. 17 The Timing and Funding of Fedwire Funds Transfers James McAndrews and Samira Rajan An examination of the Federal Reserve’s Fedwire Funds Transfer service reveals that the highest concentration of funds-transfer value occurs in the late afternoon. The authors attribute this activity peak to attempts by banks (and their customers) to coordinate payment timing more closely. By synchronizing payments, banks can take advantage of incoming funds to make outgoing payments— especially during periods of heavy payment traffic. Conversely, during off-peak times, banks must rely more on account balances or overdrafts to fund payments, which increases the cost of making payments. For this reason, banks time their payments to coincide with an activity peak, thereby reinforcing the peak. 33 Capital Ratios as Predictors of Bank Failure Arturo Estrella, Sangkyun Park, and Stavros Peristiani The current review of the 1988 Basel Capital Accord has put the spotlight on the ratios used to assess banks’ capital adequacy. This article examines the effectiveness of three capital ratios—the first based on leverage, the second on gross revenues, and the third on risk-weighted assets—in forecasting bank failure over different time frames. Using 1988-93 data on U.S. banks, the authors find that the simple leverage and gross revenue ratios perform as well as the more complex risk-weighted ratio over one- or two-year horizons. Although the risk-weighted measures prove more accurate in predicting bank failure over longer horizons, the simple ratios are less costly to implement and could function as useful supplementary indicators of capital adequacy. 53 Support for Resistance: Technical Analysis and Intraday Exchange Rates Carol Osler “Support” and “resistance” levels—points at which an exchange rate trend may be interrupted and reversed—are widely used for short-term exchange rate forecasting. Nevertheless, the levels’ ability to predict intraday trend interruptions has never been rigorously evaluated. This art icle undertakes such an analysis, using support and resistance levels provided to customers by six firms active in the foreign exchange market. The author offers strong evidence that the levels help to predict intraday trend interruptions. However, the levels’ predictive power is found to vary across the exchange rates and firms examined. Cara S. Lown, Donald P. Morgan, and Sonali Rohatgi Listening to Loan Officers: The Impact of Commercial Credit Standards on Lending and Output • The Federal Reserve’s Senior Loan Officer hen the Federal Open Market Committee (FOMC) Opinion Survey offers information useful in Weased monetary policy on October 15, 1998, it noted the forecasting commercial loan growth and “growing caution by lenders and unsettled conditions in overall economic activity. financial markets more generally. .” Sharply higher spreads on commercial paper and corporate bonds made it clear that • Statistical analysis reveals a strong correlation the U.S. markets were unsettled, but how could policymakers between loan officers’ reports of tighter credit tell if lenders were growing more cautious? Commercial bank standards and slowdowns in commercial loans are rarely traded, so loan rates are not instantly lending and output. observable. Moreover, the “price” of commercial bank credit extends beyond the interest rate; bank loan officers set • Reported changes in credit standards can standards that firms must clear even before the rate is also help predict narrower measures of negotiated. These standards are decided in thousands of bank business activity, including inventory offices across the country, so how can the Federal Reserve tell if investment and industrial production. lenders are growing cautious? For that matter, how can we tell if banks are “throwing caution to the wind” and easing • The chain of events following a tightening standards? We ask. Once each quarter, participants in the of standards resembles a “credit crunch”: Federal Reserve’s Senior Loan Officer Opinion Survey are Commercial loans plummet, output falls, asked whether their standards for making commercial loans and the federal funds rate is lowered. have “tightened” or “eased” since the previous quarter. Loan officers at approximately sixty large domestic banks across the United States participate in the survey. Although we praise the survey in the end, there certainly are reasons to doubt it. The survey is entirely qualitative, for one: respondents provide opinions, not hard numbers. The small Cara S. Lown is a research officer, Donald P. Morgan an economist, and The authors thank John Duca, Ken Kuttner, Phil Strahan, Egon Zakrajšek, Sonali Rohatgi an assistant economist at the Federal Reserve Bank participants in the Domestic Research/Banking Studies Seminar Series, and of New York. two anonymous referees. The views expressed are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. FRBNY Economic Policy Review / July 2000 1 sample size is another concern: with more than 8,000 banks in federal funds rate, which we identify with the stance of the United States, can sixty bankers tell us anything useful monetary policy, declines. about aggregate lending? Reporting bias is yet another concern; In the next section, we describe the Senior Loan Officer respondents in general may try to please surveyors, but the bias Opinion Survey and relate the motivation for the survey to with this survey may be more severe because the loan officers the credit “availability doctrine” of the 1950s and to more work at banks that are likely supervised by the Federal Reserve. recent theories of quantity credit rationing. We then examine Loan officers who suspect, albeit wrongly, that their input will the correlation between the changes in commercial credit be used for supervisory purposes may shade their responses standards reported by loan officers in the survey and various accordingly. measures of credit availability, including lending itself. Because of these concerns, this article examines the value of We follow this discussion with a look at the

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