October 18, 2021

Financial Regulation

Stability and inclusivity of stablecoins: A conversation with Circle CEO Jeremy Allaire

BY Financial Institutions, Brookings Institute

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Originally published on by Brookings Institute. Link to original report

( 2 mins)
Stability and inclusivity of stablecoins: A conversation with Circle CEO Jeremy Allaire 1

While cryptocurrency has been around for over a decade, it has only gained mainstream popularity recently. Crypto backers see the technology as the way of the future, but its instability leaves others skeptical. As a less volatile alternative to traditional cryptocurrencies, asset-backed stablecoins have joined the market. But as with all new technology, important questions must be resolved before stablecoins could become a more widely accepted part of our financial system.

In this fireside chat with Circle co-founder, chairman, and CEO Jeremy Allaire, we will discuss the rise of stablecoins, the state of regulation of stablecoins, and the potential for greater inclusion through new financial technology (fintech). The dialogue will cut through much of the hype of cryptocurrency – stablecoins in particular – and dive into the two important and distinct issues surrounding stablecoins: financial stability and inclusion.

This event will be part of the Brookings Center on Regulation and Markets’ Series on Financial Markets and Regulation, which looks at financial institutions and markets broadly and explores how regulatory policy affects consumers, businesses, investors, fintech, financial stability, and economic growth.

Viewers can submit questions for speakers by emailing [email protected] or via Twitter using #Stablecoin.

Credit scoring: Improve or eliminate?

( 2 mins) Your credit score plays a major role in your life, impacting your ability to rent an apartment, buy a house, get a credit card, and even how much you pay for auto insurance. These three-digit numbers, graded on a scale that resembles the SAT, have become more accessible to consumers due to recent changes in law, technology, and business. Credit scores are clearly impactful in the lives of Americans, but are they being created accurately, fairly, and with proper regulatory oversight? Is there a better way?
Credit scores are built on credit reports, files kept on most Americans by several large credit reporting bureaus. What are these reports and scores made of? How accurate are they? Who ensures they are fair and accurate?
On December 7, the Center on Regulation and Markets will convene a group of experts to discuss these questions and get to the core of the issue: Are credit scores and credit reports the right method for society to allocate credit? If so, how can they be improved? If not, what should replace them?
Viewers can submit questions for speakers by emailing [email protected] or via Twitter using #CreditScore.

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How Fintech Companies Can Mitigate the Racial Wealth Gap

( 2 mins) On November 2, 2021, Brookings Metro Fellow Kristen Broady testified to the U.S. House Financial Services Committee’s Task Force on Financial Technology, during a hearing titled Buy Now, Pay More Later? Investigating Risks and Benefits of BNPL and Other Emerging Fintech Cash Flow Products.

Broady’s research, as detailed in her written testimony, shows how fintech companies can mitigate racial financial health and wealth gaps that hamper Black and Hispanic families’ financial security through product offerings and policies they put in place. Through technology and automation, they can reduce costs and prices, speed up delivery and increase convenience for underserved populations (Saunders, 2019). Over the past 20 years, fintech companies have provided new ways to capture data, reach broader audiences, and expand access to credit (Strochak, 2017). These companies also have the potential to think differently about policies and programming that can amplify opportunities for Black and minority communities. These private sector innovations can be paired with public policy interventions as well as to address some of the systemic issues that have contributed to the financial health and wealth gaps.
Broady provides several steps that public policymakers can take to increase financial health, including:

Increase investments in the CDFI Fund and make any relevant programs that sunset (like NMTC) permanent.
Create a mandatory financial health curriculum for middle and high schoolers.
Enhance broadband deployment.
Raise minimum wage for companies with over 500 employees.
Foster utilization of the CFPB Special Purpose Credit Program (SPCP).
Revise and revive the SBIC program under the SBA to incentivize private sector investments in BIPOC founders.
Revise SBA 7(a) program to enable fintechs to more easily engage with the program.

The ongoing COVID-19 pandemic has disproportionately impacted the Black community in terms of health and economic effects and shined a light on historical racial wealth and financial health gaps in America. Closing these gaps will require that structural, systemic, and historical economic disparities are addressed through significant public policy changes.
To read Broady’s full testimony, click here. To watch the testimony video, click here.

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Expensive and growing: Loudoun County, Va.

( 7 mins) Navigation

November 4, 2021

Loudoun County is rapidly growing, high-priced county located in a growing, high-priced metropolitan area (Washington, D.C.). All but one of the metro area’s 25 jurisdictions saw positive population growth from 2009 to 2019, and eight jurisdictions fall into the highest cost category (housing value-to-income ratios over 4). Loudoun had the second highest population growth rate in the metro area (0.25).

To develop a more complete picture of housing market conditions in Loudoun County, we draw on a broader set of measures that capture demand, affordability of both owner-occupied and rental housing, and housing quality (Table 1). 

Key findings from this comparison are:

Loudoun County’s population growth rate, 0.35, is more than double that of the average county in the D.C. metro area, and well above the national average. Fast population growth drives the demand for additional housing.The typical household in the Washington D.C. metro area would have to pay 4.9 times their annual income to purchase the median home in Loudoun County. Home value-to-income ratios between 2.5-3.5 are considered healthy.Households earning less than $74,800 (or 78% of the metro area median income) would have difficulty paying rent for the median rental home in Loudoun County, while spending no more than 30% of their income on rent. While most middle-income households in the metro area can afford median rent in Loudoun, most low- and moderate-income households in the region will fall below this threshold.20.2% of renters in Loudoun County are severely cost burdened, meaning they spend more than half their income on rent. That is slightly below the severely cost-burdened share for the entire D.C. metro area and below the national average.The vacancy rate, 3.3%, is very low. Vacancy rates of 6-10% are considered healthy. Low vacancy rates are an indication that supply is not keeping up with demand.The housing stock is quite new relative to the region and country: only 2.8% of homes were built prior to 1940, while 72.6% were built after 1990. New housing is generally higher quality than older homes and more expensive to buy or rent, while having lower maintenance costs.

Recommended policy solutions

Increase housing supply. Housing is expensive because supply has not kept up with demand. High prices and rents, combined with low vacancy rates, indicate that there is unmet demand for housing. It is important to realize that no single county can produce enough housing to meet demand for the entire metro area. Reducing housing costs in expensive, supply-constrained metro areas will require sustained periods of increased housing production across multiple jurisdictions. All high-cost counties within a metro area adopting the strategies described below will have better results than actions by a single county, and county officials can play a leading role in coordinating across jurisdictions and sectors to achieve those goals.

About the Authors

Jenny Schuetz

Senior Fellow – Metropolitan Policy Program, Future of the Middle Class Initiative

Tim Shaw

Associate Director of Policy – Aspen Institute

Make it easier to build small, moderately-priced homes. In expensive metro areas, the size of homes and the amount of land used per home are major factors in the price of individual homes. Single-family detached homes on large lots are the most expensive structure type. Rowhouses, townhomes, two-to-four family homes, and low-rise apartment buildings have lower per-unit development costs than detached homes. These structures are also well suited for rental housing, which is more affordable to moderate-income households, and as “starter homes” for prospective first-time buyers who are currently priced out of the market. Zoning changes that enable smaller, less land-intensive structures to be built as-of-right in more parts of the county will increase the diversity of housing choices and widen the price range of available homes. Companion zoning reforms include relaxing dimensional requirements, such as minimum lot sizes, setbacks, lot coverage, or floor-to-area ratios. Reducing minimum parking requirements and allowing flexibility in design standards can also result in cost savings for newly built homes.

Developing a specific menu of zoning reforms will require an assessment of the county’s current housing types, density, and land availability. Exactly what types of zoning reform will yield the largest supply increases and cost reductions will vary across high-cost counties. A locality that has predominantly detached homes on one-acre lots—typical of many outer suburbs—could realize substantial cost savings by allowing rowhouses on 4,000 square foot lots. For urban counties and inner-ring suburbs that currently have many small-lot homes and little undeveloped land, increasing housing supply may require zoning reforms that allow redeveloping single-family homes, parking lots, or commercial buildings as low- or mid-rise apartments. High-rise construction has the highest per-square-foot costs, and will typically only occur in places with very expensive land and high rents.

Make the development process simpler and shorter. The length of time required to complete development projects, combined with the complexity of the process, are significant factors in the price of newly built housing. Local development processes that make decisions on a case-by-case basis, rather than following consistent, transparent rules, increase the uncertainty and risk of development, which translates into higher costs. Discretionary processes include requiring special permits (also called conditional use permits), site plan reviews, environmental impact reviews, and negotiations over impact fees all add to development costs. Policy changes that reduce development time and complexity include allowing more development as-of-right; integrating approvals for multiple parts of the development process through a one-stop-shopping approach; setting a clear and transparent impact fee schedule; and setting deadlines that require decisions to be made within a set period of time.

Expand vouchers or income supports for low-income renters. Even in communities where enough housing is built to accommodate increased demand, market-rate housing remains unaffordable to many low-income households. The poorest 20% of households everywhere in the U.S. spend more than half their income on housing, well above the threshold HUD defines as affordable. Only one in four eligible households receives federal rental assistance, including vouchers and public housing. Local governments that have sufficient resources can supplement these programs through locally funded rental vouchers or direct income supports. These programs require an ongoing funding source; high-income counties may be able to finance local vouchers from general tax revenues such as property or sales taxes, while lower-income counties will require support from state or federal governments. 

An alternative to household-based subsidies for low-income households is to provide land or financial support for acquisition or construction of affordable housing. Local jurisdictions often own or have significant control over physical assets—such as publicly owned land or airspace—that can be leveraged to increase the availability of affordable housing in the community. Affordable housing trust funds are a flexible financing vehicle to support these activities.

Housing market conditions can vary across submarkets within counties. These policy recommendations are based on an assessment of overall county-level housing metrics. Larger counties often have multiple distinct submarkets with varying affordability, physical quality, infrastructure availability, and development regulations. Cities, towns, and neighborhoods that offer the best economic opportunity—proximity to well-paid jobs, transportation, good schools, and other amenities—often have housing that is too expensive for moderate-income households in the county. Lower-cost communities tend to have older, poorer quality housing. Addressing within-county disparities in housing costs, availability, and quality may require coordinating between independent political entities (e.g., separate cities and towns) in counties with more fragmented local government.

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Focus on bank supervision, not just bank regulation

( 12 mins) Introduction
Last month, the Biden administration made headlines nominating Cornell Law School Professor Saule Omarova to serve as Comptroller of the Currency, a position from which she would oversee the National Banking System. Omarova’s nomination has drawn sharp criticism from the financial services industry, placing her alongside other Biden appointments within financial regulation such as chair of the Securities and Exchange Commission Gary Gensler and director of the Consumer Financial Protection Bureau (CFPB) Rohit Chopra. In each case, the appointments represent a sea change, embracing an approach to regulation that starkly differs from the priorities of the Trump administration. These existing appointments and nominations set the stage for the financial regulatory appointments that the administration has not yet made, including three vacancies on the Federal Reserve — the Fed Chair, Vice Chair for Supervision, and a member of Fed’s Board of Governors —and vacancies at the Federal Deposit Insurance Corp (FDIC), among others.

Debate over these key personnel focus on different visions of regulation, the rules political appointees write that apply to the entire financial system. These include what financial regulation should do about climate change, how it should support under-represented minorities, how it can ensure financial stability, and much more. But the biggest piece of the puzzle is still missing: these agencies and appointments also control the supervision of the financial system, not just its regulation. The difference between these two concepts is very important. If regulation sets the rules of the road, supervision is the process that ensures obedience to these rules (and sometimes to norms that exist outside these rules entirely). Regulation is the highly choreographed process of generating public engagement in the creation of rules. Supervision is the mostly secret process of managing the public and private responsibilities over the risks that the financial system generates.
Political groups organize in support or opposition of various regulatory nominees usually on the basis of the candidates’ perceived regulatory priorities. This is important, but this exclusive focus is a mistake. We, all of us, should pay far more attention to the candidates’ vision and philosophy of supervision. This part of the public vetting is all the more important given the culture of secrecy that surrounds bank supervision. If the public is going to have a say in the kind of supervisory system we should have, then the appointment process is likely the first and last chance to do it.
The question for senators who provide advice and consent necessary to obtain these jobs and for the general public in vetting these candidates for appointment should focus on how these nominees view the tradeoffs inherent in the supervisory process wholly independent of financial regulation. It should focus on what they will do—now—to maintain the culture of supervision or to change it.
What Supervision Means
The idea that supervision and regulation should receive separate priorities is not new. More recently, in contemporary debates, some view supervision as part of a long-standing settlement of monetary questions of special relevance during the Civil War, others as the implementation of regulatory priorities, others as a kind of regulatory monitoring. We view it differently. While many of these conceptions of supervision capture elements of what makes this mode of public governance so unusual, the full picture is more historically contingent and flexibly comprehensive. In our view, supervision is the management of residual risk at the boundary of public and private, the space where private banks and public officials sometimes spar, sometimes collaborate, over responsibility over the financial system. Because risks in the financial system are constantly evolving,  supervision has done the same.
In our work on the history of bank supervision, we offer a typology that captures this range of functions. The typology has two parts. First, supervision functions as a distinct mechanism of legal obedience—a means by which government or private actors seek to alter bank behavior. These mechanisms can be displayed on two axes, between public and private mechanisms, which require the exercise of coercive and non-coercive power.

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In this sense, supervision represents a choice for policymakers, distinct from other alternatives. It is a choice, as the graphic indicates, which authorizes government officials to exercise substantial discretion about how to alter behavior.

Relatedly, what supervision looks like on the ground depends almost entirely on what supervisors think they are trying to accomplish, self-conceptions that divide not only according to an external logic of coercion vs. non-coercion and public vs. private but also an internal one. These self-conceptions operate within a framework with axes spanning punitive to collaborative and from retrospective to prospective, as summarized in Figure 2.

Together, the two typologies indicate a range of possible supervisory actions (external) and the motivations behind such actions (internal). They imply constant trade-offs that supervisors must make as they share risk management responsibilities with participants in the private sector. Despite the extraordinary flexibility that this model of supervision permits, supervisors cannot hold all ground at once and be all things to all people. They must choose and in choosing navigate the often conflicting and sometimes contradictory policy goals placed by Congress on bank supervisors: between safety and soundness and firm competitiveness, between consumer protection and facilitation of financial innovation, between punitive and collaborative approaches, and many others.
When a new public official is appointed to lead one of the major elements of bank supervision, she inherits a toolbox with many different kinds of tools. Members of Congress should ask nominees which tools they prefer for which kinds of jobs, how they view these trade-offs and what they would prioritize, and how they think about alternatives. A short-hand method is to listen for the metaphors nominees use to describe supervision. Do nominees conceive of supervisors as cops on the beat? As fire wardens? As referees and umpires? As compliance officers? As management consultants? Are banks their customers? What tools will they use in accomplishing this vision? What flexibility will they use and under what circumstances?
Who Supervisors Are
Because supervision is fundamentally flexible and evolving, personnel decisions are vital. Supervisory officials—independent of legislative and regulatory processes—constantly reshape the methods, tools, and rationales of supervision in relation to their understandings of financial risk and their evaluation of relevant policy tradeoffs.
History provides rich examples of this process. Looking back to the nineteenth century, comptrollers, and later officials at the Federal Reserve and FDIC, created supervisory bureaucracies with little congressional guidance on how those bureaucracies should be structured. In doing so, they crafted supervisory tools, like standardized examination forms or “schools” of supervision complete with simulated banks getting practice exams, which guided frontline agency staff and bankers through the thicket of managing residual financial risk. Sometimes appointees proved too lenient or too eager to encourage bank chartering and growth at the expense of systemic safety. At other times they proved too harsh, making a theatrical display of cracking down on shoddy bank oversight and in doing so potentially undermining agency credibility with bankers who doubt supervisors’ intentions.
Two recent examples highlight the ways conceptions of supervisory purpose translate into agency action. First, the CFBP emerged in the wake of the 2008 financial crisis in part because existing supervisory agencies tended to sacrifice consumer protection. In its early years, the architects of the CFPB adopted Senator Elizabeth Warren’s “cop on the beat” approach, bringing enforcement lawyers to routine exams even when there was no enforcement action pending. Thus, while other agencies tended to have a collaborative and prospective view of consumer protection—identifying potential problems and helping bankers navigate past them—the CFPB was looking to punish past mistakes and ensure compliance in the future. Bankers struggled to reconcile the agency’s seemingly contradictory positions. The enforcement attorneys left the examination teams, but the tone set from the top continued to be decisively important. Under Democrat Richard Cordray, the CFPB leveled more than $5.5 million in fines a day compared to slightly less than $2 million per day under Trump appointee Kathy Kraninger. The CFPB used civil enforcement aggressively and then didn’t.
Second, the design and implementation of stress tests for the nation’s largest, most systemically important banks has also undergone significant change at the hands of Federal Reserve appointees Dan Tarullo and Randy Quarles. There is much that is purely regulatory about these changes—the pace of stress tests, the reliance on qualitative versus quantitative metrics. But stress tests are ultimately a supervisory activity leaving a huge amount of space for supervisors to shape individual responses to idiosyncratic factors. The question for a new head of an agency is not simply what regulatory rules will govern stress tests but how that official thinks supervisory interactions with individual banks through the stress test process should occur.
Finally, changes in the approach to and methods of supervision seldom spring fully-formed from the head of a Senate-confirmed nominee. Rather, supervisory officials must also develop plans for recruiting, training, and retaining a superb corps of supervisors who can be independent of banks but also expert at managing those relationships to alter bank behavior. In doing so, they face two challenges. First, political appointees necessarily take the helm of an unwieldy ship. Frontline supervisors are in place and working hard in offices across the country. They have methods, routines, and ingrained expectations developed over years of experience and training by distant political appointees whose visions and ideologies of supervision may have been repudiated by a recent election. Supervisory leaders must have a strategy for learning their agencies’ bearing and changing course as necessary. They must do so, secondly, while holding onto experienced staff who may be attracted to the lure of more lucrative private-sector jobs. Retaining and retraining staff is a signature challenge of bank supervision. Senators should inquire about nominees’ plans for doing so.
Ten questions policymakers should ask
If Biden administration officials and senators heed our calls to take supervision seriously, then there are a number of questions they should direct to candidates and nominees alike.

What do you see as the purpose of supervision? What is the supervisory agency’s primary role? What, if any, secondary goals would you emphasize?
How would you plan to balance the inherent trade-offs between these goals? How would this balance differ—if at all—from your predecessor?
Which supervisory tools do you view as most important for accomplishing these goals? How would you use these tools differently than your predecessors?
How do you plan to learn about the existing supervisory culture at your agency? How do you plan to realign that culture around your goals?
How will you recruit, train, and retain supervisory staff?
How will you organize your office such that regulatory and supervisory functions inform each other but do not absorb each other?
How do you plan to work with other bank supervisory agencies—at the federal level, internationally, and in the states? Do you see these other agencies as competitors or collaborators?
What is the relationship between supervision and enforcement in your agency? How will you manage the process through which supervisors learn sensitive information that may be relevant to an enforcement action but that may also be an opportunity to change bank behavior without enforcement?
How will you ensure that bank supervisors do not unduly adopt the point of view of the banks supervised?
How will you ensure that bank supervisors understand the point of view of the banks supervised?

Although regulatory issues such as climate change, federal bank chartering, diversity, and fintech dominate conversations about regulatory appointments, a lack of focus on supervisory issues comes at a great cost to public governance and financial stability. Fights over regulation that ignore supervision may obscure these critical issues more than they illuminate. Bank supervision is an unusual set of institutions, homegrown in the United States and refined by federalism, financial crisis, and historical accident. Supervision remains the most important tool in the federal administrative toolkit for changing the way we understand the business of banking. The process of public governance should give it its due.

The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.
Sean Vanatta is a Lecturer in U.S. Economic and Social History at the University of Glasgow, and an un-paid member of the Federal Reserve Archival System for Economic Research (FRASER) Advisory Board. The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Other than the aforementioned, they are currently not an officer, director, or board member of any organization with an interest in this article.

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Greening Asia for the long haul: What can central banks do?

( 5 mins) Here in Hong Kong, Category 8 typhoons used to be infrequent. Just as floods in Germany and massive wildfires in California were disasters we might see every decade or so. Sadly, this is no longer the case. In one week alone this October, Hong Kong saw two Category 8 typhoons. Earlier this year, floods devastated parts of central Germany, and California saw five of the largest wildfires in its history in 2020. Hong Kong, Germany, and California are not outliers. Extreme weather conditions have been documented in much of the world.

It is widely recognized that climate change implies more frequent and severe weather events, greatly increasing the physical risks to financial and economic stability. In the absence of urgent action, the impact will be widespread and affect most countries, people’s lives and livelihoods, and many industries. The financial sector will be no exception.
Central banks have an important role to play in responding to this challenge. They are interested in these issues for at least three reasons: (i) preserving financial stability as societies move toward reducing their carbon footprints; (ii) diversifying the investments of central bank reserves to minimize unnecessary risks; and (iii) in keeping with their mandates and expertise, providing support to global efforts to achieve the objectives of the Paris climate accord.
The Asia-Pacific region has the largest need for infrastructure investments, around $1.7 trillion per year for developing Asia alone, according to the Asian Development Bank (ADB). Much of this needs to be green investment. It is also among the most vulnerable regions if actions to combat climate change are not taken urgently. At the same time, Asia has, relatively speaking, an extremely large pool of foreign exchange reserves, at around $5.7 trillion by the end of 2019. So, there is a clear case that we need to find a way to bring these two together and do so creatively and safely. The BIS Asian Green Bond Fund is an attempt in this direction.
The fund is designed to provide central banks with opportunities to invest in high quality bonds issued by sovereigns, supranationals, and corporations that comply with strict international green standards. It has two distinct features. First—compared to the BIS’ previous green bond funds—it has a broader group of eligible issuers. It will invest in corporations, including financial firms, because much of the financing in Asia is through commercial banks rather than directly from capital markets. Second, the BIS has engaged with multiple international financial institutions and development finance institutions—the ADB, the Asian Infrastructure Investment Bank, the World Bank, and the International Finance Corporation—to explore opportunities for collaboration to develop a pipeline of green products in the region to invest in. These institutions also have expertise on the ground to ensure that the highest standards are being followed in forming these green investment opportunities to allay concerns about greenwashing.
On the technical side, in line with reserve managers’ appetite for safety, liquidity, and return, all central features of the BIS’s financial products, the Asian Green Bond Fund would be established as a BIS Investment Pool (BISIP), a collective investment scheme structured under Swiss law that is commonly used by the BIS for its fixed income investment products.

While the fund would provide the opportunity for central banks to invest their reserves into greening the economies in the region, the fund is not restricted to investors from Asia. Broad interest to invest in the fund has been expressed by central banks well beyond Asia, reflecting the need of the global central banking community for reserve diversification. Regardless of the domicile of the central bank, central bank investments are generally made with a long-term investment horizon in mind. The fund will thus help channel global central bank reserves to green projects for long-term sustainable growth in the region, which has contributed more than two-thirds of global growth in the past decade.
In light of the fast-changing developments of the green bond market in the Asia-Pacific region, the Asian Green Bond Fund will be an evolving fund, allowing it to be agile and make changes as needed. For example, while the fund will be denominated in U.S. dollars initially, green bonds denominated in Asian local currency will be considered at its first and/or second anniversary. Similarly, while ICMA (International Capital Market Association) and CBI (Climate Bond Initiative) standards will be used at the start, the BIS is open to alternative standards, for example, for bonds funding projects that may not be green at present but are aligned with a transition toward low-carbon activities.
Technologists often say: “Think big, start small and scale fast.” That is how the BIS too plans to approach this endeavor. The Asian Green Bond Fund will represent an important addition to the existing suite of green bond funds at the BIS. As the fund evolves, it will also allow central banks to consider ways of expanding green financial markets, either through diversifying into regional currencies, or by considering the next generation of sustainable bonds adhering to even stricter standards and aligned to the objectives of the Paris accord.

Read More »

Greening Asia for the long haul: What can central banks do?

( 5 mins) Here in Hong Kong, Category 8 typhoons used to be infrequent. Just as floods in Germany and massive wildfires in California were disasters we might see every decade or so. Sadly, this is no longer the case. In one week alone this October, Hong Kong saw two Category 8 typhoons. Earlier this year, floods devastated parts of central Germany, and California saw five of the largest wildfires in its history in 2020. Hong Kong, Germany, and California are not outliers. Extreme weather conditions have been documented in much of the world.

It is widely recognized that climate change implies more frequent and severe weather events, greatly increasing the physical risks to financial and economic stability. In the absence of urgent action, the impact will be widespread and affect most countries, people’s lives and livelihoods, and many industries. The financial sector will be no exception.
Central banks have an important role to play in responding to this challenge. They are interested in these issues for at least three reasons: (i) preserving financial stability as societies move toward reducing their carbon footprints; (ii) diversifying the investments of central bank reserves to minimize unnecessary risks; and (iii) in keeping with their mandates and expertise, providing support to global efforts to achieve the objectives of the Paris climate accord.
The Asia-Pacific region has the largest need for infrastructure investments, around $1.7 trillion per year for developing Asia alone, according to the Asian Development Bank (ADB). Much of this needs to be green investment. It is also among the most vulnerable regions if actions to combat climate change are not taken urgently. At the same time, Asia has, relatively speaking, an extremely large pool of foreign exchange reserves, at around $5.7 trillion by the end of 2019. So, there is a clear case that we need to find a way to bring these two together and do so creatively and safely. The BIS Asian Green Bond Fund is an attempt in this direction.
The fund is designed to provide central banks with opportunities to invest in high quality bonds issued by sovereigns, supranationals, and corporations that comply with strict international green standards. It has two distinct features. First—compared to the BIS’ previous green bond funds—it has a broader group of eligible issuers. It will invest in corporations, including financial firms, because much of the financing in Asia is through commercial banks rather than directly from capital markets. Second, the BIS has engaged with multiple international financial institutions and development finance institutions—the ADB, the Asian Infrastructure Investment Bank, the World Bank, and the International Finance Corporation—to explore opportunities for collaboration to develop a pipeline of green products in the region to invest in. These institutions also have expertise on the ground to ensure that the highest standards are being followed in forming these green investment opportunities to allay concerns about greenwashing.
On the technical side, in line with reserve managers’ appetite for safety, liquidity, and return, all central features of the BIS’s financial products, the Asian Green Bond Fund would be established as a BIS Investment Pool (BISIP), a collective investment scheme structured under Swiss law that is commonly used by the BIS for its fixed income investment products.

While the fund would provide the opportunity for central banks to invest their reserves into greening the economies in the region, the fund is not restricted to investors from Asia. Broad interest to invest in the fund has been expressed by central banks well beyond Asia, reflecting the need of the global central banking community for reserve diversification. Regardless of the domicile of the central bank, central bank investments are generally made with a long-term investment horizon in mind. The fund will thus help channel global central bank reserves to green projects for long-term sustainable growth in the region, which has contributed more than two-thirds of global growth in the past decade.
In light of the fast-changing developments of the green bond market in the Asia-Pacific region, the Asian Green Bond Fund will be an evolving fund, allowing it to be agile and make changes as needed. For example, while the fund will be denominated in U.S. dollars initially, green bonds denominated in Asian local currency will be considered at its first and/or second anniversary. Similarly, while ICMA (International Capital Market Association) and CBI (Climate Bond Initiative) standards will be used at the start, the BIS is open to alternative standards, for example, for bonds funding projects that may not be green at present but are aligned with a transition toward low-carbon activities.
Technologists often say: “Think big, start small and scale fast.” That is how the BIS too plans to approach this endeavor. The Asian Green Bond Fund will represent an important addition to the existing suite of green bond funds at the BIS. As the fund evolves, it will also allow central banks to consider ways of expanding green financial markets, either through diversifying into regional currencies, or by considering the next generation of sustainable bonds adhering to even stricter standards and aligned to the objectives of the Paris accord.

Read More »

Status check: Managing debt sustainability and development priorities through a ‘Big Push’

( 9 mins) Executive Summary
Emerging market and developing economies (EMDEs) have seen development prospects fade in the two years since the onset of COVID-19. Growth turned negative in 2020, is forecast to snap back in 2021, but then revert to a declining trend.1 Investment levels in Latin America and Africa are forecast to remain in the range of 20-25 percent of GDP in the medium term. Outside of Asia, prospects for growth and for convergence with advanced economies are dim. Unlike in advanced economies, the GDP trajectory in EMDEs post-COVID-19 is significantly lower than pre-COVID-19 estimates; 31 developing countries may have lower levels of GDP per capita in 2025 than in 2019.

Meanwhile, general government debt levels in EMDEs have risen by 9 percentage points of GDP. At current low levels of world interest rates, the debt service implications are manageable for most countries, but risks remain if inflation causes major central banks to raise interest rates. As a result, EMDEs are under pressure to cut public spending, even in face of higher needs to respond to the pandemic.
The present trajectory, therefore, is one of slow growth, low investment and public spending, and rising debt service burdens in many, if not most, EMDEs. There is significant risk that this trajectory will prove unsustainable for economic, social, or political reasons.
The current trajectory is also highly inefficient, with high-return projects in EMDEs left unfunded due to debt overhang considerations, and highly inequitable, with poor and vulnerable countries and populations left to manage the pandemic with limited support.

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Global aspirations for a universal transformation to a low-carbon economy and a “just transition” are not likely to be met in the current baseline scenario for the global economy because EMDEs are central to both objectives and without additional public spending neither transition will happen.
There is another way forward, one that offers better prospects for global growth and equity, with lower risks of systemic debt defaults. Rather than relying on austerity, it is a path that seeks to accelerate green, inclusive and resilient growth. This path takes advantage of historically low prices of energy, made possible by technological advances in renewables, and of historically low interest rates on international capital markets to undertake a “big push” to transform economic structures and accelerate growth.

There are four key ingredients of the “big push” approach.
First, a set of investments needs to be identified to achieve the desired transformations. The country-by-country analytical work on which this paper draws suggests that EMDEs (ex-China) should be increasing their investment rates by about 3-4 percent of GDP above pre-pandemic levels in order to provide adequate growth of zero-carbon energy and infrastructure, sustainable agriculture, forestry, and land use (AFOLU), adaptation and resilience, and human capital. This translates into incremental annual investments of about $1.3 trillion by 2025, and more thereafter.
Second, a financing plan is needed that is aligned with the types of expenditures being considered. The proposal advanced here is for an even split between domestic and external financing. The latter, in turn, can be mobilized from ODA, multilateral and other official financial institutions, and private capital. These are not fully fungible—each has a role to play.
Domestic resource mobilization is a core component of any investment strategy. It is essential for general purpose financing like human capital and recurrent spending on nature and adaptation. Thus, a key part of the big push strategy is improving developing country tax administrative capacity, while reducing fossil fuel subsidies. The needed increase of 2.7 percentage points of GDP is well within the range of possibilities identified by the IMF. Additional revenues may accrue from new regulations governing base erosion and profit shifting (BEPS), but the current G-20 agreement may not yield much for many developing countries in the medium term. Stronger international efforts are also needed to stem illicit financial flows and encourage greater information sharing between tax authorities in advanced and developing countries.
Concessional finance is needed to help poor countries, to promote equity, and to incentivize countries to invest adequately in global public goods that have international spillovers—for example, mitigation, nature, and pandemic preparedness. Bilateral donors have already pledged to double climate finance from $30 billion to $60 billion, and agreement seems likely on a $100 billion IDA20 replenishment by year’s end. However, more is needed. ODA in 2020 from DAC countries amounted to only 0.32 percent of their GDP. A new collective agreement is needed to back the transformational change that is proposed here. Our approach calls for a 50 percent increase in concessional finance relative to 2019 levels, an incremental $96 billion by 2025. This is equivalent to 0.15 percent of donor GDP.
Our proposal is not just a call for more ODA, defined as money designed to promote the welfare of developing countries. As the past year has shown, weak health systems and pandemic surveillance in one country have global repercussions. The point is that provision of concessional finance for implementation of global public goods in developing countries benefits advanced countries as well as developing countries. Our proposal calls for a mixture of ODA and a fair funding of global public goods on concessional terms.
Multilateral finance and other official finance. Multilateral development banks (MDBs) are able to offer lower cost loans at longer maturities than other lenders, making debt more sustainable. They could stretch their current balance sheets by making better use of callable capital and reforming statutory lending limits—perhaps freeing up headroom for an additional $750 billion to $1.3 trillion of loans. Other reform efforts, including balance sheet optimization, greater risk pooling, greater use of blended finance and guarantee facilities, and asset sales could also help expand MDB lending. Our proposal calls for MDBs to triple their lending levels, from $63 billion in 2019 to $189 billion by 2025.
Private capital can be attracted into sustainable infrastructure projects, which generate revenue streams to cover equity returns and the debt service associated with the project. There are currently both supply and demand side obstacles that have prevented the scale-up of greater private investment in developing countries: a lack of bankable projects, and a limited appetite for long term investments with perceived high risk. New institutional innovations, such as the development of country platforms, standardized processes, and experience with risk-mitigating official finance suggest that a rapid ramp-up in private finance is now feasible. Our proposal calls for an approximate doubling of the 2019 level of private finance for infrastructure in developing countries by 2025. MDBs and other development partners will need to be more proactive to mobilize and catalyze private finance on this scale.
The third element of the “big push” is policy and institutional reform in countries to ensure that investments generate maximum returns. These reforms are partly sectoral (carbon equivalent taxes and removal of fossil fuel subsidies are clear examples) and partly cross-cutting. Reducing corruption and bureaucratic red tape, increasing voice and citizen participation, and consideration of gender issues are examples. Many countries have the capacity to absorb far larger amounts of investment than they actually receive. To illustrate, the IMF’s public investment management assessment scores African countries at 4.4 compared to 4.5 for Asia. Yet Asian countries profitably invest 15 percentage points of GDP more than African countries. The dispersion in scores is large, suggesting some countries have considerable room to improve, but equally suggesting that other countries have reasonable policy frameworks in place already.
The fourth and final element of the “big push” is international coordination. A “big push” will not work without a concerted global plan and agreement. In some cases, this reflects the need for global policy coordination—the BEPS agreement, proposed measures for carbon taxes and standardized approaches in blended finance are examples. More fundamentally, however, international coordination is needed to change mindsets about appropriate policy. No finance minister in an EMDE will support a big push strategy if this is not approved by the international financial institutions that s/he will rely on to provide needed resources. No private investor will willingly provide funds into a high-debt situation without clarity on how debt work-out mechanisms will operate. No civil society advocate will support a big push without greater transparency on how funds will be spent by their government.
All this suggests the need for a process of consensus building around how to scale up cross-border financing. There are many ongoing discussions and ideas for strengthening parts of the system, but less has been done on forging a common approach so that all parts of the system act in a linked-up fashion. There must be international oversight of core recovery programs, the building of consensus around which individual actors can orient their actions, and the inclusion of regional partners to augment the voice of developing countries. Transparency will be a crucial pillar of any financial architecture reform effort.
The response to COVID-19 thus far has bought us some time, but it is far from enough. The world faces a host of looming medium-term challenges in addition to the short-term imperatives of managing COVID-19 and ensuring recovery. Foremost among these are a low-carbon transition, increasing biodiversity and nature needs, growing adaptation and resilience challenges, and a large deficit in human capital spending. Big problems require big solutions. A stepped-up “big push” investment of around $1.3 trillion in EMDEs by 2025 would enable greater spending on all of these global challenges. A financing strategy must match the right source of financing to each of these needs and deliver this in a timely fashion to enable transformational change over the next decade. The moment is ripe for greater international collaboration and action. In 2020, advanced economies spent over $12 trillion on domestic response efforts. In the next decade, we must mobilize a similarly ambitious effort to tackle a global response.
Download the full working paper

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Status check: Managing debt sustainability and development priorities through a ‘Big Push’

( 9 mins) Executive Summary
Emerging market and developing economies (EMDEs) have seen development prospects fade in the two years since the onset of COVID-19. Growth turned negative in 2020, is forecast to snap back in 2021, but then revert to a declining trend.1 Investment levels in Latin America and Africa are forecast to remain in the range of 20-25 percent of GDP in the medium term. Outside of Asia, prospects for growth and for convergence with advanced economies are dim. Unlike in advanced economies, the GDP trajectory in EMDEs post-COVID-19 is significantly lower than pre-COVID-19 estimates; 31 developing countries may have lower levels of GDP per capita in 2025 than in 2019.

Meanwhile, general government debt levels in EMDEs have risen by 9 percentage points of GDP. At current low levels of world interest rates, the debt service implications are manageable for most countries, but risks remain if inflation causes major central banks to raise interest rates. As a result, EMDEs are under pressure to cut public spending, even in face of higher needs to respond to the pandemic.
The present trajectory, therefore, is one of slow growth, low investment and public spending, and rising debt service burdens in many, if not most, EMDEs. There is significant risk that this trajectory will prove unsustainable for economic, social, or political reasons.
The current trajectory is also highly inefficient, with high-return projects in EMDEs left unfunded due to debt overhang considerations, and highly inequitable, with poor and vulnerable countries and populations left to manage the pandemic with limited support.

Related Content

Global aspirations for a universal transformation to a low-carbon economy and a “just transition” are not likely to be met in the current baseline scenario for the global economy because EMDEs are central to both objectives and without additional public spending neither transition will happen.
There is another way forward, one that offers better prospects for global growth and equity, with lower risks of systemic debt defaults. Rather than relying on austerity, it is a path that seeks to accelerate green, inclusive and resilient growth. This path takes advantage of historically low prices of energy, made possible by technological advances in renewables, and of historically low interest rates on international capital markets to undertake a “big push” to transform economic structures and accelerate growth.

There are four key ingredients of the “big push” approach.
First, a set of investments needs to be identified to achieve the desired transformations. The country-by-country analytical work on which this paper draws suggests that EMDEs (ex-China) should be increasing their investment rates by about 3-4 percent of GDP above pre-pandemic levels in order to provide adequate growth of zero-carbon energy and infrastructure, sustainable agriculture, forestry, and land use (AFOLU), adaptation and resilience, and human capital. This translates into incremental annual investments of about $1.3 trillion by 2025, and more thereafter.
Second, a financing plan is needed that is aligned with the types of expenditures being considered. The proposal advanced here is for an even split between domestic and external financing. The latter, in turn, can be mobilized from ODA, multilateral and other official financial institutions, and private capital. These are not fully fungible—each has a role to play.
Domestic resource mobilization is a core component of any investment strategy. It is essential for general purpose financing like human capital and recurrent spending on nature and adaptation. Thus, a key part of the big push strategy is improving developing country tax administrative capacity, while reducing fossil fuel subsidies. The needed increase of 2.7 percentage points of GDP is well within the range of possibilities identified by the IMF. Additional revenues may accrue from new regulations governing base erosion and profit shifting (BEPS), but the current G-20 agreement may not yield much for many developing countries in the medium term. Stronger international efforts are also needed to stem illicit financial flows and encourage greater information sharing between tax authorities in advanced and developing countries.
Concessional finance is needed to help poor countries, to promote equity, and to incentivize countries to invest adequately in global public goods that have international spillovers—for example, mitigation, nature, and pandemic preparedness. Bilateral donors have already pledged to double climate finance from $30 billion to $60 billion, and agreement seems likely on a $100 billion IDA20 replenishment by year’s end. However, more is needed. ODA in 2020 from DAC countries amounted to only 0.32 percent of their GDP. A new collective agreement is needed to back the transformational change that is proposed here. Our approach calls for a 50 percent increase in concessional finance relative to 2019 levels, an incremental $96 billion by 2025. This is equivalent to 0.15 percent of donor GDP.
Our proposal is not just a call for more ODA, defined as money designed to promote the welfare of developing countries. As the past year has shown, weak health systems and pandemic surveillance in one country have global repercussions. The point is that provision of concessional finance for implementation of global public goods in developing countries benefits advanced countries as well as developing countries. Our proposal calls for a mixture of ODA and a fair funding of global public goods on concessional terms.
Multilateral finance and other official finance. Multilateral development banks (MDBs) are able to offer lower cost loans at longer maturities than other lenders, making debt more sustainable. They could stretch their current balance sheets by making better use of callable capital and reforming statutory lending limits—perhaps freeing up headroom for an additional $750 billion to $1.3 trillion of loans. Other reform efforts, including balance sheet optimization, greater risk pooling, greater use of blended finance and guarantee facilities, and asset sales could also help expand MDB lending. Our proposal calls for MDBs to triple their lending levels, from $63 billion in 2019 to $189 billion by 2025.
Private capital can be attracted into sustainable infrastructure projects, which generate revenue streams to cover equity returns and the debt service associated with the project. There are currently both supply and demand side obstacles that have prevented the scale-up of greater private investment in developing countries: a lack of bankable projects, and a limited appetite for long term investments with perceived high risk. New institutional innovations, such as the development of country platforms, standardized processes, and experience with risk-mitigating official finance suggest that a rapid ramp-up in private finance is now feasible. Our proposal calls for an approximate doubling of the 2019 level of private finance for infrastructure in developing countries by 2025. MDBs and other development partners will need to be more proactive to mobilize and catalyze private finance on this scale.
The third element of the “big push” is policy and institutional reform in countries to ensure that investments generate maximum returns. These reforms are partly sectoral (carbon equivalent taxes and removal of fossil fuel subsidies are clear examples) and partly cross-cutting. Reducing corruption and bureaucratic red tape, increasing voice and citizen participation, and consideration of gender issues are examples. Many countries have the capacity to absorb far larger amounts of investment than they actually receive. To illustrate, the IMF’s public investment management assessment scores African countries at 4.4 compared to 4.5 for Asia. Yet Asian countries profitably invest 15 percentage points of GDP more than African countries. The dispersion in scores is large, suggesting some countries have considerable room to improve, but equally suggesting that other countries have reasonable policy frameworks in place already.
The fourth and final element of the “big push” is international coordination. A “big push” will not work without a concerted global plan and agreement. In some cases, this reflects the need for global policy coordination—the BEPS agreement, proposed measures for carbon taxes and standardized approaches in blended finance are examples. More fundamentally, however, international coordination is needed to change mindsets about appropriate policy. No finance minister in an EMDE will support a big push strategy if this is not approved by the international financial institutions that s/he will rely on to provide needed resources. No private investor will willingly provide funds into a high-debt situation without clarity on how debt work-out mechanisms will operate. No civil society advocate will support a big push without greater transparency on how funds will be spent by their government.
All this suggests the need for a process of consensus building around how to scale up cross-border financing. There are many ongoing discussions and ideas for strengthening parts of the system, but less has been done on forging a common approach so that all parts of the system act in a linked-up fashion. There must be international oversight of core recovery programs, the building of consensus around which individual actors can orient their actions, and the inclusion of regional partners to augment the voice of developing countries. Transparency will be a crucial pillar of any financial architecture reform effort.
The response to COVID-19 thus far has bought us some time, but it is far from enough. The world faces a host of looming medium-term challenges in addition to the short-term imperatives of managing COVID-19 and ensuring recovery. Foremost among these are a low-carbon transition, increasing biodiversity and nature needs, growing adaptation and resilience challenges, and a large deficit in human capital spending. Big problems require big solutions. A stepped-up “big push” investment of around $1.3 trillion in EMDEs by 2025 would enable greater spending on all of these global challenges. A financing strategy must match the right source of financing to each of these needs and deliver this in a timely fashion to enable transformational change over the next decade. The moment is ripe for greater international collaboration and action. In 2020, advanced economies spent over $12 trillion on domestic response efforts. In the next decade, we must mobilize a similarly ambitious effort to tackle a global response.
Download the full working paper

Read More »

What does success at the Glasgow climate conference (COP26) look like?

( 2 mins) Global leaders are gathering in Glasgow in the coming weeks as the United Kingdom hosts the 26th United Nations Climate Change Conference of the Parties, known as COP26. As global temperatures continue to rise, the calls for action on addressing the climate change threat rise as well. On this episode of the Brookings Cafeteria podcast, a leading expert on global climate policy and financing for climate action, Amar Bhattacharya, senior fellow in the Center for Sustainable Development at Brookings, shares his perspective on what will make COP26 successful, what sustainable and inclusive approaches to climate mitigation look like, and what gives him hope for the future.
Also on this episode, John McArthur, senior fellow and director of the Center for Sustainable Development, reflects on the Center’s first anniversary, noting significant accomplishments of Center scholars and looking ahead to projects to come, including the “17 Rooms” podcast. Listen to this segment also on SoundCloud.

Related Content

Climate Change
Our last, best chance on climate

Amar Bhattacharya and Nicholas Stern
Wednesday, September 8, 2021

Follow Brookings podcasts here or on iTunes, send feedback email to [email protected], and follow us and tweet us at @policypodcasts on Twitter.
The Brookings Cafeteria is part of the Brookings Podcast Network.

Amar Bhattacharya

Senior Fellow – Global Economy and Development, Center for Sustainable Development

Fred Dews

Managing Editor, Podcasts and Digital Projects

Twitter
publichistory

Read More »

What does success at the Glasgow climate conference (COP26) look like?

( 2 mins) Global leaders are gathering in Glasgow in the coming weeks as the United Kingdom hosts the 26th United Nations Climate Change Conference of the Parties, known as COP26. As global temperatures continue to rise, the calls for action on addressing the climate change threat rise as well. On this episode of the Brookings Cafeteria podcast, a leading expert on global climate policy and financing for climate action, Amar Bhattacharya, senior fellow in the Center for Sustainable Development at Brookings, shares his perspective on what will make COP26 successful, what sustainable and inclusive approaches to climate mitigation look like, and what gives him hope for the future.
Also on this episode, John McArthur, senior fellow and director of the Center for Sustainable Development, reflects on the Center’s first anniversary, noting significant accomplishments of Center scholars and looking ahead to projects to come, including the “17 Rooms” podcast. Listen to this segment also on SoundCloud.

Related Content

Climate Change
Our last, best chance on climate

Amar Bhattacharya and Nicholas Stern
Wednesday, September 8, 2021

Follow Brookings podcasts here or on iTunes, send feedback email to [email protected], and follow us and tweet us at @policypodcasts on Twitter.
The Brookings Cafeteria is part of the Brookings Podcast Network.

Amar Bhattacharya

Senior Fellow – Global Economy and Development, Center for Sustainable Development

Fred Dews

Managing Editor, Podcasts and Digital Projects

Twitter
publichistory

Read More »