Research
Working papers
Flash loans: lending without trust, collateral, or risk (with Farshid Abdi and Cornelius Johnson)
Flash loans are a means of unsecured lending in the decentralised finance (DeFi) system. A smart contract creates conditionality so that, if the borrower does not repay, the flash loan is never advanced. Such a contract is infeasible in traditional finance. This arrangement eliminates credit risk for the lender, but also means the borrower can costlessly default. Therefore, a flash loan insures a trader against loss: if the payoff from a trade would have been negative, then the trade does not settle. We examine the effect on market liquidity of arbitrage financed by flash loans. Bid-ask spreads widen when there are more flash-financed traders, but a market can exist so long as there are some uninformed traders. However, if flash-financing is cheap enough, then spreads are so wide that informed traders drop out of the market, and private information is no longer incorporated into prices. Our predictions are testable using blockchain data.
A monetary model of cryptocurrency
Paper coming soon! Click here for poster.
I show price formation for cryptocurrencies is very different to standard assets. Blockchains have limited settlement space, creating competition between users of the currency. I adapt this insight into a Lagos-Wright model featuring a settlement constraint and a financial market. Speculative activity can crowd out monetary usage. This means higher speculative demand for cryptocurrencies can reduce prices, contrary to standard economic models. Crowding-out also raises the riskiness of investing in cryptocurrency, explaining high observed price volatility.
An earlier version of this paper, which used a different model, was circulated under the title 'Blockchain structure and cryptocurrency prices'. Click here for a non-technical summary. Also published as a 'Bank Underground' blog post.
Media coverage: Irish Independent, CoinDesk, New Money Review, Bitcoin Exchange Guide.
Relationship lending when banks are fragile (with Alan Morrison and Joel Shapiro)
We present a novel demand-side explanation for credit crunches following financial crises, based on an adverse selection problem. When the probability of distress at a relationship lender is high, borrowers insure against the risk of not being financed by choosing smaller projects that other, less informed, lenders are willing to lend against. We show that, when the probability of distress reaches a critical level, there is a discontinuous drop in the borrower's chosen project size, and in welfare. This means that even a small shock to financial stability can have very large real consequences.
Interest rate risk at US credit unions (with Grant Rosenberger)
Rising interest rates have prompted concerns about losses on bank assets, especially following the failure of Silicon Valley Bank (SVB) in March 2023. In this working paper, we examine whether US credit unions could be subject to similar losses as banks and analyze how their regulatory capital would be affected. We estimate that after realizing losses from assets that have decreased in value and not yet been sold the overall net worth of the credit union industry would have fallen by 40 percent in 2023:Q1. Unrealized losses were most severe at the largest credit unions. Nonetheless, the bulk of deposits at credit unions were insured, suggesting limited risk of an SVB-style run. In addition, credit union deposit rates are relatively insensitive to market interest rates, providing credit unions with a hedge against a rising rate environment. Overall, credit unions’ balance sheet positions seemed to be more resilient to unrealized interest rate risk than banks’.
Media coverage: California and Nevada credit union news
The sterling unsecured loan market during 2006-08: insights from network theory (with Anne Wetherilt and Kimmo Soramäki)
We model the unsecured overnight market in the United Kingdom as a network of relationships and examine how the structure has changed over the recent period of crisis.
Bank of England working paper 2010, no. 398.
Publications in referred journals
Uncovering retail trading in Bitcoin: the impact of COVID-19 stimulus checks (with Anantha Divakaruni)
Management Science 2024, vol. 70, no. 4, pages 2066-2085.
In April 2020, the US government sent stimulus cheques directly to households, as part of its measures to address the COVID-19 pandemic. The modal cheque was for $1,200. We find a significant increase in Bitcoin buy trades for size $1,200 during the period immediately following cheque disbursement.
Media coverage: Bloomberg, The Atlantic, Motley Fool, CoinDesk, Coin Bureau.
Awarded Best Paper at the 2021 Cryptocurrency Research Conference.
The Lightning Network: turning Bitcoin into money (with Anantha Divakaruni)
Finance Research Letters 2023, vol. 52, no. 103480.
We find a robust and significant association between adoption of the Lightning Network and reduced blockchain congestion. This improvement cannot be explained by other factors, such as changes in speculative demand for Bitcoin.
Media coverage: Bitcoin Magazine, CoinGeek.
Earlier version published as Federal Reserve Bank of Cleveland working paper no 22-19.
Centralized netting in financial networks (with Rodney Garratt)
Journal of Banking & Finance 2020, vol. 112, no. 105270.
We consider how the introduction of centralized netting in financial networks affects total netted exposures between counterparties. Our results can explain why, in the absence of regulation, traders in a derivatives network do not develop central clearing.
Earlier version published as Federal Reserve Bank of New York staff report no. 717.
Cited in SEC ruling on Euroclear Bank.
A mechanism for LIBOR (with Brian Coulter and Joel Shapiro)
Review of Finance 2018, vol. 22, no. 2.
We introduce a new method for constructing LIBOR that is based solely on transactions and produces an unbiased estimator of the true rate. We explore how this approach applies to other financial benchmarks and how it works even in markets in which there are few transactions.
Coverage in The Times and Al Jazeera.
Harvard Law School Forum on Corporate Governance and Financial Regulation article.
Identification of over and under provision of liquidity in real-time payment systems (with Edward Denbee and Rodney Garratt)
Journal of Financial Market Infrastructures 2015, vol. 4, no. 2.
Liquidity provision in real-time payment systems has social benefits, as it greases the wheels of the system. We devise methods for measuring liquidity contributions and assessing whether systemic inequality is greater than would be expected from random payment flows.
Earlier versions published as Bank of England working paper no. 513 and in Hellqvist and Laine (2012), 'Diagnostics for the financial markets – computational studies of payment system'.
The role of counterparty risk in CHAPS following the collapse of Lehman Brothers (with Evangelos Benos and Rodney Garratt)
International Journal of Central Banking 2014, vol. 10, no. 4.
We show that, in the two months following the Lehman Brothers failure, banks in the main UK payments system made payments at a slower pace than before the failure. We find that this slowdown is related to concerns about counterparty default risk, thereby identifying a new channel through which counterparty risk manifests itself in financial markets.
2012 Vox article.
Earlier version published as Bank of England working paper no. 451.
Policy articles and book contributions
Why worry about financial exclusion? (with Paola Boel)
Federal Reserve Bank of Cleveland Economic Commentary 2022-09.
Should policymakers aim to expand access to bank accounts? When financial exclusion is due to frictions that prevent banking from operating efficiently, intervention may be justified. Applying simple economic principles, we highlight such potential frictions, and we assess their importance using insights from data and the academic and policy literature.
Unbanked in America: a review of the literature (with Paola Boel)
Federal Reserve Bank of Cleveland Economic Commentary 2022-07.
We review the recent literature on the causes and consequences of financial exclusion—that is, the lack of bank account ownership—in the United States. We examine existing work in a range of fields, including economics, finance, public policy, and sociology.
Coverage in Signal Cleveland.
The cheque republic: money in a modern economy with no banks (with Ben Norman)
‘Bank Underground’ blog 2016.
What happens when a country’s banking system shuts down? In 1970, the main banks in the Republic of Ireland closed for several months. We find that contemporary material from the Bank of England's archive suggests that this event may have been more economically damaging than has been thought. We compare this incident to the closure of Greek banks in 2015.
Coverage in Business Insider UK.
Market discipline, public disclosure and financial stability (with Rhiannon Sowerbutts)
Chapter in ‘The handbook of post-crisis financial modelling’ 2015, eds Haven, Molyneux, Wilson, Fedotov and Duygun, Palgrave Macmillan.
Inadequate disclosure by commercial banks has been cited as a contributing factor to the global financial crisis. We discuss the economic literature and the limits of market discipline.
Who benefits from the implicit subsidy? (with Rhiannon Sowerbutts)
‘Bank Underground’ blog 2015.
The expectation that governments will bail out troubled banks provides an implicit subsidy to the banking system, worth as much as £100bn in the UK. Who exactly benefits from this subsidy? Our analysis suggests that bank owners and staff extract the most benefit, with customers and creditors gaining relatively little.
Disclosure and market discipline (with Rhiannon Sowerbutts and Ilknur Zer)
Bank of England Quarterly Bulletin 2013, vol. 53, no. 4.
We measure public disclosure by banks over time. Internationally, disclosure has improved since 2000. However, more information alone is not sufficient to guarantee that market discipline fulfills its role.
Shorter version in a 2014 Vox article.
The economics of large-value payments and settlement: theory and policy issues for central banks (contributor)
Oxford University Press 2009.
First comprehensive guide to the theory and practice of large-value payment systems.