Regulating Synchronization, Not Just Solvency: A “Correlation Capital” Framework for Bank Stability

Tabor and Zhang (2020) show that during Lehman, neither higher capital nor liquidity reliably insulated banks; instead, simple market correlation was a powerful predictor of exposure. That is a striking deviation from standard firefighting doctrines (capital view vs. contagion view). In parallel, Goldstein, Kopytov, Shen, and Xiang (2020) show theoretically that heterogeneity in bank assets desynchronizes fire sales and dampens runs. Marrying these insights suggests a new regulatory lever: explicitly measure and cap banks’ exposure to common factors and business-model similarity—think “correlation capital” or “anti-synchronization buffers.” Concretely, supervisors would (i) monitor time-varying market beta/correlation networks and factor exposures, (ii) surcharge capital for highly correlated portfolios, (iii) incentivize structural differentiation (funding mix, duration, sectoral exposures), and (iv) price lender-of-last-resort (LOLR) access partly on co-movement risk. This departs from existing frameworks that treat correlation as a background statistic rather than a supervisory target. If successful, it operationalizes Goldstein et al.’s heterogeneity insight and addresses Tabor–Zhang’s anomaly head-on, potentially lowering the probability and severity of systemwide runs by breaking synchronization channels ex ante.

References:

1. Bank Heterogeneity and Financial Stability. Itay Goldstein, A. Kopytov, Lin Shen, Haotian Xiang (2020). Social Science Research Network.
2. Capital, Contagion, And Financial Crises. N. K. Tabor, Jeffery Y. Zhang (2020).