nep-ban New Economics Papers
on Banking
Issue of 2018‒08‒13
twenty papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. The banking systems of Germany, the UK and Spain form a spatial perspective: The UK case By Flögel, Franz; Gärtner, Stefan
  2. Half-full or Half-empty? Financial Institutions, CDS Use, and Corporate Credit Risk By Cecilia Caglio; R. Matthew Darst; Eric Parolin
  3. Financial Inclusion and Contract Terms: Experimental Evidence From Mexico By Sara G. Castellanos; Diego Jiménez Hernández; Aprajit Mahajan; Enrique Seira
  4. Life below zero: bank lending under negative policy rates By Heider, Florian; Saidi, Farzad; Schepens, Glenn
  5. Pushed Past the Limit? How Japanese Banks Reacted to Negative Interest Rates By Gee Hee Hong; John Kandrac
  6. Measuring the Capital Shortfall of Large U.S. Banks By Eric Jondeau; Amir Khalilzadeh
  7. Transparency and Market Discipline: Evidence from the Russian Interbank Market By Francois Guillemin; Maria Semenova
  8. Financial Intermediation, Capital Accumulation and Crisis Recovery By Hans Gersbach; Jean-Charles Rochet; Martin Scheffel
  9. Quantile-Based Risk Sharing By Paul Embrechts; Haiyan Liu; Ruodu Wang
  10. Empirical assessment of alternative structural methods for identifying cyclical systemic risk in Europe By Jorge E. Galán; Javier Mencía
  11. Persistent and transient inefficiency: Explaining the low efficiency of Chinese big banks By Fungáčová, Zuzana; Klein, Paul-Olivier; Weill, Laurent
  12. The banking systems of Germany, the UK and Spain form a spatial perspective: The German case By Flögel, Franz; Gärtner, Stefan
  13. Bank Resolution and the Structure of Global Banks By Bolton, Patrick; Oehmke, Martin
  14. Assessing the impact of Basel III on bank behaviour: A micro-founded approach By Jérémy Pépy; Benjamin Williams
  15. Does response time predict withdrawal decisions? Lessons from a bank-run experiment By Hubert Janos Kiss; Ismael Rodriguez-Lara; Alfonso Rosa-Garcia
  16. Capital Regulation under Price Impacts and Dynamic Financial Contagion By Zachary Feinstein
  17. Move a Little Closer? Information Sharing and the Spatial Clustering of Bank Branches By Shusen Qi; Ralph De Haas; Steven Ongena; Stefan Straetmans
  18. Bank Lending Standards, Loan Demand, and the Macroeconomy: Evidence from the Emerging Market Bank Loan Officer Survey By Sangyup Choi
  19. Measuring risks to UK financial stability By Aikman, David; Bridges, Jonathan; Burgess, Stephen; Galletly, Richard; Levina, Iren; O'Neill, Cian; Varadi, Alexandra
  20. A General Equilibrium Appraisal of Capital Shortfall By Eric Jondeau; Jean-Guillaume Sahuc

  1. By: Flögel, Franz; Gärtner, Stefan
    Abstract: As expected, this comparison of the German and the UK banking systems shows substantial differences between the countries. In the UK, savings banks disappeared long ago and other regional banks have never become important in lending to business. Instead, the five large commercial banks dominate business lending. Hardly any short-distance lenders still currently exist in the UK according to our qualitative distance classification of banks and other financial providers for small firms. The closure of the very last local savings bank in 2017 marks the preliminary end of traditional regional banking in the UK and indicates that the financial crisis indirectly challenges small and regional banks disproportionally. This is because the low interest rate environment and more complex banking regulations affect small and regional banks more, making it almost impossible for small standalone banks to survive. Problems in small firm finance have been discussed in the UK at least since the 1990s and government support has been given to community development financial institutions and credit unions in order to close the financial gap for small firms. Due to the financial crisis, access to finance has become increasingly difficult for small businesses, especially in remote regions, so the debate on how to reinvent local banking (and hence how to improve access to finance) has gathered momentum. Three options are under discussion. The first is to create in one stroke a regional and public banking group with a substantial market share by restructuring the Royal Bank of Scotland into a network of local and public banks. The second is to recreate regional banks on an entirely new basis with the help of a new association that would provide economies of scale and knowledge in order to enable local people to create their local banks. The third is to establish local banking by upscaling other financial providers, such as credit unions and responsible finance providers. Whether any of these options are realistic is difficult to say right now. One additional option that could improve SME finance are the so-called challenger banks, a type of bank unknown in Germany. These banks differ in terms of ownership, business model and regional market orientation, yet our findings suggest that they tend to operate on a more decentralised (short-distance) business model than large commercial banks.
    Keywords: comparing banking systems,SME finance in the UK,decentralised vs. centralised banking
    JEL: D43 E21 G01 G21 G38 R12
    Date: 2018
  2. By: Cecilia Caglio; R. Matthew Darst; Eric Parolin
    Abstract: We construct a novel U.S. data set that matches bank holding company credit default swap (CDS) positions to detailed U.S. credit registry data containing both loan and corporate bond holdings to study the effects of banks' CDS use on corporate credit quality. Banks may use CDS to mitigate agency frictions and not renegotiate loans with solvent but illiquid borrowers resulting in poorer measures of credit risk. Alternatively, banks may lay off the credit risk of high quality borrowers through the CDS market to comply with risk-based capital requirements, which does not impact corporate credit risk. We find new evidence that corporate default probabilities and downgrade likelihoods, if anything, are slightly lower when banks purchase CDS against their borrowers. The results are consistent with banks using CDS to efficiently lay off credit risk rather than inefficiently liquidate firms.
    Keywords: Bank lending ; Credit default swaps ; Risk management
    JEL: G2 G21 G23
    Date: 2018–07–19
  3. By: Sara G. Castellanos; Diego Jiménez Hernández; Aprajit Mahajan; Enrique Seira
    Abstract: This paper provides evidence on the difficulty of expanding access to credit through large institutions. We use detailed observational data and a large-scale countrywide experiment to examine a large bank's experience with a credit card that accounted for approximately 15% of all first-time formal sector borrowing in Mexico in 2010. Borrowers have limited credit histories and high exit-risk – a third of all study cards are defaulted on or canceled during the 26 month sample period. We use a large-scale randomized experiment on a representative sample of the bank's marginal borrowers to test whether contract terms affect default. We find that large experimental changes in interest rates and minimum payments do little to mitigate default risk. We also use detailed data on purchases and payments to construct a measure of bank revenue per card and find it is generally low and difficult to predict (using machine learning methods), perhaps explaining the bank's eventual discontinuation of the product. Finally, we show that borrowers generating a favorable credit history are much more likely to switch banks providing suggestive evidence of a lending externality. Taken together these facts highlight the difficulty of increasing financial access using large formal sector financial organizations.
    JEL: D14 D18 D82 G20 G21
    Date: 2018–07
  4. By: Heider, Florian; Saidi, Farzad; Schepens, Glenn
    Abstract: We show that negative policy rates affect the supply of bank credit in a novel way. Banks are reluctant to pass on negative rates to depositors, which increases the funding cost of high-deposit banks, and reduces their net worth, relative to low-deposit banks. As a consequence, the introduction of negative policy rates by the European Central Bank in mid-2014 leads to more risk taking and less lending by euro-area banks with greater reliance on deposit funding. Our results suggest that negative rates are less accommodative, and could pose a risk to financial stability, if lending is done by high-deposit banks. JEL Classification: E44, E52, E58, G20, G21
    Keywords: bank balance-sheet channel, bank risk-taking channel, deposits, negative interest rates, zero lower bound
    Date: 2018–08
  5. By: Gee Hee Hong; John Kandrac
    Abstract: In this paper, we investigate how negative interest rate policy (NIRP) introduced in January 2016 by the Bank of Japan (BoJ) affected Japanese banks' lending and risk taking behavior. The BoJ's announcement was an unexpected surprise to the market and was followed by a sharp drop in equity prices of Japanese financial firms. We exploit the cross-sectional variation in the change of share prices on the day of the announcement to measure banks' differential exposure to NIRP. We show that more exposed banks increased their credit and took on more risk compared to banks that were less exposed to negative rates.
    Keywords: Bank lending rates;Central banks and their policies;Monetary transmission mechanism;Negative interest rates;Asia and Pacific;Economic conditions;Japan;monetary transmission, bank risk taking, lending channel, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2018–06–13
  6. By: Eric Jondeau (University of Lausanne and Swiss Finance Institute); Amir Khalilzadeh (University of Lausanne)
    Abstract: We develop a new methodology to measure the capital shortfall of commercial banks during a market downturn. The measure, which we call stressed expected loss (SEL), adopts the structure of the individual bank's balance sheet. SEL is defined as the difference between the market value of assets in the stress scenario and the book value of the deposits and short-term debt of the bank. We estimate the probability of default and the SEL of the 31 largest commercial banks in the U.S. between 1996 and 2016. The probability of default in a market downturn was as high as 25%, on average, between 2008 and 2012. It is now much lower and close to 5%, on average. SEL was very high (between $250 and $350 billion) during the subprime crisis. In 2016, it is close to $200 billion.
    Keywords: Systemic Risk, Capital Shortfall, Stress Test, Multi-factor Model
    JEL: C32 G01 G21 G28 G32
    Date: 2018–02
  7. By: Francois Guillemin (National Research University Higher School of Economics); Maria Semenova (National Research University Higher School of Economics)
    Abstract: This paper investigates the role of bank voluntary disclosure, as a source of information about risk, in the interbank market. Using data on the 179 largest Russian banks over the period of 2004-2013 we test whether the ability to attract interbank loans is sensitive to various transparency indices such as those disclosing bank risks, board composition, or even corporate event details. We show that larger but riskier banks – at least in terms of credit risk – behave more transparently and disclose more. The article is also the first to provide evidence that the ability to attract funds in the interbank market is positively correlated with the degree of transparency. This result is stable for various aspects of disclosure.
    Keywords: banks, interbank market, disclosure, transparency, banking governance
    JEL: G21 P2
    Date: 2018
  8. By: Hans Gersbach (ETH Zurich, IZA Institute of Labor Economics, CESifo (Center for Economic Studies and Ifo Institute), and Centre for Economic Policy Research (CEPR)); Jean-Charles Rochet (University of Zurich, University of Toulouse I, and Swiss Finance Institute); Martin Scheffel (University of Cologne)
    Abstract: This paper integrates banks into a two-sector neoclassical growth model to account for the fact that a fraction of firms relies on banks to finance their investments. There are four major contributions to the literature. First, although banks’ leverage amplifies shocks, the endogenous response of leverage to shocks is an automatic stabilizer that improves the resilience of the economy. In particular, financial and labor market institutions are essential factors that determine the strength of this automatic stabilization. Second, there is a mix of publicly financed bank re-capitalization, dividend payout restrictions, and consumption taxes that stimulates a Pareto-improving rapid build-up of bank equity and accelerates economic recovery after a slump in the banking sector. Third, the model replicates typical patterns of financing over the business cycle: procyclical bank leverage, procyclical bank lending, and countercyclical bond financing. Fourth, the framework preserves its analytical tractability wherefore it can serve as a macro-banking module that can be easily integrated into more complex economic environments.
    Keywords: Financial Intermediation, Capital Accumulation, Banking Crisis, Macroeconomic Shocks, Business Cycles, Bust-Boom Cycles, Managing Recoveries
    JEL: E21 E32 F44 G21 G28
    Date: 2018–01
  9. By: Paul Embrechts (Swiss Federal Institute of Technology Zurich and Swiss Finance Institute); Haiyan Liu (Michigan State University); Ruodu Wang (University of Waterloo)
    Abstract: We address the problem of risk sharing among agents using a two-parameter class of quantile-based risk measures, the so-called Range-Value-at-Risk (RVaR), as their preferences. The family of RVaR includes the Value-at-Risk (VaR) and the Expected Shortfall (ES), the two popular and competing regulatory risk measures, as special cases. We first establish an inequality for RVaR-based risk aggregation, showing that RVaR satisfies a special form of subadditivity. Then, the Pareto-optimal risk sharing problem is solved through explicit construction. To study risk sharing in a competitive market, an Arrow-Debreu equilibrium is established for some simple, yet natural settings. Further, we investigate the problem of model uncertainty in risk sharing, and show that, generally, a robust optimal allocation exists if and only if none of the underlying risk measures is a VaR. Practical implications of our main results for risk management and policy makers are discussed, and several novel advantages of ES over VaR from the perspective of a regulator are thereby revealed.
    Keywords: Value-at-Risk, Expected Shortfall, risk sharing, regulatory capital, robustness, Arrow-Debreu equilibrium
    Date: 2018–01
  10. By: Jorge E. Galán (Banco de España); Javier Mencía (Banco de España)
    Abstract: The credit-to-GDP gap, as proposed by the Basel methodology, has become the reference measure for the activation of the Countercyclical Capital Buffer (CCyB) due to its simplicity and good predictive power for future systemic crises. However, it presents several shortcomings that could lead to suboptimal decisions in many countries if it were used as an automatic rule for the activation of the CCyB. We study to what extent the purely statistical nature of the Basel methodology is responsible for these undesired effects by considering potential complementary credit gap measures that incorporate economic fundamentals. Specifically, we analyse the performance of two alternative (semi-) structural models that may account for these factors. We assess the proposed measures using time series data from the 70’s for six European countries and compare them to the Basel gap. We find that the proposed models provide more accurate early warning signals of the build-up of cyclical systemic risk than the Basel gap, as well as lower upward and downward biases after rapid changes in fundamentals. Nonetheless, results evidence heterogeneity in the ability from different models and specifications across countries to forewarn about future crises. This result evidences the differences in the financial cycles and their drivers across countries, and shows the importance in macroprudential policy of considering flexible approaches that adapt to national specificities.
    Keywords: Credit imbalances, cyclical systemic risk, early-warning models, macroprudential policy, model-based indicators.
    JEL: C32 E32 E58 G01 G28
    Date: 2018–08
  11. By: Fungáčová, Zuzana; Klein, Paul-Olivier; Weill, Laurent
    Abstract: Considering the evidence that China’s five largest state-owned banks (the Big Five) suffer from low cost efficiency, this paper decomposes overall efficiency of Chinese banks into: persistent efficiency and transient efficiency components. Low persistent efficiency reflects structural problems, while low transient efficiency is associated with short-term problems. Using the model of Kumbhakar, Lien and Hardaker (2014) based on the stochastic frontier approach, we measure persistent efficiency and transient efficiency for a large sample of 166 Chinese banks over the period 2008–2015. In line with existing evidence, we find a lower average cost efficiency of Big Five banks compared to other Chinese banks. It is almost entirely due to low persistent cost efficiency. Big Five transient efficiency is similar to other Chinese banks. Our findings support the view that major structural reforms are needed to enhance the efficiency of China’s Big Five banks.
    JEL: C23 D24 G21
    Date: 2018–07–20
  12. By: Flögel, Franz; Gärtner, Stefan
    Abstract: A comparison of the German banking system with that of the United Kingdom (UK) and Spain shows Germany to be decentralised not only regarding the distribution of banks, but also its financial and political system more generally. Decentralised banks, which are predominantly regional savings banks and cooperative banks in Germany, nearly account for most lending to business and have extended lending at the expense of centralised banks (such as the four big banks, for example). Federalism and strong redistribution mechanisms between the regions support decentralised banking in Germany. Furthermore, close cooperation in their banking groups is shown to allow decentralised banks to realise economies of scale and develop superior techniques for retail banking, like bank-ICT and rating systems. The detailed comparison of a savings bank with a big bank suggests that shorter (functional) distances allow regional banks to consider soft information easily and reliably when lending to SMEs. Short-distance lending not only reduces the financial constraints of (financially distressed) SMEs, but can also be profitable for banks as they are able to realise higher interest earnings in business with informationally opaque enterprises. However, decentralised banking is also under threat in Germany due to tightening (more complex) banking regulations and the continuing low interest rate environment. Therefore, decentralised banks need to cut costs, which is why they have merged to larger units and closed branches in recent years. Furthermore, they have tried to increase fee earnings at the risk of disintermediation. This paper identifies two dilemmas of these cost-cutting strategies. First, disintermediation challenges regional savings-investment cycles and thus regional independency. Second, mergers, branch closures and the standardisation of processes endanger local decision-making authority and hence short-distance lending. As the detailed comparison make clear, the ability of regional banks to decide on credit at a short distance enables profitable lending to informationally opaque SMEs, meaning SMEs that appear to be very risky on the basis of hard information, by utilising soft information. Accordingly, short distance tends to be a key competitive advantage of regional banks, especially in a low interest rate environment. Cost-cutting measures must be conducted with full awareness of this advantage. With respect to lending to SMEs, branch closures may be less critical than mergers and standardisation because most branches are not involved in lending to SMEs anyway.
    Keywords: comparing banking systems,SME finance in Germany,savings and cooperative banks,decentralised vs. centralised banking
    JEL: D43 E21 G01 G21 G38 R12
    Date: 2018
  13. By: Bolton, Patrick; Oehmke, Martin
    Abstract: We study the resolution of global banks by national regulators. Single-point-of-entry (SPOE) resolution, where loss-absorbing capital is shared across jurisdictions, isefficient but may not be implementable. First, when expected transfers across jurisdictions are too asymmetric, national regulators fail to set up SPOE resolution ex ante. Second, when required ex-post transfers are too large, national regulators ring-fence assets instead of cooperating in SPOE resolution. In this case, a multiple-point-of-entry (MPOE) resolution, where loss-absorbing capital is pre-assigned, is more robust. Our analysis highlights a fundamental link between efficient bank resolution and the operational structures and risks of global banks.
    Keywords: bank resolution; single point of entry
    JEL: G01 G18 G21 G33
    Date: 2018–07
  14. By: Jérémy Pépy (CERDI - Centre d'Études et de Recherches sur le Développement International - Clermont Auvergne - UCA - Université Clermont Auvergne - CNRS - Centre National de la Recherche Scientifique); Benjamin Williams (CRCGM - Centre de Recherche Clermontois en Gestion et Management - Clermont Auvergne - École Supérieure de Commerce (ESC) - Clermont-Ferrand - UCA - Université Clermont Auvergne)
    Abstract: The failures of the banking sector to promote sustainable lending and to build strong capital and liquidity buffers prior to the 2008 Financial Crisis addressed the rationale for implementing the banking regulatory regime Basel III. In this paper, we question the fundamental role of this new regulatory regime in promoting bank lending and ensuring the adequate funding structure of the banking sector regarding the introduction of unprecedented international liquidity standards notably. We build a theoretical model of bank behaviour under a regulatory regime à la Basel III which points to two major results. First, Regulatory Authorities need to define the objectives and thus, the underlying tools implemented in order to achieve the optimum-optimurum. Second, we show that the competitive structure of the markets the bank faces is a determinant to take into account for achieving this optimum-optimurum.
    Keywords: Basel III, Regulation, Bank behaviour, Regulatory distortions
    Date: 2018–07–19
  15. By: Hubert Janos Kiss (Research fellow in the Momentum (LD-004/2010) Game Theory Research Group, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences Department of Economics, Eötvös Loránd University, Budapest, Hungary.); Ismael Rodriguez-Lara (Department of Economics, Middlesex University London, UK); Alfonso Rosa-Garcia (Facultad de Ciencias Jurídicas y de la Empresa, Universidad Católica San Antonio, Murcia, Spain)
    Abstract: We study how response time in a laboratory experiment on bank runs affects withdrawal decisions. In our setup, the bank has no fundamental problems, depositors decide equentially (if to keep the money in the bank or to withdraw) and may observe previous decisions depending on the information structure. We consider two levels of difficulty of decisionmaking conditional on the presence of strategic dominance and strategic uncertainty. We posit that i) decisions in information sets characterized by the lack of strategic dominance are more difficult than in those with strategic dominance; ii) in the latter group, decisions are more difficult when there is strategic uncertainty. We investigate how response time associates with the difficulty and optimality of withdrawal decision. We hypothesize that a) the more difficult the decision, the longer the response time; b) the predictive power of response time depends on difficulty. We find that response time is longer in information sets with strategic uncertainty compared to those without (as expected), but we do not find such relationship when considering strategic dominance (contrary to our hypothesis). Response time correlates negatively with optimal decisions in information sets with a dominant strategy (contrary to our expectation) and also when decisions are obvious in the absence of strategic uncertainty (in line with our hypothesis). When there is strategic uncertainty, we find suggestive evidence that response time predicts optimal decisions. Thus, freezing deposits for some time may be beneficial and help to avoid massive withdrawals as it engthens response times.
    Keywords: bank run, cognitive abilities, coordination games, dominant strategy, experiment, response time, sequential rationality, strategic uncertainty
    JEL: C72 C91 D80 G21
    Date: 2018–05
  16. By: Zachary Feinstein
    Abstract: We construct a continuous time model for price-mediated contagion precipitated by a common exogenous stress to the trading book of all firms in the financial system. In this setting, firms are constrained so as to satisfy a risk-weight based capital ratio requirement. We use this model to find analytical bounds on the risk-weights for an asset as a function of the market liquidity. Under these appropriate risk-weights, we find existence and uniqueness for the joint system of firm behavior and the asset price. We further consider an analytical bound on the firm liquidations, which allows us to construct exact formulas for stress testing the financial system with deterministic or random stresses. Numerical case studies are provided to demonstrate various implications of this model and analytical bounds.
    Date: 2018–07
  17. By: Shusen Qi (Xiamen University); Ralph De Haas (European Bank for Reconstruction and Development and Tilburg University); Steven Ongena (University of Zurich, Swiss Finance Institute, KU Leuven, and Centre for Economic Policy Research (CEPR)); Stefan Straetmans (Maastricht University and University of Antwerp)
    Abstract: We study how information sharing between banks influences the geographical clustering of branches. We construct a spatial oligopoly model with price competition that explains why bank branches cluster and how the introduction of information sharing impacts clustering. Dynamic data on 59,333 branches operated by 676 banks in 22 countries between 1995 and 2012 allow us to test the hypotheses derived from this model. Consistent with our model, we find that information sharing spurs banks to open branches in localities that are new to them but that are already relatively well served by other banks. Information sharing also allows firms to borrow from more distant banks.
    Keywords: Information Sharing, Branch Clustering
    JEL: D43 G21 G28 L13 R51
    Date: 2018–01
  18. By: Sangyup Choi (Yonsei University)
    Abstract: Despite renewed interest spurred by the global financial crisis, identifying a bank loan supply shock from demand-side factors remains challenging. While existing sigh-restriction studies often rely on the bank lending rate and the loan volume to identify a loan supply shock, they implicitly assume that the observed interest rate always equates supply and demand for loans. Using bank loan officer survey from eight emerging market economies (EMEs), I document a distinct cyclical pattern of bank lending standards and loan demand in the EMEs from that in the U.S. or the Euro area. Using quarterly Korean data, I demonstrate that a conventional sign-restriction approach could result in a misguided interpretation of credit slowdown when credit rationing or non-price lending terms exist. To resolve this issue, I propose an alternative identifying scheme by exploiting the information from bank loan officer survey and find that a negative loan supply shock has a strong adverse effect on output, followed by a decline in inflation and the policy rate.
    Keywords: Bank loan officer survey, Sign-restriction VARs, Bank lending shocks, Emerging market economies, Credit market imperfections
    JEL: E32 E44 E51
    Date: 2018–07
  19. By: Aikman, David (Bank of England); Bridges, Jonathan (Bank of England); Burgess, Stephen (Bank of England); Galletly, Richard (Bank of England); Levina, Iren (Bank of England); O'Neill, Cian (Bank of England); Varadi, Alexandra (Bank of England)
    Abstract: We present a framework for measuring the evolution of risks to financial stability over the financial cycle, which we apply to the United Kingdom. We identify 29 indicators of financial stability risk, drawing from the literature on early warning indicators of banking crises. We normalise and aggregate these indicators to produce three composite measures, capturing: leverage in the private nonfinancial sector, including the level and growth of household and corporate debt, as well as the United Kingdom’s external debt; asset valuations in residential and commercial property markets, and in government and corporate bond and equity markets; and credit terms facing household and corporate borrowers. We assess these composite measures relative to their historical distributions. And we present preliminary evidence for how they influence downside risks to economic growth and different horizons. The measures provide an intuitive description of the evolution of the financial cycle of the past three decades. And they could lend themselves to simple communication, both with macroprudential policymakers and the wider public.
    Keywords: Macroprudential policy; financial crises; financial stability; early warning indicators; countercyclical capital buffers; data visualisation
    JEL: E44 G01 G10 G28
    Date: 2018–07–20
  20. By: Eric Jondeau (University of Lausanne and Swiss Finance Institute); Jean-Guillaume Sahuc (Banque de France, Université Paris Ouest - Nanterre, and La Défense - EconomiX)
    Abstract: We quantify the capital shortfall that results from a global financial crisis by using a macro-finance dynamic stochastic general equilibrium model that captures the interactions between the financial and real sectors of the economy. We show that a crisis similar to that observed in 2008 generates a capital shortfall (or stressed expected loss, SEL) equal to 2.8% of euro-area GDP, which corresponds to approximately 250 billion euros. We also find that using a cycle-dependent capital ratio that combines concern for both credit growth and SEL has a positive effect on output growth while mitigating the excessive risk taking of the banking system. Finally, our estimates confirm that most of the variability of the macroeconomic and financial variables at business cycle frequencies is due to investment and risk shocks.
    Keywords: Capital Shortfall, Systemic Risk, Leverage, Financial system, Euro Area, DSGE Model
    JEL: E32 E44 G01 G21
    Date: 2018–02

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