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Banking Regulation

Paper Session

Friday, Jan. 4, 2019 10:15 AM - 12:15 PM

Hilton Atlanta, 305
Hosted By: International Banking, Economics, and Finance Association
  • Chair: Luisa Lambertini, EPFL

A Dynamic Model of Bank Behaviour under Multiple Regulatory Constraints

Markus Behn
,
European Central Bank
Claudio Daminato
,
ETH Zurich
Carmelo Salleo
,
European Central Bank

Abstract

We develop a structural model of bank behaviour that helps to understand how banks adjust their asset and liability structures in response to changes in regulatory capital and liquidity requirements or economic shocks. When adjusting their balance sheet structure bank managers need to consider various trade-offs simultaneously. Generally, taking more risk allows them to generate higher expected returns, while it increases the possibility of breaching regulatory requirements or having to raise fresh equity. As a result, banks hold precautionary buffers on top of capital and liquidity requirements. Reactions to regulatory changes or economic shocks are highly non-linear and depend on banks' initial asset and liability structure. More constrained banks generally react stronger and follow a different mode of adjustment, inter alia implying stronger reductions in loan supply. The model illustrates how capital and liquidity dimensions interact with each other and is useful for regulators and policy makers who are interested in the real effects of changes in capital and liquidity requirements.

Financial Stability, Growth and Macroprudential Policy

Chang Ma
,
Fudan University

Abstract

This paper studies the effect of optimal macroprudential policy in a small open economy model where growth is endogenous. By introducing endogenous growth, this model is able to capture the persistent effect of financial crises on output, which is different from previous literature but consistent with the data. Furthermore, there is a new policy trade-off between the cyclical and trend consumption growth. By constraining external borrowing to reduce systemic risk, the macroprudential policy hurts trend growth in good times but reduces the permanent output loss from a crisis. In a calibrated version of my model, I find that the optimal macroprudential policy significantly enhances financial stability (reducing the probability of crisis by two-thirds) at the cost of lowering average growth by a small amount. The welfare gains from policy intervention do not increase with endogenous growth because crises are rare events.

The Impact of Stress Tests on Bank Lending

Jose M. Berrospide
,
Federal Reserve Board
William F. Bassett
,
Federal Reserve Board

Abstract

We investigate one channel through which the annual bank stress tests, as part of the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) review, could unexpectedly curtail the provision of bank credit, or change its allocation. To quantify the impact of the stress tests, we construct a measure of the capital implied by the supervisory stress tests relative to the level of capital implied by the banks’ own models, which we call the capital gap. We then study the impact of the capital gap on the loan growth of BHCs with more than $10 billion in assets. The higher capital implied by supervisory stress tests relative to that suggested by the banks’ own models does not appear to unduly restrict loan growth. Consistent with previous results in the bank capital literature, we find evidence that among the CCAR banks, more capital is associated with higher loan growth.

Shadow Banking, Macroprudential Regulation and Financial Stability

Margarita Rubio
,
University of Nottingham

Abstract

This paper studies the implications of the presence of an unregulated shadow banking sector for economic activity, financial stability, and welfare. To explore this topic, I consider a Dynamic Stochastic General Equilibrium (DSGE) model with housing and collateral constraints for borrowers, in which lending can come from two different sources; a formal bank or private lending. Banking regulation, in the form of capital requirements, only applies to the formal banking sector. Private lenders represent the shadow banking system. Results show that, on the one hand, shadow banking leads to a higher amount of credit in the economy, which in turn implies more borrower's consumption, although at the expense of risks for financial stability. On the other hand, an unregulated banking sector can lead to unintended effects of macroprudential policy. Stricter regulation in the traditional banking sector may result in an increase in credit flows to those banks with lower regulatory levels, especially when this regulation comes from borrower-based instruments. Thus, macroprudential authorities should take into account both costs and benefits of shadow banking when considering their regulatory perimeter.
Discussant(s)
Andrea Presbitero
,
International Monetary Fund
Victoria Nuguer
,
Inter-American Development Bank.
Sergey Tsyplakov
,
University of South Carolina
Kebin Ma
,
University of Warwick
JEL Classifications
  • G2 - Financial Institutions and Services
  • G1 - General Financial Markets