Working Paper: CEPR ID: DP10299
Authors: Jochen Mankart; Alexander Michaelides; Spyros Pagratis
Abstract: We estimate the structural parameters of a quantitative banking model featuring maturity transformation and endogenous failures in the presence of undiversifiable background risk and regulatory constraints. Pervasive balance sheet cross-sectional heterogeneity can be rationalized with idiosyncratic shocks and differential access to wholesale funding markets. Moreover, loans are highly procyclical, bank failures strongly countercyclical and increasing in leverage. Tightening capital requirements increases precautionary equity but results in higher failures because equity rises proportionately less than the capital ratio requirement change. The endogenous fall in the expected return on equity lowers the incentive to further increase precautionary equity.
Keywords: bank failures; bank leverage; capital requirements; uninsurable risks
JEL Codes: E32; E44; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increasing capital requirements (G28) | higher bank failure rates (G21) |
| tighter capital requirements (G28) | increased precautionary equity (G52) |
| increased precautionary equity (G52) | decrease in expected returns on equity (G12) |
| decrease in expected returns on equity (G12) | reduce banks' incentives to accumulate additional equity (G21) |
| larger banks are more sensitive to capital ratio changes (G21) | reduce loan issuance significantly more than smaller banks (G21) |
| reduce loan issuance significantly more than smaller banks (G21) | increases failure rates (G33) |
| expected return on equity decreases as banks raise equity (G21) | exacerbates failure risks (G33) |