Working Paper: CEPR ID: DP17793
Authors: Toni Ahnert; Kartik Anand; Philipp Koenig
Abstract: How do real interest rates affect financial fragility? We study this issue in a model in which bank borrowing is subject to rollover risk. A bank's optimal borrowing trades off the benefit from investing additional funds into profitable assets with the cost of greater risk of a run by bank creditors. Changes in the interest rate affect the price and amount of borrowing, both of which in influence bank fragility in opposite directions. Thus, the marginal impact of changes to the interest rate on bank fragility depends on the level of the interest rate. Finally, we derive testable implications that may guide future empirical work.
Keywords: Global Games; Bank Fragility; Rollover Risk; Real Interest Rates; Bank Borrowing; Funding Liquidity Risk Channel
JEL Codes: G01; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lower interest rates (E43) | increased bank borrowing (G21) |
| increased bank borrowing (G21) | increased investment (E22) |
| lower interest rates (E43) | increased bank fragility (F65) |
| interest rate level (E43) | marginal impact of interest rate changes on bank fragility (F65) |
| interest rate changes (E43) | bank fragility (F65) |
| low interest rates (E43) | price effect increases fragility (F12) |
| high interest rates (E43) | scale effect reduces fragility (F12) |
| interest rate changes (E43) | ambiguous total effect on bank fragility (F65) |