Working Paper: CEPR ID: DP17846
Authors: Daniel Dimitrov; Sweder van Wijnbergen
Abstract: We develop a credit portfolio approach to a Central Bank’s exposure to systemic risk, modeling it as risk arising from holding a portfolio containing (a subset of) the banks the CB supervises. We apply the model to a sample of European banks using CDS prices, which allows the inclusion of non-listed banks. We derive optimal macroprudential capital buffers based on individual banks’ contributions to systemic risk in two steps. First, we minimize aggregate systemic risk subject to an average capital buffer by varying individual buffers while maintaining the average. Then we set that average buffer optimally balancing the social costs and benefits of macroprudential buffers. We find substantial gaps between market-price-based optimal buffers and macroprudential buffers currently in use.
Keywords: systemic risk; regulation; capital buffers; implied market measures; financial institutions; CDS rates
JEL Codes: G01; G20; G18; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increasing macroprudential capital buffers for systemic banks (F65) | Reduction in expected costs of systemic defaults (G33) |
| Increasing macroprudential capital buffers for systemic banks (F65) | Enhancement of overall financial stability (G28) |
| Higher capital buffers (G28) | Lowering individual bank's expected default costs (G21) |
| Higher capital buffers (G28) | Reduction in systemic costs associated with concurrent default of other banks (G33) |
| Optimal calibration of capital buffers (G28) | Minimize average systemic risk across the banking sector (E44) |
| Optimal calibration of capital buffers (G28) | Balance potential negative impacts on lending activity (F65) |