Working Paper: NBER ID: w18537
Authors: Robin Greenwood; Augustin Landier; David Thesmar
Abstract: When a bank experiences a negative shock to its equity, one way to return to target leverage is to sell assets. If asset sales occur at depressed prices, then one bank's sales may impact other banks with common exposures, resulting in contagion. We propose a simple framework that accounts for how this effect adds up across the banking sector. Our framework explains how the distribution of bank leverage and risk exposures contributes to a form of systemic risk. We compute bank exposures to system-wide deleveraging, as well as the spillover of a single bank's deleveraging onto other banks. We show how our model can be used to evaluate a variety of crisis interventions, such as mergers of good and bad banks and equity injections. We apply the framework to European banks vulnerable to sovereign risk in 2010 and 2011.
Keywords: banking; systemic risk; deleveraging; financial contagion
JEL Codes: G01; G21; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Negative equity shock (G19) | Asset sales (G32) |
| Asset sales (G32) | Depressed market prices (G19) |
| Depressed market prices (G19) | Impact on other banks (F65) |
| Capital injections (O16) | Reduced deleveraging effects (G19) |