A Network Model for Bank Lending Capacity

17 Pages Posted: 2 Mar 2011 Last revised: 2 May 2011

Christian Schmaltz

University of Aarhus; True North Institute

Sebastian Pokutta

Georgia Institute of Technology

Date Written: April 30, 2011

Abstract

We provide a structural framework to study the impact of a macroeconomic shock on the banking sector’s lending capacity. Our model consists of three building blocks: first, the evolution of non-bank assets that provide the entrance point for shocks from the real economy into the banking sector. Second, a network model that describes the propagation of the shock. Third, regulatory capital constraints that restrict banks’ lending behaviour. Therefore, the framework combines the literature on systemic risk and the literature on the bank lending channel. The building blocks ensure that our model captures six important aspects: firstly, by measuring systemic risk as the reduction in lending capacity, it aligns the model definition of systemic risk to the definition of the European Systemic Risk Board. Secondly, it models banks’ lending behavior as a function of counterparty risk addressing the usual critique of missing microfoundations of bank behavior. Thirdly, it emphasizes that not only defaulted banks, but also distressed banks are a thread for the real economy due to reduced lending capacity. Fourthly, our model shows the procyclicality of current (static) capital requirements. Fifthly, it allows us to study the effects of micro-prudential capital requirements in a network setting. And finally, the model describes the feedback loop of a shock that stems from the real economy through the banking sector back into the real economy.

Keywords: Systemic risk, network model, bank lending channel, credit crunch

JEL Classification: G21

Suggested Citation

Schmaltz, Christian and Pokutta, Sebastian, A Network Model for Bank Lending Capacity (April 30, 2011). Systemic Risk, Basel III, Financial Stability and Regulation 2011. Available at SSRN: https://ssrn.com/abstract=1773964 or http://dx.doi.org/10.2139/ssrn.1773964

Christian Schmaltz (Contact Author)

University of Aarhus ( email )

Nordre Ringgade 1
Aarhus, DK-8000
Denmark

True North Institute ( email )

145-157 St. John Street
London, EC1V 4PY
United Kingdom
+49-17621761996 (Phone)

HOME PAGE: http://www.tninstitute.eu

Sebastian Pokutta

Georgia Institute of Technology ( email )

Atlanta, GA 30332
United States

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