Vulnerable Banks

64 Pages Posted: 20 Nov 2011 Last revised: 13 Mar 2013

See all articles by Robin M. Greenwood

Robin M. Greenwood

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Augustin Landier

HEC

David Thesmar

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA)

Multiple version iconThere are 2 versions of this paper

Date Written: November 7, 2011

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 this effect and adds it up across all related banks. The framework explains how the distribution of leverage and risk exposures across banks contributes to 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 use the model to evaluate a variety of policy proposals, such as caps on size or leverage, mergers of good and bad banks, and equity injections. In our model, “microprudential” interventions, which target the solvency of individual banks, tend to be less effective than “macroprudential” policies which aim to minimize spillovers across firms. We apply the framework to European banks vulnerable to sovereign risk in 2010 and 2011, and US banks between 2001 and and 2010.

Keywords: systemic risk, deleveraging, liquidity

JEL Classification: G21, G38

Suggested Citation

Greenwood, Robin M. and Landier, Augustin and Thesmar, David, Vulnerable Banks (November 7, 2011). Available at SSRN: https://ssrn.com/abstract=1961952 or http://dx.doi.org/10.2139/ssrn.1961952

Robin M. Greenwood

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6979 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Augustin Landier

HEC ( email )

France
+33630006051 (Phone)

HOME PAGE: http://https://sites.google.com/site/augustinlandier/

David Thesmar (Contact Author)

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States
16172259767 (Phone)

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