Bank Leverage Cycles

Abstract

We study the cyclical fluctuations of leverage and assets of financial intermediaries and GDP in the United States. Leverage and assets are several times more volatile than GDP, and experience larger fluctuations for unregulated (‘shadow’) intermediaries than for regulated ones. While the leverage of regulated intermediaries is rather acyclical with respect to their assets and to GDP, the leverage of unregulated intermediaries is strongly procyclical in relation to their assets, and mildly procyclical in relation to GDP. We then build a general equilibrium model with both regulated and unregulated financial intermediaries. The latter borrow from investors in the form of short-term collateralized risky debt, and are subject to endogenous leverage constraints. We find that volatility shocks are key to generating fluctuations and comovements similar to those found in the data. Also, in a scenario with lower cross-sectional volatility, output is higher on average but more volatile, due to higher leverage of unregulated banks.

Keywords: financial intermediaries, short-term collateralized debt, limited liability, call option, put option, moral hazard, leverage

JEL Classification: E20, G10, G21