Overleveraging in the Banking Sector: Evidence from Europe

36 Pages Posted: 2 Oct 2014

See all articles by Frauke Schleer

Frauke Schleer

ZEW – Leibniz Centre for European Economic Research

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Julian Illner

ZEW – Leibniz Centre for European Economic Research

Date Written: September 21, 2014

Abstract

Overleveraging of the banking sector has been considered as one of the main causes of the 2007-09 financial crisis and the subsequent great recession. It was also of major concern for the subsequent BIS regulatory policies resulting in Basel III and its request for higher capital requirements. It has now become highly relevant for the planned European banking union. Overleveraging of the banking sector exposes the financial sector and the macroeconomy to vulnerabilities, but also, as critics state, seems to constrain credit flows to the private sector. We present here a measure of overleveraging, defined as the difference of actual and sustainable debt, conduct an empirical study on overleveraging for 40 banks in Europe, and study the vulnerabilities and credit contractions that can arise subsequently. Before the year 2004 overleveraging has not been a serious problem as leverage was on a sustainable level. However, in the run-up to the financial crisis, actual and optimal debt ran apart and the banking sector began to suffer from overleveraging. We use a nonlinear Vector STAR model to evaluate the hypothesis that periods of increasing debt levels are accompanied by more severe credit constraints than periods of low leveraging. We demonstrate this for country groups across Europe.

Keywords: Overleveraging, banking sector, Vector STAR, real economy, credit flows, regime switch

JEL Classification: C61, E32, G01

Suggested Citation

Schleer, Frauke and Semmler, Willi and Illner, Julian, Overleveraging in the Banking Sector: Evidence from Europe (September 21, 2014). ZEW - Centre for European Economic Research Discussion Paper No. 14-066. Available at SSRN: https://ssrn.com/abstract=2503838 or http://dx.doi.org/10.2139/ssrn.2503838

Frauke Schleer (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

Willi Semmler

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

Julian Illner

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
102
Abstract Views
664
rank
274,427
PlumX Metrics