Banks, Capital Flows and Financial Crises

45 Pages Posted: 29 Nov 2014

See all articles by Ozge Akinci

Ozge Akinci

Federal Reserve Bank of New York

Albert Queralto

Federal Reserve Board - Trade and Financial Studies Section

Date Written: October 29, 2014

Abstract

This paper proposes a macroeconomic model with financial intermediaries (banks), in which banks face occasionally binding leverage constraints and may endogenously affect the strength of their balance sheets by issuing new equity. The model can account for occasional financial crises as a result of the nonlinearity induced by the constraint. Banks' precautionary equity issuance makes financial crises infrequent events occurring along with "regular" business cycle fluctuations. We show that an episode of capital in flows and rapid credit expansion, triggered by low country interest rates, leads banks to endogenously decrease the rate of equity issuance, contributing to a higher likelihood of future crises. Macroprudential policies directed at strengthening banks' balance sheets, such as capital requirements, are shown to lower the probability of financial crises and to enhance welfare.

Keywords: Financial Intermediation; Sudden Stops; Leverage Constraints; Occasionally Binding Constraints.

JEL Classification: E32; F41; F44; G15

Suggested Citation

Akinci, Ozge and Queralto, Albert, Banks, Capital Flows and Financial Crises (October 29, 2014). FRB International Finance Discussion Paper No. 1121. Available at SSRN: https://ssrn.com/abstract=2531685 or http://dx.doi.org/10.2139/ssrn.2531685

Ozge Akinci

Federal Reserve Bank of New York ( email )

New York, NY 10045
United States

Albert Queralto (Contact Author)

Federal Reserve Board - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

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