A Dynamic Model of Banking with Uninsurable Risks and Regulatory Constraints

63 Pages Posted: 23 Jan 2015

See all articles by Jochen Mankart

Jochen Mankart

Deutsche Bundesbank Research Centre

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Spyros Pagratis

Athens University of Economics and Business - Department of Economics

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Date Written: December 2014

Abstract

We estimate the structural parameters of a quantitative banking model featuring maturity transformation and endogenous failures in the presence of undiversifiable background risk and regulatory constraints. Pervasive balance sheet cross-sectional heterogeneity can be rationalized with idiosyncratic shocks and differential access to wholesale funding markets. Moreover, loans are highly procyclical, bank failures strongly countercyclical and increasing in leverage. Tightening capital requirements increases precautionary equity but results in higher failures because equity rises proportionately less than the capital ratio requirement change. The endogenous fall in the expected return on equity lowers the incentive to further increase precautionary equity.

Keywords: bank failures, bank leverage, capital requirements, uninsurable risks

JEL Classification: E32, E44, G21

Suggested Citation

Mankart, Jochen and Michaelides, Alexander and Pagratis, Spyros, A Dynamic Model of Banking with Uninsurable Risks and Regulatory Constraints (December 2014). CEPR Discussion Paper No. DP10299. Available at SSRN: https://ssrn.com/abstract=2554374

Jochen Mankart (Contact Author)

Deutsche Bundesbank Research Centre ( email )

Wilhelm-Epstein-Strasse 14
Frankfurt/Main D-60431
Germany

Alexander Michaelides

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Spyros Pagratis

Athens University of Economics and Business - Department of Economics ( email )

76 Patission Street
GR-10434 Athens
Greece

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