Search for Yield

47 Pages Posted: 21 Sep 2015

See all articles by David Martinez-Miera

David Martinez-Miera

Universidad Carlos III de Madrid - Department of Business Administration; Center for Economic Policy Research

Rafael Repullo

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: September 2015

Abstract

We present a model of the connection between real interest rates, credit spreads, and the structure and the risk of the banking system. Banks intermediate between entrepreneurs and investors, and choose the monitoring intensity on entrepreneurs' projects. We characterize the equilibrium for a fixed aggregate supply of savings, showing that safer entrepreneurs will be funded by nonmonitoring (shadow) banks and riskier entrepreneurs by monitoring (traditional) banks. We also show that a savings glut reduces interest rates and spreads, increases the relative size of the shadow banking system and the probability of failure of the traditional banks. The model provides a framework for understanding the emergence of endogenous boom and bust cycles, as well as the procyclical nature of the shadow banking system, the existence of countercyclical risk premia, and the low levels of interest rates and spreads leading to the buildup of risks during booms.

Keywords: bank monitoring, banking crises, boom and bust cycles, credit spreads, financial stability, real interest rates, savings glut, shadow banks

JEL Classification: E44, G21, G23

Suggested Citation

Martinez, David and Repullo, Rafael, Search for Yield (September 2015). CEPR Discussion Paper No. DP10830. Available at SSRN: https://ssrn.com/abstract=2663408

David Martinez (Contact Author)

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

Center for Economic Policy Research ( email )

London
United Kingdom

Rafael Repullo

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91429 0551 (Phone)
+34 91429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~repullo/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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