Financial Intermediation, Capital Accumulation, and Recovery

52 Pages Posted: 1 Dec 2015

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Jean-Charles Rochet

Swiss Finance Institute; University of Geneva - Geneva Finance Research Institute (GFRI); University of Zurich - Swiss Banking Institute (ISB)

Martin Scheffel

University of Cologne - Center for Macroeconomic Research (CMR)

Date Written: November 2015

Abstract

This paper integrates a simple model of banks into a two-sector neoclassical growth model. The integration yields an analytically tractable framework with two coupled accumulation rules for household capital and bank equity. We analyze steady state properties, transition and recovery patterns, as well as policies to accelerate recoveries. After establishing existence, uniqueness and global stability of the steady state, we identify in particular five key results and predictions, and we provide a quantitative assessment. First, larger financial frictions in financial intermediation may increase banker wealth although total capital is depressed. Second, negative shocks to bank equity cause considerably larger downturns than comparable shocks to household wealth, but their persistence is similar. Third, temporary worsening of shocks to financial frictions (called "trust shocks") induces divergent reactions of household wealth and bank equity, causes a boom in the banking sector, and possibly in the economy - after an initial bust. Fourth, the model replicates typical patterns of financing over the business cycle: procyclical bank leverage, procyclical bank lending, and counter-cyclical bond financing. Finally, a combination of bailouts and dividend-payout-restrictions ensures a rapid build-up of bank equity after a slump in the banking sector and increases total production.

Keywords: banking crises, business cycles, bust-boom cycles, capital accumulation, financial intermediation, macroeconomic shocks, recovery policies

JEL Classification: E21, E32, F44, G21, G28

Suggested Citation

Gersbach, Hans and Rochet, Jean-Charles and Scheffel, Martin, Financial Intermediation, Capital Accumulation, and Recovery (November 2015). CEPR Discussion Paper No. DP10964, Available at SSRN: https://ssrn.com/abstract=2697597

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Research ( email )

Zürichbergstrasse 18
Zurich, 8092
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+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

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Germany

CESifo (Center for Economic Studies and Ifo Institute)

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Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Jean-Charles Rochet

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland

Martin Scheffel

University of Cologne - Center for Macroeconomic Research (CMR) ( email )

Cologne
Germany

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