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What Happened to Profitability? Shocks, Challenges and Perspectives for Euro Area Banks

55 Pages Posted: 16 Jun 2017  

Gong Cheng

European Stability Mechanism

Dirk Mevis

European Stability Mechanism

Date Written: November 2, 2015

Abstract

Transaction cost shocks in financial markets are known to affect asset prices. This paper analyses how changes in transaction costs may affect the value of assets that banks use to collateralise borrowings in monetary policy operations. Based on a simple asset pricing model and employing a dataset of hypothetical Eurosystem collateral positions, we simulate and quantify the resulting change in collateral value pledged by counterparties to the Eurosystem, resulting from a transaction cost shock. A 10 basis point increase in transaction costs entails a direct -0.30% decrease of collateral value and a -0.07% decrease when adjusted for the expected reduction in the number of trades of each asset. We conclude that banks will on average suffer small collateral losses while selected institutions could face a considerably larger collateral decrease.

Keywords: Bank, Profit, Return on Asset, Bank Regulation, Bank Business Model

JEL Classification: G21, G28, G33, L25

Suggested Citation

Cheng, Gong and Mevis, Dirk, What Happened to Profitability? Shocks, Challenges and Perspectives for Euro Area Banks (November 2, 2015). European Stability Mechanism Working Paper No. 5. Available at SSRN: https://ssrn.com/abstract=2986967

Gong Cheng (Contact Author)

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Dirk Mevis

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

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