Risk-Shifting, Concentration Risk and Heterogeneous Borrowers

Abstract

This article analyzes the effect of valuations-based capital requirements and concentration risk provisions on the risk-shifting response of the banking sector to monetary easing. It provides a closed economy DSGE model for the Euro zone with costly bank capital and two heterogeneous borrowers. Banks maximize their profits by choosing the optimal allocation of their loan portfolio. A procyclical movement of capital requirements is observed, which amplifies the expansionary effect of monetary easing. Capital requirements decline asymmetrically, which creates a risk-shifting impulse. Sticky bank capital rents can strengthen this risk-shift.

Keywords: risk-shifting, capital requirements, bank capital, bank lending, heterogeneity, financial stability

JEL Classification: E12, E43, E44, E52, E42, E59, G01, G21