Fiscal Distress and Banking Performance: The Role of Macroprudential Regulation

30 Pages Posted: 7 Oct 2019

See all articles by Hiona Balfoussia

Hiona Balfoussia

Bank of Greece

Harris Dellas

University of Bern - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Dimitris Papageorgiou

Bank of Greece

Date Written: September 2019

Abstract

Fiscal fragility can undermine a government's ability to honor its bank deposit insurance pledge and induces a positive correlation between sovereign default risk and financial (bank) default risk. We show that this positive relation is reversed if bank capital requirements in fiscally weak countries are allowed to adjust optimally. The resulting higher requirements buttress the banking system and support higher output and welfare relative to the case where macroprudential policy does not vary with the degree of fiscal stress. Fiscal tenuousness also exacerbates the effects of other risk shocks. Nonetheless, the economy's response can be mitigated if macroprudential policy is adjusted optimally. Our analysis implies that, on the basis of fiscal strength, fiscally weak countries would favor and fiscally strong countries would object to banking union.

Keywords: bank performance, Banking Union, Fiscal distress, Greece, optimal macroprudential policy

JEL Classification: E3, E44, G01, G21, O52

Suggested Citation

Balfoussia, Hiona and Dellas, Harris and Papageorgiou, Dimitris, Fiscal Distress and Banking Performance: The Role of Macroprudential Regulation (September 2019). CEPR Discussion Paper No. DP14003, Available at SSRN: https://ssrn.com/abstract=3464532

Hiona Balfoussia (Contact Author)

Bank of Greece ( email )

21 E. Venizelos Avenue
GR-10250 Athens
Greece

Harris Dellas

University of Bern - Department of Economics ( email )

Gesellschaftstrasse 49
Bern, CH-3012
Switzerland
+41 31 631 3989 (Phone)
+41 31 631 3992 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Dimitris Papageorgiou

Bank of Greece ( email )

21 E. Venizelos Avenue
GR 102 50 Athens
Greece

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