Cyclical Systemic Risk and Downside Risks to Bank Profitability

48 Pages Posted: 12 May 2020

See all articles by Jan Hannes Lang

Jan Hannes Lang

European Central Bank (ECB)

Marco Forletta

European Central Bank (ECB)

Date Written: May, 2020

Abstract

This paper studies the impact of cyclical systemic risk on future bank profitability for a large representative panel of EU banks between 2005 and 2017. Using linear local projections we show that high current levels of cyclical systemic risk predict large drops in the average bank-level return on assets (ROA) with a lead time of 3-5 years. Based on quantile local projections we further show that the negative impact of cyclical systemic risk on the left tail of the future bank-level ROA distribution is an order of magnitude larger than on the median. Given the tight link between negative profits and reductions in bank capital, our method can be used to quantify the level of “Bank capital-at-risk” for a given banking system, akin to the concept of “Growth-at-risk”. We illustrate how the method can inform the calibration of countercyclical macroprudential policy instruments.

Keywords: bank profitability, Growth-at-risk, local projections, quantile regressions, systemic risk

JEL Classification: G01, G17, C22, C54, G21

Suggested Citation

Lang, Jan Hannes and Forletta, Marco, Cyclical Systemic Risk and Downside Risks to Bank Profitability (May, 2020). ECB Working Paper No. 20202405, Available at SSRN: https://ssrn.com/abstract=3599010

Jan Hannes Lang (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Marco Forletta

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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