Do Risk Premia Protect from Banking Crises?
University of Bielefeld Working Paper No. 519
28 Pages Posted: 27 May 2004
Date Written: May 2004
This paper studies the question to what extent premia for macroeconomic risks in banking are sufficient to avoid banking crises. We investigate a competitive banking system embedded in an overlapping generation model subject to repeated macroeconomic shocks.
We show that even if banks fully incorporate macroeconomic risks in their pricing of loans, a banking system may enter bankruptcy with a probability of one. A major cause for this default is that risk premia of a competitive banking system may become too small if the capital base is low.
Keywords: Financial intermediation, macroeconomic risks, banking crises, risk premia, banking regulation
JEL Classification: D41, E4, G2
Suggested Citation: Suggested Citation