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The Leverage Cycle in Luxembourg?s Banking Sector

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  • Gastón Andrés Giordana

    ()

  • Ingmar Schumacher

    ()

Abstract

In this article we investigate the leverage cycle in Luxembourg?s banking sector using individual bank-level data for the period 2003 Q1 to 2010 Q1. We discuss the mechanics behind the leverage cycle in Luxembourg?s banks and show that these banks predominantly adjust leverage by changing both loans and deposits. One of our findings is that Luxembourg?s banks have a procyclical leverage. This procyclicality is not due to marking-to-market but because Luxembourg?s banks are liquidity providers to the EU banking sector. This also explains the different evolution of leverage compared to the US commercial banks (Adrian and Shin [1]) that, even though their balance sheet structure is similar to that of the Luxembourgish banks, target a constant leverage. To further understand what drives leverage in Luxembourg?s banks we empirically investigate the role of bank characteristics as well as real, financial and expectation variables that proxy for macroeconomic conditions in the pre-crisis and crisis period. We find that off-balance sheet exposures have different effects in the pre-crisis and crisis period, and that the share of liquid assets in the portfolio only affects the amount of security holdings. In terms of macroeconomic variables, we find that the Euribor-OIS spread is a significant driver of the build-up in leverage in the pre-crisis period. The reason is that most banks in Luxembourg are either branches or subsidiaries. This, firstly, makes leverage a less relevant indicator of riskiness for investors. Secondly, it implies that in times of liquidity shortages, mother companies or groups demand further liquidity from their branch or subsidiary. The downturn in leverage during the crisis can be accredited to reductions in expectations, which we proxy by an economic sentiment indicator. It can also be explained by increasing bond prices which induce depositors to shift their funds from bank deposits into bonds. We find no important role for GDP growth.

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Bibliographic Info

Paper provided by Central Bank of Luxembourg in its series BCL working papers with number 66.

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Length: 32 pages
Date of creation: Oct 2011
Date of revision:
Publication status: published as: What are the bank-specific and macroeconomic drivers of banks? leverage? Evidence from Luxembourg, Empirical Economics, 2013, 45(2): 905-928
Handle: RePEc:bcl:bclwop:bclwp066

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Web page: http://www.bcl.lu/

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Keywords: leverage dynamics; banking sector; GMM estimation; crisis effect;

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References

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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(3), pages 291-299, September.
  2. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, Elsevier, vol. 68(1), pages 29-51, July.
  3. R Blundell & Steven Bond, . "Initial conditions and moment restrictions in dynamic panel data model," Economics Papers W14&104., Economics Group, Nuffield College, University of Oxford.
  4. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports, Federal Reserve Bank of New York 328, Federal Reserve Bank of New York.
  5. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 23(1), pages 77-100, Winter.
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Cited by:
  1. Gaston Giordana & Ingmar Schumacher, 2012. "An Empirical Study on the Impact of Basel III Standards on Banks? Default Risk: The Case of Luxembourg," BCL working papers, Central Bank of Luxembourg 79, Central Bank of Luxembourg.
  2. Dirk Mevis, 2012. "The Determinants of Short Term Funding in Luxembourgish Banks," BCL working papers, Central Bank of Luxembourg 80, Central Bank of Luxembourg.

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