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Cyclical systemic risk and downside risks to bank profitability

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  • Lang, Jan Hannes
  • Forletta, Marco

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

Suggested Citation

  • Lang, Jan Hannes & Forletta, Marco, 2020. "Cyclical systemic risk and downside risks to bank profitability," Working Paper Series 2405, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202405
    Note: 2731285
    as

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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2405~0a7c3a35f7.en.pdf
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    References listed on IDEAS

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    Cited by:

    1. Ivan De Lorenzo Buratta, 2022. "How Bad Can Financial Crises Be? A GDP Tail Risk Assessment for Portugal," Working Papers w202204, Banco de Portugal, Economics and Research Department.
    2. Jorge E. Galán & María Rodríguez Moreno, 2020. "At-risk measures and financial stability," Revista de Estabilidad Financiera, Banco de España, issue Autumn.
    3. Lang, Jan Hannes & Menno, Dominik, 2023. "The state-dependent impact of changes in bank capital requirements," Discussion Papers 19/2023, Deutsche Bundesbank.
    4. Alona Shmygel, 2023. "Measuring the link between cyclical systemic risk and capital adequacy for Ukrainian banking sector," IHEID Working Papers 17-2023, Economics Section, The Graduate Institute of International Studies.
    5. Mamatzakis, Emmanuel C. & Ongena, Steven & Tsionas, Mike G., 2021. "Does alternative finance moderate bank fragility? Evidence from the euro area," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 72(C).
    6. Ivan De Lorenzo Buratta, 2022. "Mind the Build-up: Quantifying Tail Risks for Credit Growth in Portugal," Working Papers w202207, Banco de Portugal, Economics and Research Department.
    7. Hafemann, Lucas, 2023. "A house prices at risk approach for the German residential real estate market," Technical Papers 07/2023, Deutsche Bundesbank.
    8. Maria Sole Pagliari, 2023. "LSIs’ Exposures to Climate-Change-Related Risks: An Approach to Assess Physical Risks," International Journal of Central Banking, International Journal of Central Banking, vol. 19(1), pages 1-54, March.

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    More about this item

    Keywords

    bank profitability; Growth-at-risk; local projections; quantile regressions; systemic risk;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C54 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Quantitative Policy Modeling
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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