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Debt-overhang banking crises: Detecting and preventing systemic risk

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  • Occhino, Filippo

Abstract

This paper shows how the debt-overhang distortion on bank lending can generate a self-fulfilling-expectations banking crisis accompanied by a plunge in the value of banks’ assets and a contraction of bank lending and economic activity. Moral hazard in banking adds an additional channel that can generate multiple equilibria, worsen the debt-overhang distortion, and deepen the crisis. Some signals of systemic risk include: high volatility and the presence of two modes in the probability distribution functions of the returns on bank-issued bonds and on portfolios of bank-issued bonds and equities; and high correlation between the returns on bank-issued bonds. Macroprudential regulation should discourage the exposure of banks to the economic and financial cycle by raising the capital requirements for banks with more cyclical assets.

Suggested Citation

  • Occhino, Filippo, 2017. "Debt-overhang banking crises: Detecting and preventing systemic risk," Journal of Financial Stability, Elsevier, vol. 30(C), pages 192-208.
  • Handle: RePEc:eee:finsta:v:30:y:2017:i:c:p:192-208
    DOI: 10.1016/j.jfs.2015.12.008
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    References listed on IDEAS

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    Cited by:

    1. Occhino, Filippo, 2017. "The 2012 eurozone crisis and the ECB’s OMT program: A debt-overhang banking and sovereign crisis interpretation," European Economic Review, Elsevier, vol. 100(C), pages 337-363.
    2. Mark Mink & Sebastiaan Pool, 2018. "Bank Recapitalizations, Credit Supply, and the Transmission of Monetary Policy," DNB Working Papers 616, Netherlands Central Bank, Research Department.

    More about this item

    Keywords

    Multiple equilibria; Self-fulfilling expectations; Financial fragility; Moral hazard; Macroprudential regulation;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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