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When banks punch back: Macrofinancial feedback loops in stress tests

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  • Catalán, Mario
  • Hoffmaister, Alexander W.

Abstract

In the presence of adverse macroeconomic shocks, simultaneous capital losses in multiple banks can prompt them to contract their balance sheets. These bank responses generate externalities that propagate in the form of macrofinancial feedback loops. This paper develops a credit response and externalities analysis model (CREAM) that integrates a disaggregated banking sector into an otherwise standard macroeconomic structural vector autoregressive model. It shows that accounting for macrofinancial feedback loops can significantly affect macroeconomic outcomes and bank-specific stress test results. The heterogeneity in bank lending responses matters: it determines how each bank fares under adverse conditions and the external effects that banks impose on each other and on economic activity. The model can thus be used to assess the contributions of individual banks to systemic risk along the time dimension.

Suggested Citation

  • Catalán, Mario & Hoffmaister, Alexander W., 2022. "When banks punch back: Macrofinancial feedback loops in stress tests," Journal of International Money and Finance, Elsevier, vol. 124(C).
  • Handle: RePEc:eee:jimfin:v:124:y:2022:i:c:s0261560621002230
    DOI: 10.1016/j.jimonfin.2021.102572
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    Cited by:

    1. Jondeau, Eric & Sahuc, Jean-Guillaume, 2022. "Bank capital shortfall in the euro area," Journal of Financial Stability, Elsevier, vol. 62(C).
    2. Uquillas, Adriana & Tonato, Ronny, 2022. "Inter-portfolio credit risk contagion including macroeconomic and financial factors: A case study for Ecuador," Economic Analysis and Policy, Elsevier, vol. 73(C), pages 299-320.
    3. Morell, Joe & Rice, Jonathan & Shaw, Frances, 2022. "A Framework for Macroprudential Stress Testing," Research Technical Papers 7/RT/22, Central Bank of Ireland.
    4. Aikman, David & Beale, Daniel & Brinley-Codd, Adam & Covi, Giovanni & Hüser, Anne‑Caroline & Lepore, Caterina, 2023. "Macroprudential stress‑test models: a survey," Bank of England working papers 1037, Bank of England.

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    More about this item

    Keywords

    Macrofinancial amplification; Stress testing; Systemic risk; Feedback loops; Bank lending; Bank capital;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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