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Destabilizing effects of bank overleveraging on real activity - an analysis based on a threshold MCS-GVAR

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  • Gross, Marco
  • Henry, Jérôme
  • Semmler, Willi

Abstract

We investigate the consequences of overleveraging and the potential for destabilizing effects from financial- and real-sector interactions. In a theoretical framework, we model overleveraging and indicate how a highly leveraged banking system can lead to unstable dynamics and downward spirals. Inspired by Brunnermeier and Sannikov (2014) and Stein (2012), we empirically measure the deviation-from-optimal-leverage for 40 large EU banks. We then use this measure to condition the joint dynamics of credit flows and macroeconomic activity in a large-scale regime change model: A Threshold Mixed-Cross-Section Global Vector Autoregressive (T-MCS-GVAR) model. The regime-switching component of the model aims to make the relationship between credit and real activity dependent on the extent to which the banking system is overleveraged. We find significant nonlinearities as a function of overleverage. When leverage is standing above its equilibrium level, the effect of a deleveraging shocks on credit supply and economic activity are visibly more detrimental than at times of underleveraging. JEL Classification: E2, E6, C13, G6

Suggested Citation

  • Gross, Marco & Henry, Jérôme & Semmler, Willi, 2017. "Destabilizing effects of bank overleveraging on real activity - an analysis based on a threshold MCS-GVAR," Working Paper Series 2081, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20172081
    Note: 3098116
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    Cited by:

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    2. Balke, Nathan S. & Zeng, Zheng & Zhang, Ren, 2021. "Identifying credit demand, financial intermediation, and supply of funds shocks: A structural VAR approach," The North American Journal of Economics and Finance, Elsevier, vol. 56(C).
    3. Yi, Xingjian & Liu, Sheng & Wu, Zhouheng, 2022. "What drives credit expansion worldwide?——An empirical investigation with long-term cross-country panel data," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 225-242.
    4. Samar Issa, 2020. "Life after Debt: The Effects of Overleveraging on Conventional and Islamic Banks," JRFM, MDPI, vol. 13(6), pages 1-46, June.
    5. Lucidi, Francesco Simone & Semmler, Willi, 2023. "Long-run scarring effects of meltdowns in a small-scale nonlinear quadratic model," Journal of Macroeconomics, Elsevier, vol. 75(C).
    6. Joe‐Ming Lee & Ku‐Hsieh Chen & I‐Chia Chang & Chih‐Chun Chen, 2022. "Determinants of non‐performing loans, firm's corporate governance and macroeconomic factors," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(1), pages 88-98, January.
    7. Issa, Samar & Gevorkyan, Aleksandr V., 2022. "Optimal corporate leverage and speculative cycles: an empirical estimation," Structural Change and Economic Dynamics, Elsevier, vol. 62(C), pages 478-491.

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    More about this item

    Keywords

    credit supply; macro-financial linkages; overleveraging;
    All these keywords.

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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