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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
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    References listed on IDEAS

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    Cited by:

    1. Pagliari, Maria Sole, 2021. "LSIs’ exposures to climate change related risks: an approach to assess physical risks," Working Paper Series 2517, European Central Bank.

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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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