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Bank Overleverage and Macroeconomic Fragility

  • Ryo Kato

    (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: ryou.katou@boj.or.jp))

  • Takayuki Tsuruga

    (Associate Professor, Graduate School of Economics, Kyoto University, (E-mail: tsuruga@econ.kyoto-u.ac.jp))

This paper develops a dynamic general equilibrium model that explicitly includes a banking sector with a maturity mismatch. We demonstrate that, despite the perfect competition in the banking sector, rational banks take on excessive risks systemically, resulting in overleverage and inefficiently high crisis probabilities. The model accounts for the banks' rational over-optimism regarding future capital prices which arises from pecuniary externalities on their own solvency. Using the model as an example, we introduce MSR (marginal systemic risk) as a general measure to assess the macroeconomic exposure to systemic risks.

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File URL: http://www.imes.boj.or.jp/research/papers/english/11-E-15.pdf
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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 11-E-15.

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Date of creation: Jul 2011
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Handle: RePEc:ime:imedps:11-e-15
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  1. Reinhart, Carmen, 2009. "The Second Great Contraction," MPRA Paper 21485, University Library of Munich, Germany.
  2. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
  3. Ryo Kato, 2004. "Liquidity, Infinite Horizons and Macroeconomic Fluctuations," Econometric Society 2004 Far Eastern Meetings 622, Econometric Society.
  4. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  6. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
  7. Enrique G. Mendoza & Javier Bianchi, 2010. "Overborrowing, financial crises and ‘macro-prudential’ taxes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct.
  8. Jeanne, O. & Korinek, A., 2010. "Managing Credit Booms and Busts : A Pigouvian Taxation Approach," Discussion Paper 2010-108S, Tilburg University, Center for Economic Research.
  9. Ryo Kato & Takayuki Tsuruga, 2011. "The Safer, the Riskier:A Model of Bank Leverage and Financial Instability," Discussion papers e-10-014, Graduate School of Economics Project Center, Kyoto University.
  10. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 809-833.
  11. Naohisa Hirakata & Nao Sudo & Kozo Ueda, 2009. "Chained Credit Contracts and Financial Accelerators," IMES Discussion Paper Series 09-E-30, Institute for Monetary and Economic Studies, Bank of Japan.
  12. Reinhart, Carmen M. & Rogoff, Kenneth S., 2013. "Banking crises: An equal opportunity menace," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4557-4573.
  13. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Staff Working Papers 08-36, Bank of Canada.
  14. Douglas W. Diamond & Raghuram Rajan, 2011. "Illiquid Banks, Financial Stability, and Interest Rate Policy," NBER Working Papers 16994, National Bureau of Economic Research, Inc.
  15. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  16. Robert J. Barro, 2007. "Rare Disasters, Asset Prices, and Welfare Costs," NBER Working Papers 13690, National Bureau of Economic Research, Inc.
  17. Javier Bianchi, 2010. "Credit Externalities: Macroeconomic Effects and Policy Implications," American Economic Review, American Economic Association, vol. 100(2), pages 398-402, May.
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