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Bank Overleverage and Macroeconomic Fragility

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  • Ryo Kato
  • Takayuki Tsuruga

Abstract

This paper develops a dynamic general equilibrium model that explicitly includes a banking sector engaged in a maturity mismatch. We demonstrate that rational competitive banks take on excessive risks systemically, resulting in overleverage and ine¢ ciently high crisis probabilities. The model accounts for the banks seemingly over-optimistic outlook about their own solvency and the asset prices, compared to the social optimum. The result calls for policy intervention to reduce the high crisis probabilities. To this end, the government can commit to bailing out banks through public supply of liquidity or a low-interest rate policy. As opposed to the intention of the government, however, expectations of a bailout could incentivize banks to be even more overleveraged, leaving the economy exposed to higher crisis probabilities.

Suggested Citation

  • Ryo Kato & Takayuki Tsuruga, 2012. "Bank Overleverage and Macroeconomic Fragility," Discussion papers e-12-002, Graduate School of Economics Project Center, Kyoto University, revised Mar 2013.
  • Handle: RePEc:kue:dpaper:e-12-002
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    References listed on IDEAS

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    11. 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.
    12. Robert J. Barro, 2009. "Rare Disasters, Asset Prices, and Welfare Costs," American Economic Review, American Economic Association, vol. 99(1), pages 243-264, March.
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    16. Reinhart, Carmen M. & Rogoff, Kenneth S., 2013. "Banking crises: An equal opportunity menace," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4557-4573.
    17. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
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    Cited by:

    1. Keiichiro Kobayashi & Tomoyuki Nakajima, 2014. "A macroeconomic model of liquidity crises," KIER Working Papers 876, Kyoto University, Institute of Economic Research.
    2. Kosuke Aoki & Nao Sudo, 2012. "Asset Portfolio Choice of Banks and Inflation Dynamics," Bank of Japan Working Paper Series 12-E-5, Bank of Japan.
    3. Olivier Jeanne & Anton Korinek, 2020. "Macroprudential Regulation versus mopping up after the crash," Review of Economic Studies, Oxford University Press, vol. 87(3), pages 1470-1497.
    4. Kato, Ryo & Tsuruga, Takayuki, 2016. "The safer, the riskier: A model of financial instability and bank leverage," Economic Modelling, Elsevier, vol. 52(PA), pages 71-77.

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    More about this item

    Keywords

    Financial crisis; Liquidity shortage; Maturity mismatch; Credit externalities; Financial regulation;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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