Macrofinancial Effects of the Output Floor in Euro Area Banking System

Output floor has emerged as a possibly important tool to ensure financial stability within the banking system. This paper proposes to assess the quantitative potential of output floor to ensure financial stability through the lens of a general equilibrium model for the Euro Area. We get three main results. First, implementation of output floor entails macrofinancial stabilization benefits for Euro Area activities in the long run, which confirms results found by financial European regulators. Second, along financial and economic cycles, output floor activation reduces volatility of banks capital to risk-weighted-asset ratio and the dispersion of this ratio between core and periphery banks, consistently with the desired outcome defined by financial regulators. Third, moderate banking openness in Euro Area limits cross-border credit flows spillovers, which does not affect output floor efficiency. However, full banking openness (i.e. banking union) produces high spillovers and erodes this efficiency.