TY - JOUR
T1 - Long-term bank lending and the transfer of aggregate risk
AU - Reiter, Michael
AU - Zessner-Spitzenberg, Leopold
N1 - Publisher Copyright:
© 2023
PY - 2023/6
Y1 - 2023/6
N2 - Long-term loan contracts transfer aggregate risk from borrowing firms to lending banks. When aggregate shocks increase the future default probability of firms, banks are not compensated for the rising default risk of existing contracts. The flip side is that firms benefit from not facing higher interest rates in recessions. If banks are highly leveraged, this can lead to financial instability with severe repercussions in the real economy. If banks are well capitalized, the risk transfer stabilizes the economy. To study this mechanism quantitatively, we build a macroeconomic model of financial intermediation with long-term defaultable loan contracts and calibrate it to match aggregate firm and bank exposure to business cycle risks in the US. We find that moving from Basel II to Basel III capital regulation eliminates banking crises, increases output in the long run and improves welfare.
AB - Long-term loan contracts transfer aggregate risk from borrowing firms to lending banks. When aggregate shocks increase the future default probability of firms, banks are not compensated for the rising default risk of existing contracts. The flip side is that firms benefit from not facing higher interest rates in recessions. If banks are highly leveraged, this can lead to financial instability with severe repercussions in the real economy. If banks are well capitalized, the risk transfer stabilizes the economy. To study this mechanism quantitatively, we build a macroeconomic model of financial intermediation with long-term defaultable loan contracts and calibrate it to match aggregate firm and bank exposure to business cycle risks in the US. We find that moving from Basel II to Basel III capital regulation eliminates banking crises, increases output in the long run and improves welfare.
KW - Banking
KW - Financial frictions
KW - Maturity transformation
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U2 - 10.1016/j.jedc.2023.104651
DO - 10.1016/j.jedc.2023.104651
M3 - Article
AN - SCOPUS:85153030750
SN - 0165-1889
VL - 151
JO - Journal of Economic Dynamics and Control
JF - Journal of Economic Dynamics and Control
M1 - 104651
ER -