Stressed but not Helpless: Strategic Behaviour of Banks Under Adverse Market Conditions

Grzegorz Halaj and Sofia Priazhkina

Staff Working Papers from Bank of Canada

Abstract: We model bank management actions in severe stress test conditions using a game-theoretical framework. Banks update their balance sheets to strategically maximize risk-adjusted returns to shareholders given three regulatory constraints and feedback effects related to fire sales, interactions of loan supply and demand, and deteriorating funding conditions. The framework allows us to study the role of strategic behaviors in amplifying or mitigating adverse macrofinancial shocks in a banking system and the role of macroprudential policies in the mitigation of systemic risk. In a macro-consistent stress testing application, we show that a trade-off can arise between banking stability (solvency) and macroeconomic stability (lending) and test whether the release of a countercyclical capital buffer can reduce systemic risk.

Keywords: Central bank research; Economic models; Financial institutions; Financial stability; Financial system regulation and policies (search for similar items in EconPapers)
JEL-codes: C72 G21 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2021-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-gth, nep-mac and nep-rmg
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:21-35

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