Collateral Composition, Diversification Risk, and Systemically Important Merchant Banks

Alexis Derviz (alexis.derviz@cnb.cz)

Working Papers from Czech National Bank, Research and Statistics Department

Abstract: We study the impact of collateral diversification by non-financial firms on systemic risk in a general equilibrium model with standard production functions and mixed debt-equity financing. Systemic risk comes about as soon as firms diversify their collateral by holding claims on a big wholesale bank (called merchant bank in the paper) whose asset side includes claims on the same producer set. The merchant bank sector proves to be fragile (has a short distance to default) regardless of competition. In this setting, the policy response, consisting in official guarantees for the merchant bank's liabilities, entails considerable government loss risk. An alternative without the need for public sector involvement is to encourage systemically important merchant banks to introduce a simple bail-in mechanism by restricting their liabilities to contingent convertible bonds. This line of regulatory policy is particularly relevant to the containment of systemic events in globally leveraged economies serviced by big international banks outside host country regulatory control.

Keywords: CoCos; collateral; merchant bank; systemic risk (search for similar items in EconPapers)
JEL-codes: C68 D21 F36 G24 G38 (search for similar items in EconPapers)
Date: 2013-12
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-rmg
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Related works:
Journal Article: Collateral composition, diversification risk, and systemically important merchant banks (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:cnb:wpaper:2013/11

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