A Macroeconomic Model of Banks' Systemic Risk Taking

Jorge Abad, David Martinez-Miera and Javier Suarez

No 19532, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study banks' systemic risk-taking decisions in a dynamic general equilibrium model, highlighting the macroprudential role of bank capital requirements. Bankers decide on the unobservable exposure of their banks to systemic shocks by balancing risk-shifting gains against the value of preserving their capital after such shocks. Capital requirements reduce systemic risk taking but at the cost of reducing credit and output in calm times, generating welfare trade-offs. We find that systemic risk taking is maximal after long periods of calm and may worsen if capital requirements are countercyclically adjusted. Removing deposit insurance introduces market discipline but increases the bank capital necessary to support credit, implies lower (though far from zero) optimal capital requirements, and has nuanced social welfare effects.

Keywords: Capital requirements; Risk shifting; Deposit insurance; Systemic risk; Financial crises; Macro-prudential policies (search for similar items in EconPapers)
JEL-codes: E44 G01 G21 G28 (search for similar items in EconPapers)
Date: 2024-09
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