DO RISK PREMIA PROTECT AGAINST BANKING CRISES?

Hans Gersbach and Jan Wenzelburger ()

Macroeconomic Dynamics, 2008, vol. 12, issue S1, 100-111

Abstract: This paper examines the question to what extent premia for macroeconomic risks in banking are sufficient to avoid banking crises. We investigate a competitive banking system embedded in an overlapping-generations model subject to repeated macroeconomic shocks. We show that even if banks fully incorporate macroeconomic risks into their pricing of loans, a banking system may enter bankruptcy with probability one. A major cause for this default is that risk premia of a competitive banking system may become too small if the capital base is low.

Date: 2008
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