Banks Interconnectivity and Leverage

Alessandro Barattieri, Laura Moretti () and Vincenzo Quadrini

No 07/RT/16, Research Technical Papers from Central Bank of Ireland

Abstract: In the period that preceded the 2008 crisis, US financial intermediaries have become more leveraged (measured as the ratio of assets over equity) and interconnected (measured as the share of liabilities held by other financial intermediaries). This upward trend in leverage and interconnectivity sharply reversed after the crisis. To understand the factors that could have caused this dynamic, we develop a model where banks make risky investments in the non-financial sector and sell part of their investments to other banks (diversification). The model predicts a positive correlation between leverage and interconnectivity which we explore empirically using balance sheet data for over 14,000 financial intermediaries in 32 OECD countries. We enrich the theoretical model by allowing for Bayesian learning about the likelihood of a bank crisis (aggregate risk) and show that the model can capture the dynamics of leverage and interconnectivity observed in the data.

Keywords: Interconnectivity; Leverage (search for similar items in EconPapers)
JEL-codes: E21 G11 G21 (search for similar items in EconPapers)
Date: 2016-09
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-mac and nep-net
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Banks Interconnectivity and Leverage (2017)
Working Paper: Banks Interconnectivity and Leverage (2016)
Working Paper: Banks Interconnectivity and Leverage (2016)
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