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Rafael Repullo and David Martinez-Miera

No 10830, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We present a model of the connection between real interest rates, credit spreads, and the structure and the risk of the banking system. Banks intermediate between entrepreneurs and investors, and choose the monitoring intensity on entrepreneurs' projects. We characterize the equilibrium for a fixed aggregate supply of savings, showing that safer entrepreneurs will be funded by nonmonitoring (shadow) banks and riskier entrepreneurs by monitoring (traditional) banks. We also show that a savings glut reduces interest rates and spreads, increases the relative size of the shadow banking system and the probability of failure of the traditional banks. The model provides a framework for understanding the emergence of endogenous boom and bust cycles, as well as the procyclical nature of the shadow banking system, the existence of countercyclical risk premia, and the low levels of interest rates and spreads leading to the buildup of risks during booms.

Keywords: Bank monitoring; Banking crises; Boom and bust cycles; Credit spreads; Financial stability; Real interest rates; Savings glut; Shadow banks (search for similar items in EconPapers)
JEL-codes: E44 G21 G23 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-cfn and nep-mac
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Citations: View citations in EconPapers (1)

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