Working papers and other work in progress
A macroeconomic model of banks’ endogenous systemic risk taking
With David Martinez-Miera (UC3M) and Javier Suarez (CEMFI)
July 2024 | Submitted
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.
CBDC and the operational framework of monetary policy
With Galo Nuño and Carlos Thomas (Bank of Spain)
March 2024 | Resubmission requested
We analyze the impact of introducing a central bank-issued digital currency
(CBDC) on the operational framework of monetary policy and the macroeconomy
as a whole. To this end, we develop a New Keynesian model with heterogeneous
banks, a frictional interbank market, a central bank with deposit and lending facilities,
and household preferences for different liquid assets. The model is calibrated
to replicate the main monetary and financial aggregates in the euro area. Our analysis
predicts that CBDC adoption implies a roughly equivalent reduction in banks’
deposit funding. However, this ‘deposit crunch’ has a rather small effect on bank
lending to the real economy, and hence on aggregate investment and GDP. This
result reflects the parallel impact of CBDC on the central bank’s operational framework.
For relatively moderate CBDC adoption levels, the reduction in deposits is
absorbed by an almost one-to-one fall in reserves at the central bank, implying a
transition from a ’floor’ system –with ample reserves– to a ‘corridor’ one. For larger
CBCD adoption, the loss of bank deposits is compensated by increased recourse to
central bank credit, as the corridor system gives way to a ‘ceiling’ one with scarce
reserves.
- 2nd Bank of Canada and Sveriges Riksbank Conference on the Economics of Central Bank Digital Currency (Stockholm, Nov 2023)
- ECB Conference on Money Markets (Frankfurt, Nov 2023)
- 9th Research Workshop of the Eurosystem MPC Taskforce on Banking Analysis for Monetary Policy (Split, Sep 2023)
- EEA-ESEM Annual Congress (Barcelona, Aug 2023)
- 8th Society for Economic Measurement (SEM) Annual Conference (Milan, Jun 2023)
- 3rd Catalan Economic Society Congress (Barcelona, Jun 2023)
- Bank of England Agenda for Research (BEAR) Conference (London, Feb 2023)
- 6th Annual Workshop of the ESCB Research Cluster 3 (Lisbon, Oct 2022)
- CUNEF (Madrid, Oct 2022)
- Central Bank Research Association (CEBRA) Annual Meeting (Barcelona, Aug 2022)
- CEMFI Workshop on CBDC (Madrid, June 2022)
Breaking the sovereign-bank nexus
November 2019 | Resubmission requested
This paper develops a quantitative dynamic general equilibrium model
that features endogenous bank failure and sovereign default risk. It
studies the feedback loop between sovereign and banking crises, and
evaluates the effectiveness of bank capital regulation in addressing
it. In the model, bank failure contributes to an increase of sovereign
default risk through the government bailout of bank creditors. Meanwhile,
holding high-yield risky sovereign bonds may be attractive to banks
protected by limited liability. By increasing banks' failure risk and
their funding costs, sovereign exposures hurt bank lending and contribute
to further contractions in aggregate economic activity. Capital requirements
shape banks' incentives to invest in sovereign debt. More stringent capital
regulation makes banks safer, weakening the sovereign-bank nexus. This comes
at the cost of constraining the overall supply of credit.
- European Central Bank (Frankfurt, Jan 2022)
- AEA Annual Meeting (Boston, Jan 2022)
- 3rd International Conference on European Studies (Milan, Jun 2021)
- Central Bank Research Association (CEBRA) Annual Meeting (London, Sep 2020)
- EEA Annual Congress (Rotterdam, Aug 2020)
- 9th MoFiR Workshop on Banking (Lisbon, Jun 2020)
- Universidad Carlos III (Madrid, Feb 2020)
- Swedish House of Finance, Stockholm School of Economics (Stockholm, Jan 2020)
- SAFE, Goethe University (Frankfurt, Jan 2020)
- Banca d'Italia (Rome, Jan 2020)
- Tilburg University (Tilburg, Jan 2020)
- Banco de España (Madrid, Jan 2020)
- Università di Bologna (Bologna, Jan 2020)
- ECB Conference on Fiscal Policy and EMU Governance (Frankfurt, Dec 2019)
- European Winter Meeting of the Econometric Society (Rotterdam, Dec 2019)
- Symposium of the Spanish Economic Association (SAEe) (Alicante, Dec 2019)
- 2nd CEPR Summer Conference on Financial Intermediation and Corporate Finance (Athens, Sep 2019)
- ECB Forum on Central Banking (Sintra, Jun 2019)
- Financial Intermediation Research Society (FIRS) PhD Job-Market Session (Savannah, May 2019)
- New York University Student Macro Lunch (May 2019)
- DebtCon3 Sovereign Debt Research and Management Conference (Georgetown University, Apr 2019)
- 34th SUERF-Banque de France Colloquium (Paris, March 2019)
- 17th Workshop on Macroeconomic Dynamics (EIEF-LUISS, Rome, Dec 2018)
- DBB-SAFE-DIW-IWH Conference on Financial Cycles and Regulation (Bundesbank, Frankfurt, Nov 2018)
- ESRB-European Central Bank (Frankfurt, Nov 2018)
- Spanish National Securities Exchange Commission (CNMV, Madrid, Oct 2018)
- XIII Conference on Financial Stability and Banking (Banco Central do Brasil, Sao Paulo, Oct 2018)
- Deutsche Bundesbank seminar (Frankfurt, Sep 2018)
- Bank of England seminar (London, Jul 2018)
- 7th Research Workshop in Financial Economics (University of Bonn, Jul 2018)
- 26th AEFIN Finance Forum (Universidad de Cantabria, Jul 2018)
- AEFIN PhD Consortium (Santander Financial Institute, Jul 2018)
- 2nd CEPR Network on Macroeconomic Modelling and Model Comparison (Stanford University, Jun 2018)
- 3rd Conference on Financial Markets and Macroeconomic Performance (Goethe University, May 2018)
- 3rd CEPR Spring Symposium in Financial Economics (Imperial College London, Apr 2018)
- ADEMU Conference on “Sovereign Debt in the 21st Century” (Toulouse School of Economics, Apr 2018)
- Royal Economic Society (RES) Symposium of Junior Researchers (University of Sussex, Mar 2018)
- Workshop on Nonlinear Models in Macroeconomics and Finance (Norges Bank, Oslo, Jan 2018)
The procyclicality of expected credit loss provisions
With Javier Suarez (CEMFI)
October 2018 | CEPR Discussion Paper 13135 | Resubmission requested
The Great Recession has pushed accounting standards for banks' loan
loss provisioning to shift from an incurred loss approach to an expected
credit loss approach. IFRS 9 and the incoming update of US GAAP imply a
more timely recognition of credit losses but also greater responsiveness
to changes in aggregate conditions, which raises procyclicality concerns.
This paper develops and calibrates a recursive ratings-migration model to
assess the impact of different provisioning approaches on the cyclicality
of banks' profits and regulatory capital. The model is used to analyze the
effectiveness of potential policy responses to the procyclicality problem.
- VoxEU.org: IFRS 9 and COVID-19: Delay and freeze the transitional arrangements clock
- ESRB: Report on the financial stability implications of IFRS 9
- M. Draghi (ECB President): "Building on the achievements of post-crisis reforms"
- Bruegel Blog: "Accounting for true worth: the economics of IFRS9"
- Reuters: "New rules for banks may make crises worse, stability agency says"
(Excluding presentations by coauthors)
- Financial Intermediation Research Society (FIRS) Conference (Savannah, May 2019)
- Bank of England seminar (London, Jun 2018)
- Symposium of the Spanish Economic Association (SAEe) (Barcelona, Dec 2017)
The impact of provisioning and capital requirements on bank behavior
With Daisuke Ikeda (Bank of Japan)
Work in progress (draft available upon request)
Post-crisis regulatory reforms, especially enhanced capital requirements and
expected credit loss provisioning, intend to make banks resilient to negative
shocks, so that they can continue to supply credit to the real economy during
episodes of stress, and to mitigate the potential procyclicality effects of
the previous regulatory framework. To examine the impact of such reforms on
bank behavior, especially lending, we develop a structural model of banking
that features endogenous bank lending and precautionary capital buffers. The
model illustrates the effect of various regulatory and provisioning frameworks
on the procyclicality of credit supply and bank equity capital.
(Excluding presentations by coauthors)
- CEMFI (Madrid, Jun 2020)
- 27th AEFIN Finance Forum (UC3M, Madrid, Jul 2019)
- Bank of England seminar (London, Aug 2018)
Bank failure and credit spreads
Work in progress (slides available upon request)
This paper develops a macroeconomic model in which banks intermediate funds
between households and firms, and are subject to failure risk. Using the model,
it is possible to decompose credit spreads faced by bank borrowers in two components.
First, a scarcity premium arises when banks’ constraints tighten and bank equity
becomes relatively scarce at the aggregate level. Second, a failure risk premium
arises when bank risk is high and the deposit spreads faced by banks increase.
This decomposition is important for the optimal policy response to a banking crisis.
When the scarcity premium is the dominant force driving credit spreads, a reduction
in capital requirements (akin to a release of countercyclical capital buffers) can
effectively reduce funding costs of bank borrowers. If, instead, the failure risk
component dominates, a reduction in capital requirements can have the opposite effect,
leading to an increase in bank leverage and higher funding costs for banks, which
translate into higher borrowing costs for non-financial borrowers with adverse
consequences for aggregate activity.
- New York University (May 2019)
Publications in refereed journals
Mapping exposures of EU banks to the global shadow banking system
With M. D’Errico, N. Killeen, V. Luz, T. Peltonen, R. Portes and T. Urbano
2022 | Journal of Banking & Finance
This paper provides a unique snapshot of the asset exposures of EU banks to shadow banking
entities within the global financial system. Drawing on a rich and novel dataset, we show
that 60 per cent of the EU banks’ exposures are towards non-EU entities, particularly
US-domiciled shadow banking entities. We assess the degree of concentration across
different types of shadow banking counterparties. We show that while banks’ exposures are
diversified at the individual level, this diversification leads to high overlap across
different types of shadow banking entities, with consequent systemic risk. We also examine
how bank- and country-level characteristics relate to the exposures of EU banks to shadow
banking entities. Our results emphasise the importance of monitoring these cross-border
and cross-sector exposures and closing remaining data gaps.
(Excluding presentations by coauthors)
- XII Seminar on Risk, Financial Stability and Banking (Banco Central do Brasil, Sao Paulo, Aug 2017)
- 11th Meeting of the ESRB Expert Group on Shadow Banking (ECB, Frankfurt, 2016)
Other publications and policy writing
The relaxation of bank capital and liquidity requirements in the wake of the coronavirus crisis
With Rafael Repullo (CEMFI)
October 2020 | European Parliamentary Research Service.
EU banks entered the coronavirus crisis with high capital and
liquidity buffers resulting from the reforms undertaken after the
global financial crisis of 2007-2009. This allowed a bold and swift
response by supervisors oriented towards supporting banks’
ability to provide credit to the real economy. This paper provides
an overview and an assessment of the regulatory response to the
crisis, and suggestssome recommendations for the future design
of countercyclical regulation.
The credit-to-GDP gap dead end: A constructive proposal
With Rafael Repullo (CEMFI)
December 2018 | Available upon request.
The Countercyclical Capital Buffer (CCyB) is the most significant macroprudential element of
Basel III. Following the guidance of the Basel Committee, its practical design was based on
the deviation of the credit-to-GDP ratio with respect to its trend, the credit-to-GDP gap.
This ties the determination of the CCyB to a variable that, as noted by many critics, is late
in both signalling the build up and the release of the buffer. This note proposes a way out
of this dead end by computing the credit-to-GDP gap using a shorter window, say 8 years. The
results of applying this alternative gap measure to Spain show that it significantly improves
upon the standard measure so that buffers are more likely to be built up in good times and
released in bad times.
Shedding light on dark markets: First insights from the new EU-wide OTC derivatives dataset
With I. Aldasoro, C. Aymanns, M. D’Errico, L. Fache Rousova, P. Hoffmann, S. Langfield, M. Neychev and T. Roukny
September 2016 | ESRB Occasional Paper No. 11
We present a first analysis of the EU-wide transactions-level derivatives dataset collected
under the European Markets Infrastructure Regulation (EMIR). We describe the structure of
the dataset, drawing comparisons with existing survey-based evidence on derivatives markets,
and zoom in on three markets: interest rate, credit and foreign exchange derivatives. New
insights from each of these three markets provide the basis for further research.
- M. Draghi (ECB President): Welcome remarks at the third annual conference of the ESRB
- V. Constâncio (ECB Vice-President): "Macroprudential stress-tests and tools for the non-bank sector"
- V. Constâncio (ECB Vice-President): "Macroprudential policy in a changing financial system"
- M. Draghi (ECB President): ESRB annual conference welcome address
- CentralBanking.com: "ESRB publishes guide to OTC derivatives database"