Banking crises are rare events that break out in the midst of credit intensive booms and bring about particularly deep and long-lasting recessions. This paper attempts to explain these phenomena within a textbook DSGE model that features a non-trivial banking sector. In the model, banks are heterogeneous with respect to their intermediation skills, which gives rise to an interbank market. Moral hazard and asymmetric information in this market may lead to sudden interbank market freezes, banking crises, credit crunches and, ultimately, severe recessions. The model can potentially generate various types of banking crises. But the typical crisis breaks out endogenously, during a credit boom generated by a sequence of small positive supply shocks; it does not result from a large negative exogenous shock. Simulations of a calibrated version of the model indicate that it can mimic the main dynamic patterns of banking crises.
In 2013 all ECB publications feature a motif taken from the €5 banknote.note: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. All rights reserved. ISSN 1725-2806 (online) EU Catalogue NoQB-AR-13-011-EN-N (online)Any reproduction, publication and reprint in the form of a different publication, whether printed or produced electronically, in whole or in part, is permitted only with the explicit written authorisation of the ECB or the authors. Frederic BoissayEuropean Central Bank; e-mail: frederic.boissay@ecb.europa.eu Fabrice CollardUniversity of Bern; e-mail: fabrice.collard@gmail.com Frank SmetsEuropean Central Bank; e-mail: frank.smets@ecb.europa.eu AbstractThe empirical literature on systemic banking crises (SBCs) has shown that SBCs are rare events that break out in the midst of credit intensive booms and bring about particularly deep and long-lasting recessions. We attempt to explain these phenomena within a dynamic general equilibrium model featuring a non-trivial banking sector. In the model, banks are heterogeneous with respect to their intermediation skills, which gives rise to an interbank market. Moral hazard and asymmetric information on this market may generate sudden interbank market freezes, SBCs, credit crunches and, ultimately, severe recessions. Simulations of a calibrated version of the model indicate that typical SBCs break out in the midst of a credit boom generated by a sequence of positive supply shocks rather than being the outcome of a big negative wealth shock. We also show that the model can account for the relative severity of recessions with SBCs and their longer duration.Keywords: Moral Hazard, Asymmetric Information, Lending Boom, Credit Crunch, Systemic Banking Crisis JEL Class.: E32, E44, G01, G21.Disclaimer: The views expressed in this paper are our own and should not be interpreted as reflecting the views of the European Central Bank or the Eurosystem. 1 Non-Technical SummaryRecent empirical research on systemic banking crises (henceforth, SBCs) has highlighted the existence of similar patterns across diverse episodes. SBCs are rare events. Recessions that follow SBC episodes are deeper and longer lasting than other recessions. And, more importantly for the purpose of this paper, SBCs follow credit intensive booms; "banking crises are credit booms gone wrong" (see e.g., Schularick and Taylor, 2012, p. 1032; the notion that banking crises are endogenous and follow prosperous times is also present in Minsky, 1977). Rare, large, adverse financial shocks could possibly account for the first two properties. But they do not seem in line with the fact that the occurrence of an SBC is not random but rather closely linked to credit conditions. So, while most of the existing macro-economic literature on financial crises has focused on understanding and modeling the propagation and the amplification of adverse random shocks, the presence of ...
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