Bank Leverage Cycles

Abstract

We propose a general equilibrium framework with financial intermediaries subject to endogenous leverage constraints, and assess its ability to explain the observed fluctuations in intermediary leverage and real economic activity. In the model, intermediaries (“banks”) borrow in the form of short-term risky debt. The presence of risk-shifting moral hazard gives rise to a leverage constraint, and creates a link between the volatility in bank asset returns and leverage. Unlike TFP or capital quality shocks, volatility shocks produce empirically plausible fluctuations in bank leverage. The model replicates well the fall in leverage, assets, and GDP during the 2007–2009 financial crisis. (JEL D82, E44, G01, G21, G32)

Agent Based-Stock Flow Consistent Macroeconomics: Towards a Benchmark Model

“…Inventories thus grows with a lag with respect to sales during expansions until the cycle is eventually reverted. Figure 6 (right panel) shows that banks' leverage, defined as total loans over banks' net worth, is pro-cyclical displaying a cross correlation with real GDP at lag 0 equal to 0.25, in line with the statistics provided by Nuño and Thomas (2013) which estimates a correlation of 0.18 and ranging between 0.12 and 0.36, according to the definition of leverage adopted. This is a consequence of the pro-cyclical behavior of firms' total debt (explained below): the endogeneity of money in the model and the adoption of stock flow consistent rules implies that, as in reality, every new loan is accompanied by the creation of a new deposit of equal value, so that the loan creation process corresponds to an expansion of banks' balance sheets which leaves unaltered their net worth (Barwell and Burrows, 2011;Jakab and Kumhof, 2015;Benes et al, 2014;McLeay et al, 2014).…”

“…In addition to the evidence on leverage cyclicality, Nuño and Thomas (2013) find that banks' leverage is almost twice as volatile as real output. This is consistent with our finding that banks' leverage relative standard deviation is equal to 1.69.…”

Sustainable Shadow Banking

“…See, for example, Poznar et al and Taylor (2016) for evidence of asset bubbles prior to the recent financial collapse, and see Nuño and Thomas (2017) and Jordà, Schularick, and Taylor (2016) for evidence of bank leverage prior to such collapse. These relations also have been highlighted and explained by other theoretical underpinnings, such as those outlined by Fostel and Geanakoplos (2008), Borio and Zhu (2012), and Adrian and Shin (2014).…”

China's household balance sheet: Accounting issues, wealth accumulation, and risk diagnosis

“…Nevertheless, in the aftermath of frequent financial turmoil in Latin American and East Asia over the 1980s and 1990s, the limitations of the conventional macroeconomic analysis based upon flow indicators, such as Gross Domestic Product (GDP) and factor inputs, become more apparent, while the stock perspective, such as macro-level balance sheets, gains increasing attention among academia. In this respect, influential research lines and topics include the "balance sheet approach (BSA)" to financial crisis (Allen et al, 2002, Rosenberg et al, 2005, Lima et al, 2006, Mathisen and Pellechio, 2006, and Reinhart et al, 2014, the risk contagion through balance sheet channels (Kiyotaki and Moore, 2002, Gray et al, 2007, Ahrend and Goujard, 2012, and Paltalidis et al, 2015, the balance sheet adjustments in business cycles (Caballero et al, 2008, He et al, 2010, Koo, 2011, Eggertsson and Krugman, 2012, and Nuño and Thomas, 2017, and the balance sheet-based wealth analysis (Piketty, 2014, andPiketty andZucman, 2014) 3 .…”