Essays on financial crises and bank capital regulation

Zhang, Xue

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URN: urn:nbn:de:bsz:180-madoc-465137
Document Type: Doctoral dissertation
Year of publication: 2018
Place of publication: Mannheim
University: Universität Mannheim
Evaluator: Tertilt, Michèle
Date of oral examination: 21 September 2018
Publication language: English
Institution: Außerfakultäre Einrichtungen > Graduate School of Economic and Social Sciences - CDSE (Economics)
School of Law and Economics > VWL, Makro- u. Entwicklungsökonomie (Tertilt 2010-)
Subject: 330 Economics
Subject headings (SWD): Finanzkrise , Eigenkapital , Regulierung , Maximalbelastungstheorie
Keywords (English): Bank Capital Regulation , Financial Crises
Abstract: This thesis consists of three chapters, all of which contribute to the literature on financial crises and bank capital regulation. A common feature of the quantitative models in the three chapters is the endogenous bank run equilibrium a la Gertler and Kiyotaki (2015). Chapter 1 studies the cost and benefit of retail bank capital requirements in an economy with both retail and shadow banks, where financial crises take the form of shadow bank runs. Chapter 2 compares the effect of three macroprudential policies on financial stability in an economy with intertwined housing and banking crises. Chapter 3 analyzes the macroeconomic effects of the policy combination of bank capital requirement (an ex-ante intervention policy) and credit easing (an ex-post intervention policy). Chapter 1 is co-authored with Johannes Poeschl. Chapter 2 is a joint work with Johannes Poeschl and Marcus Molbak Ingholt. Chapter 3 is single-authored. Chapter 1, titled Endogenous Shadow Banking Crises and Bank Capital Regulation, sheds light on the optimal level and dynamic design of retail bank capital requirements in an economy with two banking sectors – retail and shadow banking. Systemic banking crises occur endogenously in the form of self-fulfilling runs on shadow banks. A negative externality exists, as banks do not internalize the effects of their leverage choices on the probability of bank runs, creating a role for government interventions, e.g., through bank capital requirements. We show that a dynamic capital requirement, which requires retail banks to build up capital buffers during normal times and allows the buffers to be depleted during a bank run, can reduce the frequency and severity of systemic banking crises. We highlight the importance of relaxing the capital requirement in a timely manner when a bank run happens. Otherwise, the capital requirement would restrict the retail banks’ ability to absorb liquidated assets of shadow banks, resulting in more frequent and more severe banking crises. Meanwhile, tightening the capital requirement leads to less financial intermediation and shifts banking activities from retail to shadow banks. Based on our calibration, we find retail bank capital requirements undesirable, as the welfare cost of less financial intermediation outweighs the benefit of fewer bank runs. Chapter 2 is titled Housing, Financial Crises and Macroprudential Regulation: The Case of Spain. Based on the observation of the intertwined housing and banking crisis in Spain between 2008 and 2016, our objective is to study the effectiveness of different macroprudential regulation policies in preventing crises of this kind. We develop a dynamic stochastic general equilibrium (DSGE) model in which we introduce a housing market and mortgage credit while keeping the mechanism of banking crises as in Chapter 1. However, instead of distinguishing retail and shadow banking, we simplify the model by including only one banking sector in the economy. The equilibrium mortgage credit allocation in the economy is determined either by a capital requirement on the banks or a loan-to-value (LTV) constraint on the borrowers. Large drops in the house price (housing crises) occur endogenously and can lead to runs on the banking sector (banking crises). We calibrate the model to match the Spanish economy in 2007-2017. We find that all three macroprudential policies can reduce the mortgage default rate and the frequency of bank runs, but the effect is stronger with the higher capital requirement and the tighter LTV constraint. Dynamic loan loss provisioning is effective at reducing the cyclicality of the capital structure of banks, while a tighter LTV constraint amplifies the cyclicality of bank and household leverage. Chapter 3 is titled Capital Requirements and Credit Easing: Ex-ante vs Ex-Post Intervention Policy. In the first two chapters, the policy focus is on ex-ante macroprudential policies, which are designed to improve financial stability and prevent potential financial crises in the future. In this chapter, I turn to ex-post intervention policies. In particular, I introduce a credit easing policy by the central bank to an economy with endogenous banking crises similar to Chapter 1 but has only one banking sector. I show that bank capital requirements and credit easing policies exhibit very different trade-offs. In particular, tightening bank capital requirements effectively reduces bank leverage but leads to less financial intermediation. For the credit easing policy, I highlight an unintended ex-ante effect: it decreases the banks’ risk premium in a financial crisis, resulting in more leverage taking of banks and a higher frequency of bank runs. Nonetheless, the credit easing policy facilitates financial intermediation in both normal and crisis periods and stabilizes asset prices during financial crises. A combination of the two policies can offset their respective negative effects, reducing the frequency and severity of financial crises while maintaining efficient financial intermediation in the economy. The thesis is structured as follows. The quantitative model and main findings of each chapter are presented in respective Chapters 1 to 3. Data sources, full statement of the model equilibrium, and numerical solution algorithms for Chapter 1 and 2 are gathered in Appendices A and B, respectively. All the references are in Bibliography.

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