When Banks Punch Back: Macrofinancial Feedback Loops in Stress Tests
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Summary:
In the presence of adverse macroeconomic shocks, simultaneous capital losses in multiple banks can prompt them to contract their balance sheets. These bank responses generate externalities that propagate in the form of macro-financial feedback loops. This paper develops a credit response and externalities analysis model (CREAM) that integrates a disaggregated banking sector into an otherwise standard macroeconomic structural vector autoregressive model. It shows that accounting for macro-financial feedback loops can significantly affect macroeconomic outcomes and bank-specific stress tests results. The heterogeneity in bank lending responses matters: it determines how each bank fares under adverse conditions and the external effects that banks impose on each other and on economic activity. The model can thus be used to assess the contributions of individual banks to systemic risk along the time dimension.
Series:
Working Paper No. 2020/072
Subject:
Bank credit Banking Capital adequacy requirements Financial institutions Financial regulation and supervision Financial services Financial statements Loans Money Public financial management (PFM) Yield curve
English
Publication Date:
May 29, 2020
ISBN/ISSN:
9781513534916/1018-5941
Stock No:
WPIEA2020072
Pages:
65
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