Long-term bank lending and the transfer of aggregate risk

Reiter, MichaelORCID: https://orcid.org/0000-0001-9490-8746 and Zessner-Spitzenberg, Leopold (2023) Long-term bank lending and the transfer of aggregate risk. Journal of Economic Dynamics and Control, 151, 104651, pp. 1-26. https://doi.org/10.1016/j.jedc.2023.104651

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Long-term loan contracts transfer aggregate risk from borrowing firms to lending banks. When aggregate shocks increase the future default probability of firms, banks are not compensated for the rising default risk of existing contracts. The flip side is that firms benefit from not facing higher interest rates in recessions. If banks are highly leveraged, this can lead to financial instability with severe repercussions in the real economy. If banks are well capitalized, the risk transfer stabilizes the economy. To study this mechanism quantitatively, we build a macroeconomic model of financial intermediation with long-term defaultable loan contracts and calibrate it to match aggregate firm and bank exposure to business cycle risks in the US. We find that moving from Basel II to Basel III capital regulation eliminates banking crises, increases output in the long run and improves welfare.

Item Type: Article in Academic Journal
Keywords: Banking, Financial frictions, Maturity transformation
Classification Codes (e.g. JEL): E32, E43, E44, G01, G21
Research Units: Current Research Groups > Macroeconomics and Business Cycles
Date Deposited: 05 Dec 2023 12:17
Last Modified: 05 Dec 2023 12:17
DOI: 10.1016/j.jedc.2023.104651
ISSN: 0165-1889
URI: https://irihs.ihs.ac.at/id/eprint/6790

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