Bank Characteristics and Procyclicality: A Theoretical Approach

Marie-Sophie Gauvin

doi:10.4236/jfrm.2014.33007

Abstract

The 2007-2008 crisis highlighted liquidity management troubles. We witness a real estate asset price boom during the pre-crisis period and a difficulty for banks to raise funding afterwards. Consequently, bank choices in response to the conduct of the monetary policy along the cycle can be studied. Despite usual financial accelerator, the excessive (lack of) confidence of banks in the upward (down) phase explains procyclical balance sheet movements. Moreover, the monetary policy effects on bank behaviors vary according to their initial specifications. From a theoretical point of view, this paper examines the response of the banking sector to monetary authorities impulses, in function of their initial characteristics. So, the paper highlights a theoretical model, based on accounting identities, in which banks are distinguished in different categories according to their level of capitalization and liquidity. The principal result is that the less capitalized and liquid banks have more procyclical behaviors.

Highlights

Financial crises, characterized by an asset price bust, usually follow a euphoric phase conducive to an asset price boom
The core model presented in this paper departs from Gilles, Gauvin, & Huchet (2013) essentially by using an analysis based on the observation of the balance sheet of the banking sector
The model presented showed that the combination of monetary policy and microprudential measures (e.g. Basel II standards) could encourage bank risk-taking by having procyclical effects

Summary

Introduction

Financial crises, characterized by an asset price bust, usually follow a euphoric phase conducive to an asset price boom. Funding pressures boosted fire sales, resulting in an asset price sharp decrease In both cases, the crisis occurred after a period of innovations (1907-trusts and newly securitization), which went out of control. Throughout the paper, a theoretical model, that takes into account the relationship between monetary policy and banking, is implemented. This theoretical model involves specifying accounting identities relating to a balance sheet. Even if the impact of prudential regulation is considered, the model highlights especially the influence of monetary policy via the risk taking channel. The banks’ characteristics, that can influence the relationship between monetary policy and banks, are identified. The various ways of integrating these elements in the regulation are discussed

Survey

Outline of the Model

The Risk Taking of Banks According to Initial Characteristics

Conclusions and Discussions