Financial Intermediation, the Mortgage Market, and Macroprudential Regulation

Abstract

This article analyzes the effects of macroprudential regulation in a dynamic stochastic general equilibrium model (DSGE) model with a mortgage market where banks and borrowers are subject to a leverage constraint. I evaluate the economic impact of (i) a countercyclical non-risk-adjusted bank capital (BC) requirement ratio, (ii) a countercyclical loan-to-value ratio (LTV), and (iii) both rules during economic and financial downturns. The model simulations show two main results. First, the LTV-rule mitigates the volatility of credit more effectively than the BC regulation because the relaxed collateral limit on the LTV ratio stimulates credit demand. The inverse relation of leverage definitions accounts for the stronger de-amplification stemming from countercyclical leverage constraints of borrowers. Second, if the financial shock affects the macroeconomy exclusively over the private mortgage market, neither of both rules attenuates the negative output effect, since borrowers and savers consumption effects cancel out. These results reveal that countercyclical regulation of borrowers represents an important complement to BC-regulation for safeguarding financial stability.