Knowledge that Transforms

This paper lays out a quantitative macroeconomic model with rational risk-adjusted asset bubbles and banks. The model features an imperfect financial market structure and allows bubble assets within banks. We shed light on the channels by which a sudden burst of asset bubbles leads to a recession through the banking system and evaluate “leaning against the wind” monetary policy associated with bubble volatility and welfare. Our main findings call for monetary policy rules to preemptively stabilize intermediate asset prices rather than the bubbles.

We evaluate the impact of contagion and common exposures on banks’ capital using a structural regression framework derived from the balance sheet identity and inspired by the structural VAR literature. Contagion arises through bilateral exposures, fire sales, rollover risk, and market-based sentiment, while common exposures reflect overlapping portfolio holdings. We estimate the model using granular regulatory balance sheet and interbank exposure data for the Canadian banking sector. Our results yield three key insights. First, contagion driven by bilateral contractual exposures remains relatively stable over time until the onset of quantitative easing. In contrast, non-contractual contagion channels are less stable and move with market conditions. Second, we observe an increase in common exposure risk along with a decrease in contagion risk, following unprecedented fiscal and monetary policy measures in the COVID-19 pandemic. Third, we demonstrate how our framework complements traditional bank stress-testing approaches that focus on individual institutions by analysing second-round effects. In a policy application, we simulate targeted bailouts and show that their effectiveness in stabilizing the system is related to the interconnectedness of the rescued institution.

Using the Troubled Asset Relief Program (TARP) as a laboratory, this paper examines the impacts of bank bailouts on bank-dependent clients. We find that large TARP recipient banks reduce credit supply to dependent borrowers in the post-TARP period. A large fraction of credit supply reduction is due to regulatory uncertainty on account of an increased likelihood of fines. Liquidity hoarding by TARP banks also drives part of the reduction in credit supply. Relationship borrowers experience a valuation loss around the announcements of their main banks’ TARP approvals consistent with a credit supply reduction.

Recent financial crises have once again underscored the critical role of credit booms in driving systemic risk and financial instability in both advanced and developing countries. In this study, I examine whether macroprudential policies can attenuate systemic risk by mitigating the effects of booms in credit. The robust results show that macroprudential instruments are effective in curbing the build-up of systemic risk during household credit booms, which pose significant concerns for financial stability , though not for booms in credit to firms. Moreover, the findings suggest that limits on banks’ sectoral exposures are particularly effective in reducing systemic risk during booms in credit to the household sector. I further discover that leverage is a key transmission channel through which household credit booms contribute to systemic risk.

We examine the impact of the ECB’s asset purchase programmes on euro area non-financial firms’ cost of borrowing and their choice between corporate bonds and syndicated loans. Our findings indicate that the Corporate Sector Purchase Programme (CSPP) reduced spreads for both eligible and non-eligible corporate bonds, and that ECB purchases of covered bonds positively affected corporate bond spreads. The CSPP also compressed spreads across all syndicated loans, irrespective of eligibility. We find evidence supporting a “cost of borrowing channel” for covered bonds under the first programme and asset-backed securities, indicating that syndicated loan spreads reflect banks’ borrowing costs in the bond market. Additionally, our results reveal that the CSPP significantly influenced firms’ debt financing choices, with these effects being more pronounced for non-switchers.

The establishment of the European Banking Union constitutes a major change in the regulatory framework of the banking system. Main parts are implemented via directives that show staggered transposition timing across EU member states. Based on the newly compiled Banking Union Directives Database, we assess how banks’ funding costs responded to the Capital Requirements Directive IV (CRD IV). We find evidence of a weak increase in funding costs that results from an increase in cost of equity which is mostly offset by a decline in cost of debt. The diverging trends stem from countries with an ex-ante lower regulatory capital stringency and an ex-post quicker activation of capital buffers, which is in line with banks’ short-run adjustment needs but longer-run benefits from increased financial stability.

We develop a stress-testing network model calibrated to the largest banks and investment funds in over-the-counter (OTC) derivatives markets. We examine the impact of the mandatory collateralisation of bilateral OTC derivatives on liquidity, counterparty, and systemic risks, as well as the impact of market frictions on participants’ ability to withstand liquidity shocks. The collateralisation of bilateral trades reduces counterparty and systemic risks but increases the prominence of liquidity-driven defaults and the potential for the central counterparty to transmit losses. Frictions such as fire sales, delayed payments, and no partial payments by defaulted counterparties greatly increase liquidity risk and systemic losses.

This paper exploits changes in financial subsidy programs to investigate their effect on female employment and firm performance. The identification strategy uses a quasi-experiment from a government policy change that eliminated financial support for exporting plants in the Chilean manufacturing industry. The difference-in-differences methodology shows that the policy change increased the share of total female employment by 3.3%, driven mainly by an increase of female workers in blue-collar occupations. In comparison, male labor experienced a drop of 4.4% in white-collar occupations in the treated plants relative to those in the control group. Plant total factor productivity (TFP) decreased due to the policy change, but both total gross output and sales rose approximately 7% on average. The paper explores two possible mechanisms to explain these findings: the technology adoption channel and changes in the gender composition of labor in the presence of a gender pay gap. The findings are consistent with the international trade and corporate finance literature on firm behavior under high market fixed and sunk costs.

We examine the impact of different types of oil price volatility shocks on firm’s systemic risk using a large panel dataset of US firms. Oil price volatility shocks occur due to changes in supply or demand for oil, or through idiosyncratic fluctuations of oil prices. Our findings indicate that the supply-driven or idiosyncratic oil price volatility shocks reduce systemic risk, whereas demand-driven shocks have the opposite effect. Large-cap and high-beta firms amplify the impact of oil price volatility shocks on firms’ systemic risk. Importantly, firms with extensive supply chain networks exacerbate systemic risk when facing demand-driven oil price volatility shocks.

To rationalize the increased use of capital flows regulations in recent times, we study the capacity of capital flow management measures (CFMs) to insulate an economy from external shocks. We examine the extent to which CFMs mitigate the effects of US monetary shocks and whether measuring this mitigation at the net or gross level of flows matters. Our analysis is carried out for a panel of emerging market economies and for different disaggregations of the flows. Our results indicate that the level of aggregation matters for evaluating the effects of CFMs, and that analyses with excessively aggregated flows or with only net measures may lead to biases in assessing the insulation features of the CFMs. Furthermore, CFMs have insulation properties that mitigate capital repatriations; however, these are mostly related to risky portfolio and banking flows.