Drawing on the lessons from the global financial crisis and especially from its impact on the banking systems of Eastern Europe, the paper proposes a new practical approach to macroprudential stress testing. The proposed approach incorporates: (i) macroeconomic stress scenarios generated from both a country specific statistical model and historical cross-country crises experience; (ii) indirect credit risk due to foreign currency exposures of unhedged borrowers; (iii) varying underwriting practices across banks and their asset classes based on their relative aggressiveness of lending; (iv) higher correlations between the probability of default and the loss given default during stress periods; (v) a negative effect of lending concentration and residual loan maturity on unexpected losses; and (vi) the use of an economic risk weighted capital adequacy ratio as the relevant outcome indicator to measure the resilience of banks to materializing credit risk. The authors apply the proposed approach to a set of Eastern European banks and discuss the results.

Equilibrium credit is an important concept because it helps to identify excessive credit provision in an economy. This paper proposes a structural approach to determine equilibrium credit which is based on the long-run through-the-cycle transaction demand for credit. Using a panel data set consisting of 49 high and middle-income countries from 1980 to 2010, we show that there exists considerable variation in the cross-country estimates of the income and price elasticities of credit and that the unit elasticity restriction implicitly imposed by the credit-to-GDP ratio is strongly rejected by the data. This suggests that the credit-to-GDP ratio is not appropriate to measure equilibrium credit. We show further that the cross-sectional variation in the income and price elasticities of credit can be related to a set of relevant economic, financial and institutional development indicators of a country. The main determinants that explain the cross-sectional variation in the income and price elasticities are financial depth, access to financial services, use of capital markets, efficiency and funding of domestic banks, central bank independence, the degree of supervisory integration, and the experience of a financial crisis. As an empirical illustration, we compute equilibrium credit and credit gaps for eleven new EU member states using our structural framework and compare it to credit gaps based on the Basel III approach.

This paper studies the effects of hedge disclosure requirements on corporate risk management and product market competition. The analysis is based on a model of market entry and shows that to prevent entry incumbent firms engage in risk management when these activities remain unobserved by outsiders. In the resulting equilibrium, financial markets are well informed and entry is efficient. However, potential attempts for more transparency by additional disclosure requirements introduce a commitment device that provides incumbents with incentives to distort risk management activities thereby influencing entrant beliefs. In equilibrium, firms engage in significant risk-taking. This behavior limits entry and adversely affects the nature of competition in industries.

This article develops a theory of resource allocation in internal capital markets that is consistent with the empirical finding that multidivision firms bias their investment levels in favor of divisions with weaker investment prospects. Headquarters has private information about the capital productivities of its divisions; therefore, capital allocations in the present serve as a signal to divisional managers about future allocations. To facilitate effort provision, headquarters biases capital allocation so as to not disclose productivity differences across divisions or to credibly signal their absence. The capital allocation bias is time-varying and the relationship between the bias and the difference in average division productivities is inversely U-shaped.