Capturing Macroprudential Regulation Effectiveness: A DSGE Approach with Shadow Intermediaries (with Abdelaziz Rouabah)

This version: May 2018.

First version: Banque centrale du Luxembourg Working Paper No. 2017/114

We develop a New Keynesian DSGE model with heterogeneous agents to investigate how the shadow financial system affects macroeconomic activity and financial stability. In the adopted framework, regulated commercial banks finance small firms through traditional business loans and exert costly effort to screen the projects they finance. Shadow financial intermediaries finance large firms, provide short-term lending to commercial banks, and are engaged in the secondary market for loans. In this market, commercial banks originate asset-backed securities under moral hazard to exploit regulatory arbitrage. Shadow intermediaries purchase these loans from commercial banks under adverse selection. In general equilibrium, this set of externalities is not internalized by the financial system. We show that a macroprudential authority may successfully mitigate the externalities by activating caps to both the leverage ratio and the securitization ratio in the traditional banking sector. Such policy actions are effective in dampening aggregate volatility and safeguarding financial stability.

Working papers

Chained Financial Frictions and Credit Cycles (with Ivan Petrella and Emiliano Santoro) (Technical Appendix)

Banque centrale du Luxembourg Working Paper No. 2018/116

We examine the role of bank collateral in shaping credit cycles. To this end, we develop a tractable model where bankers intermediate funds between savers and borrowers. If bankers default, savers acquire the right to liquidate bankers' assets. However, due to the vertically integrated structure of our credit economy, savers anticipate that liquidating financial assets (i.e., bank loans) is conditional on borrowers being solvent on their debt obligations. This friction limits the collateralization of bankers' financial assets beyond that of other assets that are not involved in more than one layer of financial contracting. In this context, increasing the pledgeability of financial assets eases more credit and reduces the spread between the loan and the deposit rate, thus attenuating capital misallocation as it typically emerges in credit economies à la Kiyotaki and Moore (1997). We uncover a close connection between the collateralization of bank loans, macroeconomic amplification and the degree of procyclicality of bank leverage. A regulator may reduce macroeconomic volatility through the introduction of a countercyclical capital buffer, while a fixed capital adequacy requirement displays limited stabilization power.

Work in progress

Households Heterogeneity over the Business Cycle

Investment Funds and Liquidity

Older works

Financial Deepening and Macroeconomic Volatility [available upon request]

Firm Turnover and Unemployment Fluctuations [available upon request]