Year 2016, Issue 129

Date published

31.10.2016

Table of content

  • Tsvetomira Tsenova
    THE IMPORTANCE OF BEING PRUDENT: CAPITAL ADEQUACY, FINANCIAL STABILITY AND THE MACROECONOMY
    JEL: C68, D58, E44, E51, E52, E58, G21, G28
    Keywords: Banking, Macro-prudential Policy, Banking Regulation, Liquidity, Financial Stability, Spillovers, Uncertainty and Risk, Non-Linearities
    Summary: 109 List of Figures Figure 1. Real GDP growth in the Euro area (1999Q1-2016Q1) 48 Figure 2. HICP inflation in the Euro area (1999Q1-2016Q1) 49 Figure 3. Real GDP growth in Bulgaria (1999Q1-2016Q1) 50 Figure 4. HICP inflation in Bulgaria (1999Q1-2016Q1) 51 Figure 5. Ratio of bank equity to total assets (1999Q1-2016Q1) 54  ... ... TABLE OF CONTENTS Introduction 13 Chapter 1: Regulatory overhaul of the banking system 15 1.1. Background of current reform in the banking sector 15 1.2. Regulatory agenda concerning the capital adequacy of banks 20 1.3. Critical review of the academic literature concerning capital adequacy of banks 27 1.3.1. Criteria for an ideal modelling framework 27 1.3.2. Literature review on prudential policy analysis 30 Chapter 2: Stylised features of the Bulgarian banking system, policy influences and links to the wider national and international economy 46 2.1. Financial, economic and policy linkages between the Euro area and Bulgaria 46 2.2. Evolution of key indicators of liquidity and solvency of the banking system 52 Chapter 3: A general equilibrium analysis of the transmission of prudential policies and contingent scenario assessment 59 3.1. Key features and contributions of the theoretical and empirical framework 59 3.2. Model setup and equilibrium conditions on each market 61 3.2.1. Equilibrium on foreign interbank markets 63 3.2.2. Equilibrium on local depositors’ market 66 3.2.3. Equilibrium on local loans’ market 66 3.2.4. Banks’ optimal decision-making process 67 3.2.5. Households’ decision-making process 69 3.2.6. Aggregate equilibrium condition 71 3.3. Numerical solution and evaluation: data description, method and procedure 72 3.4. Analysis of prudential policies and contingency scenarios 77 3.4.1. Transmission of a decline in the key interest rate on the refinancing operations of the foreign monetary authority 78 3.4.2. Transmission of market pressure to report higher capital adequacy ratios 80 3.4.3. Transmission of a decline in the capital adequacy ratio of all banks owing to tighter definition of capital 84 3.4.4. Contingency scenario: transmission of a decline in the capital adequacy ratio in one of the banks owing to a negative shock 87 3.4.5. Contingency scenarios: transmission of external shocks to the real economy 92 3.4.6. Contingency scenarios: transmission of external shocks to the deposit base 96 Conclusion 98 References 102 Abstract 109 List of Figures Figure 1. Real GDP growth in the Euro area (1999Q1-2016Q1) 48 Figure 2. HICP inflation in the Euro area (1999Q1-2016Q1) 49 Figure 3. Real GDP growth in Bulgaria (1999Q1-2016Q1) 50 Figure 4. HICP inflation in Bulgaria (1999Q1-2016Q1) 51 Figure 5. Ratio of bank equity to total assets (1999Q1-2016Q1) 54 Figure 6. Bank loans to corporations and households (1999Q1-2016Q1) 56 Figure 7. Bank loans to total assets (1999Q1-2016Q1) 57 Figure 8. Bank deposits to total liabilities (1999Q1-2016Q1) 58 Figure 9. Model’s micro-structure 63 List of Tables Table 1. Stylised representation of a bank balance sheet 63 Table 2. Initial equilibrium: bank balance sheet variables and market interest rates 75 Table 3. Values of main regulatory and monetary policy parameters 76 Table 4. Banks' risk preference parameters evaluated given initial equilibrium 76 Table 5. Decline in the key policy interest rate of the foreign monetary authority 80 Table 6. Transmission of increased reputational effect from reporting higher capital adequacy 83 Table 7. Decline in regulatory capital of all banks 86 Table 8. Decline in the regulatory capital of bank τ 90 Table 9. Decline in the regulatory capital of bank δ 91 Table 10. Decline in the regulatory capital of bank γ 92 Table 11. Externally generated adverse shock to the wider economy in the ‘bad’ state of nature 94 Table 12. Externally generated favourable shock to the wider economy in the ‘bad’ state of nature 95 Table 13. Contingency scenario: an exogenous inflow of deposits to bank τ 97 ABSTRACT This monograph analyses the systemic impact of forthcoming provisions under Basel III related to banks’ capital adequacy in response to the global economic crisis. The study considers multiple policy channels which aim to achieve substantially higher capital adequacy standards, such as regulatory requirements, market-driven pressures and supervisory contingency stress tests of the banking system, as well as individual banking institutions. The analysis is based on detailed examination of current regulatory overhaul proposals and policy dilemmas, a critical review of the empirical and theoretical literature linking macroeconomics and financial intermediation and a quantitative impact assessment in the case of the Bulgarian banking system. The latter includes a dynamic identification of structural links between Bulgaria and the Euro area and an application of a general equilibrium model, incorporating financial intermediation, heterogeneity and default risk used for policy evaluation and prudential systemic stress tests.