THE IMPORTANCE OF BEING PRUDENT: CAPITAL ADEQUACY, FINANCIAL STABILITY AND THE MACROECONOMY
Authors
Keywords
Banking; Macro-prudential Policy; Banking Regulation; Liquidity; Financial Stability; Spillovers; Uncertainty and Risk; Non-Linearities
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.
Pages: 112
Price: 5 Points