Essays on Macroeconomics of Banking: Credit Frictions, Business Cycle and Bank Capital

Abstract

The role of financial frictions in the propagation of exogenous shocks in the economy has been subject of much debate in the literature and of significant implications at the institutional level. The main issue at stake is whether financial frictions are able to transform small exogenous shocks to the economy into amplified and persistent movements in aggregate output. This dissertation fits in this line of research by centering its attention on how microeconomic structures, such as the bank funding structure and the relationship between banks and borrowers, interact with macroeconomic conditions. It contributes to clarify the role of bank capital and its regulatory environment in the propagation of business cycles, taking into account the current institutional changeover from Basel I to Basel II bank capital requirements. After Chapter 1, that brings together the theoretical literature on the relationship between bank capital and the business cycle with the literature on the regulatory capital requirements under the Basel Accords, Chapter 2 proposes a dynamic general equilibrium model in which banks are constrained by a risk-based capital requirement. Taking into account that bank capital is more expensive to raise than deposits, due to households' preferences for liquidity, and that this difference tends to widen (narrow) during a recession (expansion), we explore an additional channel through which the effects of exogenous shocks on real activity are amplified - the bank capital channel. This amplification effect is larger under Basel II than under Basel I rules. To evaluate more accurately the potential procyclical effects of Basel II, we embed, in Chapter 3, the bank-borrower relationship into a heterogeneous-agent model, in which firms have different access to bank credit depending on their credit risk. We conclude that, to the extent that it is more costly to hold bank capital during recessions and that the bank's loan portfolio is characterized by a significant fraction of highly leveraged and small firms, the introduction of Basel II accentuates the procyclical tendencies of banking, amplifying business cycle fluctuations.