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Title: Bank Assets, Liquidity and Credit Cycles

Author(s): Federico Lubello, Ivan Petrella and Emiliano Santoro

Publication Date: June 2019

Keyword(s): Bank Collateral, Banking, capital misallocation, liquidity and macroprudential policy

Programme Area(s): Monetary Economics and Fluctuations

Abstract: We study how bank collateral assets and their pledgeability affect the amplitude of 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., loans) is conditional on borrowers being solvent on their debt obligations. This friction limits the collateralization of bankers' financial assets beyond that of real assets (i.e., capital). 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.

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Bibliographic Reference

Lubello, F, Petrella, I and Santoro, E. 2019. 'Bank Assets, Liquidity and Credit Cycles'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13831