DP4935 Do Risk Premia Protect from Banking Crises?

Author(s): Hans Gersbach, Jan Wenzelburger
Publication Date: February 2005
Keyword(s): banking crises, banking regulation, financial intermediation, macroeconomic risks, risk premia
JEL(s): D41, E40, G20
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4935

This paper studies the question to what extent premia for macroeconomic risks in banking are sufficient to avoid banking crises. We investigate a competitive banking system embedded in an overlapping generation model subject to repeated macroeconomic shocks. We show that even if banks fully incorporate macroeconomic risks in their pricing of loans, a banking system may enter bankruptcy with probability one. A major cause for this default is that risk premia of a competitive banking system may become too small if the capital base is low.