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Financial Crises, Bank Risk Exposure And Government Financial Policy

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Executive Summary

The authors develop a macroeconomic model with financial intermediation that allows the intermediaries (banks) to issue outside equity as well as short term debt. This makes bank risk exposure an endogenous choice. The goal is to have a model that can not only capture a crisis when banks are highly vulnerable to risk, but can also account for why banks adopt such a risky portfolio structure in the first place. They use the model to assess quantitatively how perceptions of fundamental risk and of government credit policy in a crisis affect the vulnerability of the financial system ex ante. They also study the quantitative effects of macro-prudential policies designed to offset the incentives for risk-taking.

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