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Financial frictions and real implications of macroprudential policies

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  • Alexis Derviz
Abstract
I model a number of imperfections in financial intermediation that have implications for real economic activity in a production economy with technological risk. Partially opaque firms are financed by both debt and insider equity. Banks have market power over borrowers. There can be a prior bias in public beliefs about aggregate productivity (business sentiment). I investigate the dependence of equilibrium on the biased business sentiment and a prudential policy instrument (a convex dependence of bank capital requirements on the quantity of uncollateralized credit). Loss given default can be reduced by both a monetary restriction and a macroprudential restriction. Real implications of both are very similar in the aggregate, but macroprudential policies are more advantageous for bank earnings. On the other hand, the policies considered here are unable to reduce the number of defaulting firms (default frequency). Economic activity is highly sensitive to “leaning against the wind” actions on both fronts, so that using a macroprudential instrument to intervene against an asset price bubble has tangible welfare costs comparable to those of a monetary restriction. The costs can be offset by fine tuning capital charges as a function of corporate governance on the borrower side (specifically, by discouraging limited liability of borrowing firm managers). Copyright Swiss Society for Financial Market Research 2012

Suggested Citation

  • Alexis Derviz, 2012. "Financial frictions and real implications of macroprudential policies," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(3), pages 333-368, September.
    • Handle: RePEc:kap:fmktpm:v:26:y:2012:i:3:p:333-368
    DOI: 10.1007/s11408-012-0189-y
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    Cited by:

    1. Derviz, Alexis, 2014. "Collateral composition, diversification risk, and systemically important merchant banks," Journal of Financial Stability, Elsevier, vol. 14(C), pages 23-34.

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    More about this item

    Keywords

    Debt; Equity; Bank; Default; Macroprudential policy; E44; G20; G01; E58; E23; D82;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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