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Transmission of Liquidity Conditions: Intermediary Leverage & Risk Premiums, Slides of Banking and Finance

The relationship between financial intermediary leverage and risk premiums, as well as the transmission of liquidity conditions through the global banking system. A discussion of the 'double-decker' model of credit supply, the impact of equity and leverage growth on asset growth, and the empirical implication of a negative relationship between leverage changes and unit var changes.

Typology: Slides

2012/2013

Uploaded on 07/29/2013

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sathyanarayana 🇮🇳

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Two Themes
Financial intermediary leverage drive fluctuations in risk premiums
Transmission of liquidity conditions through global banking system
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Two Themes

Financial intermediary leverage drive

fl

uctuations in risk premiums

Transmission of liquidity conditions through global banking system

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Outline

“Double-decker” model of credit supply

Global banks

Local banks

Credit supply driven by credit risk model

Lending increases to use up any spare balance sheet capacity

Liquidity conditions transmitted to local banks

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A

L

Assets

Equity

Debt

A

L

Assets

Equity

Debt

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A

L

Assets

Equity

Debt

A

L

Assets

Equity

Debt

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Asset growth

Leverage

growth

Slope = 1

0

Increasing equity

Decreasing equity

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Asset growth

Leverage

growth

Slope = 1

Constant equity

growth of

g

g

0

Constant equity

line

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1998-

2007-

2007-

2008-

.2 .1 0 -.1 -.

Total Assets (log change)

-.

-.

0

.

.

Leverage (log change)

Asset weighted, 1992Q3-2008Q1, Source: SEC

Leverage and Total Assets Growth

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Explaining Deleveraging

Value at risk (VaR) at con

fi

dence level

relative to some base level

0

is

smallest non-negative number

such that

Prob

0

Equity

meets total value at risk

×

is Unit VaR (Value-at-Risk per dollar of assets).

Leverage

satis

fi

es

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2007-Q

200

7

-Q

2008-Q

2008-Q

2008-Q

2008-Q

2009-Q

-0.2 -0.4 -0.

0

0.8 0.6 0.4 0.

1

-0.

-0.

-0.

-0.

0

Leverage Growth

Unit VaR Growth

Five (then four, three, then two) Wall Street banks, Adrian and Shin (2011)

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Pre-Crisis Standard Deviations

Unit VaRVaR/ELeverage

Bank Credit Supply and Value-at-Risk

L

f

1

Density

over

repayments

C r  1 0 

Y

w

Probability density over asset realizations

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Turning Credit Risk Model on Its Head

Vasicek one factor credit risk model (backbone of Basel)

Turn Vasicek model on its head as credit supply model

Fix

Determine credit supply

1+

1+

is ratio of

notional assets

to

notional debt

[

is normalized leverage measure, with

]

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1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Trillion pounds

Total AssetsRisk-WeightedAssets

Figure

Barclays,

risk-weighted

assets

and

total

assets

(Source:

Bankscope)

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8.0% 6.0% 4.0% 2.0% 0.0%

18.0%16.0%14.0%12.0%10.0%

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

TotalCapitalRatio Tier 1Ratio Equity/TotalAssets

Figure 3: Barclays, capital ratios (Source:

Bankscope)

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