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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.
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Financial intermediary leverage drive
fl
uctuations in risk premiums
Transmission of liquidity conditions through global banking system
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“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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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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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
L
f
1
Density
over
repayments
Y
w
Probability density over asset realizations
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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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