Discussion Paper Series 2011-E-15

Bank Overleverage and Macroeconomic Fragility

Ryo Kato, Takayuki Tsuruga

This paper develops a dynamic general equilibrium model that explicitly includes a banking sector with a maturity mismatch. We demonstrate that, despite the perfect competition in the banking sector, rational banks take on excessive risks systemically, resulting in overleverage and inefficiently high crisis probabilities. The model accounts for the banks' rational over-optimism regarding future capital prices which arises from pecuniary externalities on their own solvency. Using the model as an example, we introduce MSR (marginal systemic risk) as a general measure to assess the macroeconomic exposure to systemic risks.

Keywords: Financial crisis; Liquidity shortage; Maturity mismatch; Pecuniary externalities

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2011 Bank of Japan All Rights Reserved.

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