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Bank has 100€ assets and 90€ of debts

—> capital-ratio?

Capital-to-asset ratio=
(Equity / Assets) = ((Assets - Debts) / Assets)

= ((100-90) / 100) = 10%


Bank has 100€ assets and 90€ of debts

Assets decrease by 5%

—> maintain the same capital ratio

5% of 100€ = 5 €
—> new asset value = 95€
—> 90€ of debts and 5 of Equity

• raise capital: 5€
—> Assets 95+5
Debts 90
Equity 5+5

• sell assets:
—> capital ratio initially: 10/100 = 10%

—> ((10-5) / (X)) = 0,1
—> X= 50
Shrink assets to 50 —> sell 45 assets and pay debts back

—> Assets 95-45 = 50
Debts 90-45 = 45
Equity 5


All banks hit by negative shock of the assets

What should macroprudential policy be worried about?

Macroprudential policy: avoid that banks sell their assets
—> this would lead to a credit crunch and to fire sales of the assets ( =many banks try to sell the same type of assets at the same time)


Why are time-varying capital requirements an effective macro tool?

• forces banks to hold more capital in good times and less in bad times

—> do not have to shrink assets in bad times to maintain the capital-ratio


Why is a corrective action by the regulator, targeted at the amount of capital that has to be hold, an effective macro tool?

The regulator uses as asset value the maximum btw. current and past asset value to compute the capital-ratio of a bank.

—> if asset value decreases —> to maintain the initial capital ratio, bank has to raise equity (bc. maximum = past asset value)


Why are banks reluctant (abgeneigt) to raise new capital?

Equity is more expensive than debt (Modigliani Miller)
—> interest payments are tax deductible, while dividends are not

—> cost of funding is the main competitive advantage of banks
—> they are reluctant to raise their capital-ratio


Costs of debts: 10%
corporate tax: 50%
interest rate payments tax deductible
dividends not

bank increases capital-ratio by 10%

—> what is the change in cost of financing?

for each additional percent of equity raised, cost increases by:

10% * 50% = 5%
0,01 * 0,5 = 0,05

(costs of debts * corporate tax)

A 10% increase in capital ratio increases the cost of financing by:

10 * 0,05 = 0,5


monetary policy

what is it, and why may it not be effective?

monetary policy = decreasing the interest rate to stimulate aggregate demand

—> many mortgage contracts are fixed at a rate
• immune to changes in interest rates

• in a recession hh. have low net worths
—> take advantage of lower interest rates and increase their savings or repay debts rather than consuming


Measuring the effectiveness of monetary policy:

Why is it misleading to only look at the relationship

interest rate consumption?

How to solve it?

• interest rate may move for reasons that also affect consumption

e.g.: Central bank decreases interest rate during recession —> will also affect consumption —> ommited variable

e.g. lower consumption –> lower demand for mortgages —> affects interest rate —> reverse causality

• study hh. with adjustable rate mortgages
—> adjustment is not related to current economic condition or current demand for mortgages
—> compare the consumption of these hh. to consumption of hh. with fixed mortgages
—> difference = effectiveness of monetary policy


Is monetary policy more effective for certain groups of people?

Poorer hh. (=higher debts) should increase their consumption more when the interest rate becomes lower, bc. they are more credit constrained


How to check:

Does monetary only effect the individual level, or also the more macro level?

Counties in which the use of ARM is more frequent should be more sensitive to changes in the interest rate (=monetary policy).
—> consumption should change more in these counties