Essays on the Macroeconomics of Banking

Abstract

The role played by financial intermediaries and banks in modern economies is undeniably critical. However, explaining their importance in a theoretical general equilibrium framework presents some challenges. If firms and households have unrestricted access to complete financial markets, then at the competitive equilibrium banks make zero profits and the size and composition of the bank's balance sheet have no impact on the other economic agents. Imperfections in credit markets are key then to explain the unique role of banks when compared to alternative financing methods. The first chapter studies some of these financial frictions focusing on how can they introduce a specific need for bank financing as opposed to alternative methods. This study carries out a macroeconomics general equilibrium analysis of this topic, taking into account the feedback between firms' financing and investment decisions. Having established the relevance of bank financing for economic outcomes, the second chapter is devoted to study how bank lending can become a transmission channel of aggregate shocks to the rest of the economy. It particularly focuses on the role played by bank capital requirements, the most important banking regulation, as a financial accelerator mechanism in a model of real business cycles. Banks becomes more capital constrained during recessions as they suffer more loan losses that erode their equity, and this results in a reduction in loan supply which in turn worsens the severity of the recession. Bank-loan dependent firms suffer the most and aggregate investment and production fall. Following this line of research, the third chapter investigates yet another mechanism by which bank lending can become a transmission channel of aggregate shocks. This one hinges on the pricing of loans by banks and its variation over the business cycle. Price-cost margins can be seen as a wedge in credit markets that produce deadweight losses for the economy. Countercyclical price-cost margins uncover a financial accelerator mechanism by which deadweight losses are more severe during recessions. This is an empirical study in which the countercyclical behavior of price-cost margins in the US commercial banking sector is carefully documented.