Tuesday, 29 September 2015

The Connection between Big Banks and Systemic Risk

From GARP -

“Earlier this year, the European Central Bank published an interesting study on “bank bias.” This is the theory that the real economy is especially dependent on bank loans for their funding needs – as opposed to equity-based funding from capital markets.

European politicians, however, are trying to change this perceived over-reliance on bank funding with the upcoming Capital Markets Union.

The authors of the ECB study argue that bank bias increases systemic risk and decreases economic growth. The thinking behind this runs as follows: during a downturn in the economic cycle, asset prices and collateral values decline; consequently, banks need to adjust their balance sheets and deal with a heavier credit crunch – especially if they are highly leveraged. In this way, highly-leveraged banks amplify cyclical downturns.”

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