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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
Banks, Capital Flows and Financial Crises
Ozge Akinci
Albert Queraltó
Abstract

This paper proposes a macroeconomic model with financial intermediaries (banks), in which banks face occasionally binding leverage constraints and may endogenously affect the strength of their balance sheets by issuing new equity. The model can account for occasional financial crises as a result of the nonlinearity induced by the constraint. Banks' precautionary equity issuance makes financial crises infrequent events occurring along with "regular" business cycle fluctuations. We show that an episode of capital infl ows and rapid credit expansion, triggered by low country interest rates, leads banks to endogenously decrease the rate of equity issuance, contributing to an increase in the likelihood of a crisis. Macroprudential policies directed at strengthening banks' balance sheets, such as capital requirements, are shown to lower the probability of financial crises and to enhance welfare.


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Ozge Akinci & Albert Queraltó, Banks, Capital Flows and Financial Crises, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1121, 07 Nov 2014.
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Keywords: Financial intermediation; sudden stops; leverage constraints; occasionally binding constraints.
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