Credit and liquidity risk of banks in stress conditions : analyses from a macro perspective

This thesis brings together research on credit and liquidity risks of banks in stress conditions. It investigates banks’ reactions to those risks, presents macro stress-testing models and analyses policy measures to contain the risks during the 2007-2009 financial crisis. First we analyse how Dutch banks adjusted their credit and liquidity risk management during the crisis by empirical indicators and time series models. The results provide evidence on the time and cross-sectional dimensions of bank behaviour and on banks’ responses to funding liquidity shocks. Second, we model the impact on banks of tail events that involve credit and liquidity risk and banks’ reactions to those risks in a stress-testing framework. The framework is operationalised by a suite of models, such as reduced form satellite models, vector autoregressive (VAR) models and calibrated simulation tools. We show that shocks to the liquidity position of banks entail systemic risk through behavioural responses and that tail risks of stress scenarios are substantially lower if banks would adjust to Basel III. Third we analyse the policy responses to the credit and liquidity risks of banks in the crisis, by assessing the short-term crisis measures taken by central banks and governments in 2007-2009 and the macroeconomic effects of Basel III. Simulation outcomes of reduced form satellite models and a structural macroeconomic model indicate that the negative impact of Basel III on real GDP will be limited and be outweighed by the benefits in the new steady state.