Financial Regulation in an Agent Based Macroeconomic Model

Riccetti, Luca and Russo, Alberto and Mauro, Gallegati (2013): Financial Regulation in an Agent Based Macroeconomic Model.

Abstract

Starting from the agent-based decentralized matching macroeconomic model proposed in Riccetti et al. (2012), we explore the effects of banking regulation on macroeconomic dynamics. In particular, we study the overall credit exposure and the lending concentration towards a single counterparty, finding that the portfolio composition seems to be more relevant than the overall exposure for banking stability, even if both features are very important. We show that a too tight regulation is dangerous because it reduces credit availability. Instead, on one hand, too loose constraints could help banks to make money and to increase their net worth, thus making the constraints not binding. However, on the other hand, if bank profits are tied to higher payout ratio (as it really happened along the deregulation phase of the last 20 years), then the financial fragility increases causing a weaker economic environment (e.g., higher mean unemployment rate), a more volatile business cycle, and a higher probability of triggering financial crises. Accordingly, simulation results support the introduction of the Capital Conservation Buffer (Basel 3 reform).

• Item Type: MPRA Paper
• Language: English
• Keywords: financial regulation, agent-based macroeconomics, business cycle, crisis, unemployment, leverage
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C63 - Computational Techniques ; Simulation Modeling; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation

References

Acharya V.V., Gujral I., Shin H.S. (2009), "Dividends and Bank Capital in the Financial Crisis of 2007-2009", SSRN Working Paper, available at http://dx.doi.org/10.2139/ssrn.1362299.

Adrian T., Shin H.S. (2008), "Liquidity, monetary policy and financial cycles", Current Issues in Economics and Finance, 14(1), Federal Reserve Bank of New York (January/February).

Adrian, T., Shin, H.S. (2009), "Money, Liquidity, and Monetary Policy", American Economic Review, 99(2): 600-605.

Adrian, T., Shin, H.S. (2010), "Liquidity and leverage", Journal of Financial Intermediation, 19(3): 418-437.

Agenor P.R., Pereira da Silva L.A. (2012), "Cyclical effects of bank capital requirements with imperfect credit markets", Journal of Financial Stability, 8(1): 43-56.

Agur I. (2013), "Wholesale bank funding, capital requirements and credit rationing", Journal of Financial Stability, 9(1): 38-45.

Al-Darwish A., Hafeman M., Impavido G., Kemp M., O'Malley P. (2011), "Possible Unintended Consequences of Basel III and Solvency II", IMF Working Papers, 11/187.

Allen B., Chan K.K., Milne A., Thomas S. (2012), "Basel III: Is the cure worse than the disease?", International Review of Financial Analysis, 25(C): 159-166.

Andersen H. (2011), "Procyclical implications of Basel II: Can the cyclicality of capital requirements be contained?", Journal of Financial Stability, 7(3): 138-154.

Booth L., Asli Demirgu-Kunt V.A., Maksimovic V. (2001), "Capital Structures in Developing Countries", Journal of Finance, 56(1): 87-130.

Brav A., Graham J.R., Harvey C.R., Michaely R. (2005), "Payout policy in the 21st century", Journal of Financial Economics, 77: 483-527.

Brogi M. (2010), "Capital Adequacy and Dividend Policy: Evidence from Italian Banks ", LE BANCHE ITALIANE SONO SPECIALI?, G. Bracchi and D. Masciandaro, eds., XV Rapporto annuale della Fondazione Rosselli, available at SSRN: http://ssrn.com/abstract=1707962.

Brunnermeier M.K., Pedersen L.H. (2009), \Market liquidity and funding liquidity", Review of Financial Studies, 22(6): 2201-2238.

Carlson M., Shan H., Warusawitharana M. (2011), "Capital Ratios and Bank Lending: A Matched Bank Approach", Finance and Economics Discussion Series 2011-34, Board of Governors of the Federal Reserve System (U.S.).

Cincotti S., Raberto M., Teglio A. (2010), "Credit money and macroeconomic instability in the agent-based model and simulator Eurace", Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, 4(26).

Cincotti S., Raberto M., Teglio A. (2012), "Debt Deleveraging and Business Cycles. An Agent-Based Perspective", Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, 6(27).

Dawid H., Neugart M. (2011), "Agent-Based Models for Economic Policy Design", Eastern Economic Journal, 37(1): 44-50.

DeAngelo H., DeAngelo L., Skinner D.J. (2004), "Are dividends disappearing? Dividend concentration and the consolidation of earnings", Journal of Financial Economics, 72: 425-456.

Delli Gatti D., Gaffeo E., Gallegati M. (2005), "The apprentice wizard: monetary policy, complexity and learning", New Mathematics and Natural Computation, 1(1): 109-128.

Delli Gatti, D., Gallegati, M., Greenwald, B., Russo, A., and Stiglitz, J.E. (2009), "Business Fluctuations and Bankruptcy Avalanches in an Evolving Network Economy", Journal of Economic Interaction and Coordination 4(2): 195-212.

Delli Gatti D., Gallegati M., Greenwald B., Russo A., Stiglitz J.E. (2010), "The financial accelerator in an evolving credit network", Journal of Economic Dynamics and Control, 34(9):1627-1650.

Denis D.J., Osobov I. (2008), "Why do firms pay dividends? International evidence on the determinants of dividend policy", Journal of Financial Economics, 89: 62-82.

Diamond D.W., Rajan R. (2000), "A Theory of Bank Capital", Journal of Finance, 55(6): 2431-2465.

Dosi G., Fagiolo G., Roventini A. (2010), "Schumpeter meeting Keynes: A policy-friendly model of endogenous growth and business cycles", Journal of Economic Dynamics and Control, 34(9): 1748-1767.

Dosi G., Fagiolo G., Napoletano M., Roventini A. (2012), "Income Distribution, Credit and Fiscal Policies in an Agent-Based Keynesian Model", LEM Papers Series 2012/03, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.

Eliasson G. (1977), "Competition and Market Processes in a Simulation Model of the Swedish Economy", American Economic Review, 67: 277-281.

Elliott D. (2009), "Quantifying the Effects on Lending of Increased Capital Requirements", Pew Financial Reform Project Briefing Paper, 7.

Elliott D. (2010), "A Further Exploration of Capital Requirements: Effects of Competition from Other Financial Sectors and Effects of Size of Bank or Borrower and of Loan Type", Mimeo, The Brooking Institution.

Epstein J.M., Axtell R.L. (1996), Growing Artificial Societies: Social Science from the Bottom Up, MIT Press.

Fagiolo G., Dosi G., Gabriele R. (2004), "Matching, Bargaining, And Wage Setting In An Evolutionary Model Of Labor Market And Output Dynamics", Advances in Complex Systems, 7(2): 157-186.

Fagiolo G., Roventini A. (2009), "On the Scientific Status of Economic Policy: A Tale of Alternative Paradigms", The Knowledge Engineering Review, 27(Special Issue 02): 163-185.

Fagiolo G., Roventini A. (2012), "Macroeconomic Policy in DSGE and Agent-Based Models", SSRN Workin Paper Series, available at http://ssrn.com/abstract=2011717.

Flannery M.J. (1994), "Debt Maturity and the Deadweight Cost of Leverage: Optimally Financing Banking Firms", American Economic Review, 84(1): 320-31.

Fostel A., Geanakoplos J. (2008), "Leverage Cycles and the Anxious Economy", American Economic Review, 98(4): 1211-44.

Francis W.B., Osborne M. (2012), "Capital requirements and bank behavior in the UK: Are there lessons for international capital standards?", Journal of Banking & Finance, 36(3): 803-816.

Gaffeo G., Delli Gatti D., Desiderio S., Gallegati M. (2008), "Adaptive Microfoundations for Emergent Macroeconomics", Eastern Economic Journal, 34(4): 441-463.

Geanakoplos J. (2010), "Leverage cycle", Cowles foundation Paper No. 1304, Yale University.

Godley W., Lavoie M. (2006), Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth, Palgrave MacMillan.

Graham J.R., Harvey C. (2001), "The Theory and Practice of Corporate Finance", Journal of Financial Economics, 60: 187-243.

Greenlaw D., Hatzius J., Kashyap A.K., Shin H.S. (2008), "Leveraged Losses: Lessons from the Mortgage Market Meltdown", Proceedings of the U.S. Monetary Policy Forum.

Gropp R., Heider F. (2010), "The Determinants of Bank Capital Structure", Review of Finance, 14(4): 587-622.

Haber G. (2008), "Monetary and Fiscal Policy Analysis with an Agent-Based Macroeconomic Model", Jahrbucher fur Nationalokonomie und Statistik, 228: 276-295.

Hanson S., Kashyap A., Stein J. (2010), "An Analysis of the Impact of Substantially Heightened Capital Requirements on Large Institutions", Mimeo, University of Chicago, Booth School of Business and Harvard University.

He Z., Khang I.G., Krishnamurthy A. (2010), "Balance Sheet Adjustments in the 2008 Crisis", IMF Economic Review, 58: 118-156.

Hellwig M. (2010), "Capital Regulation after the Crisis: Business as Usual?", CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, 8(2): 40-46.

Jokipii T., Milne A. (2008), "The cyclical behaviour of European bank capital buffers", Journal of Banking & Finance, 32(8): 1440-1451.

Jokipii T., Milne A. (2011), "Bank capital buffer and risk adjustment decisions", Journal of Financial Stability, 7(3): 165-178.

Kalemli-Ozcan S., Sorensen B., Yesiltas S. (2011), "Leverage Across Firms, Banks, and Countries", NBER Working Papers 17354.

Kiema I., Jokivuolle E. (2011), "Leverage ratio requirement, credit allocation and bank stability", Bank of Finland Research Discussion Papers, 10.

King M.R. (2010), "Mapping capital and liquidity requirements to bank lending spreads", BIS Working Papers, 324, November.

Kinsella S., Greiff M., Nell E. (2011), "Income Distribution in a Stock-Flow Consistent Model with Education and Technological Change", Eastern Economic Journal, 37(1): 134-149.

Lazonick W., O'Sullivan M. (2000), "Maximising shareholder value: a new ideology for corporate governance", Economy and Society, 29(1): 13-35.

LeBaron B., Tesfatsion L.S. (2008), "Modeling Macroeconomies as Open-Ended Dynamic Systems of Interacting Agents", American Economic Review, 98(2): 246-250.

Lemmon M., Roberts M., Zender J. (2008), "Back to the beginning: Persistence and the cross-section of corporate capital structure", Journal of Finance, 63: 1575-1608.

Mannaro K., Marchesi M., Setzu A. (2008), "Using an Artificial Financial Market for Assessing the Impact of Tobin-like Transaction Taxes", Journal of Economic Behavior and Organization, 67: 445-462.

Mora N., Logan A. (2012), "Shocks to bank capital: evidence from UK banks at home and away", Applied Economics, 44(9): 1103-1119.

Neuberger D., Rissi R. (2012), "Macroprudential banking regulation: Does one size fit all?", Thuenen-Series of Applied Economic Theory, University of Rostock, Institute of Economics.

Neugart M. (2008), "Labor Market Policy Evaluation with ACE", Journal of Economic Behavior and Organization, 67: 418-430.

Orcutt G.H. (1957), "A New Type of Socio Economic System", Review of Economics and Statistics, 58: 773-797.

Rajan R., Zingales L. (1995), "What do we know about capital structure? Some evidence from international data", Journal of Finance, 50: 1421-1460.

Riccetti L., Russo A., Gallegati M. (2012), "An Agent-Based Decentralized Matching Macroeconomic Model", SSRN Working Paper Series, available at http://papers.ssrn.com/sol3/papers.cfm?abstract id=2163581.

Riccetti L., Russo A., Gallegati M. (2013), "Leveraged Network-Based Financial Accelerator", Journal of Economic Dynamics and Control, 37(8): 1626-1640.

russo A., Catalano M., Gaffeo E., Gallegati M., Napoletano M. (2007), \Industrial dynamics, fiscal policy and R&D: Evidence from a computational experiment", Journal of Economic Behavior and Organization, 64(3-4): 426-447.

Seppecher P. (2012), "Flexibility of wages and macroeconomic instability in an agent-based computational model with endogenous money", Macroeconomic Dynamics, 16(s2): 284-297.

Skinner D.J. (2008), "The evolving relation between earnings, dividends, and stock repurchases", Journal of Financial Economics, 87: 582-609.

Stockhammer E. (2004), "Financialisation and the slowdown of accumulation", Cambridge Journal of Economics, 28(5): 719-741.

Tesfatsion L.S., Judd K.L. (2006), Handbook of Computational Economics: Agent-Based Computational Economics, Vol. 2, North-Holland.

Tutino F., Birindelli G., Ferretti P. (2012), "Bank capital and Basel 3 impacts on Italian banks", Corporate Ownership & Control, 10(1): 75-87.

Vollmer U., Wiese H. (2013), "Minimum capital requirements, bank supervision and special resolution schemes. Consequences for bank risk-taking", Journal of Financial Stability, 9(4):487-497.

Westerhoff F. (2008), "The Use of Agent-Based Financial Market Models to Test the Effectiveness of Regulatory Policies", Jahrbucher fur Nationalokonomie und Statistik, 228: 195-227.

Westerhoff F., Dieci R. (2006), "The Effectiveness of Keynes' Tobin Transaction Taxes when Heterogeneous Agents can Trade in Different Markets: A Behavioral Finance Approach", Journal of Economic Dynamics and Control, 30: 293-322.

Westerhoff F., Franke R. (2012), "Agent-Based Models for Economic Policy Design: Two Illustrative Examples", BERG Working Paper, 88, University of Bamberg.

Zhou C. (2013), "The impact of imposing capital requirements on systemic risk", Journal of Financial Stability, 9(3): 320-329.