A risk assessment model for banks

Summary. This paper proposes a model to assess risk for banks. Its main innovation is to incorporate endogenous interaction among banks, where the actual risk an individual bank bears also depends on its interaction with other banks and investors. We develop a two-period general equilibrium model with three active heterogeneous banks, incomplete markets, and endogenous default. The model is calibrated against UK banking data and therefore can be implemented as a risk assessment tool for regulators and central banks. We address the impact of monetary and regulatory policy, credit and capital shocks in the real and financial sectors.We are grateful to Lea Zicchino, an anonymous referee, seminar participants at the Bank of England, and the third Conference in Research in Economic Theory and Econometrics, Syros, for helpful comments. The views expressed are those of the authors and do not necessarily reflect those of the Bank of England.This revised version was published online in January 2005 with corrections to the Cover date.     

A Time Series Analysis of Financial Fragility in the UK Banking System

This paper extends the model proposed by Goodhart, Sunirand, and Tsomocos (2004, 2005, 2006) to an infinite horizon setting. Thus, we are able to assess how the model conforms with the time series data of the UK banking system. We conclude that, since the model performs satisfactorily, it can be readily used to assess financial fragility given its flexibility, computability, and the presence of multiple contagion channels and heterogeneous banks and investors. JEL Classification Numbers C68, E4, E5, G11, G21 We are grateful to seminar participants at the Bank of England, European Central Bank, University of Oxford, University of Pireaus, 59th International Atlantic Economic Conference, London and especially an anonymous referee for helpful comments and suggestions     

The optimal monetary instrument for prudential purposes

The purpose of this paper is to assess the choice between adopting a monetary base or an interest rate setting instrument to maintain financial stability. Our results suggest that the interest rate instrument is preferable, since during times of a panic or financial crisis the Central Bank automatically satisfies the increased demand for money. Thus, it prevents sharp losses in asset values and enhanced asset volatility.     

A model to analyse financial fragility

Summary. This paper sets out a tractable model which illuminates problems relating to individual bank behaviour, to possible contagious inter-relationships between banks, and to the appropriate design of prudential requirements and incentives to limit ‘excessive’ risk-taking. Our model is rich enough to include heterogeneous agents, endogenous default, and multiple commodity, and credit and deposit markets. Yet, it is simple enough to be effectively computable and can therefore be used as a practical framework to analyse financial fragility. Financial fragility in our model emerges naturally as an equilibrium phenomenon. Among other results, a non-trivial quantity theory of money is derived, liquidity and default premia co-determine interest rates, and both regulatory and monetary policies have non-neutral effects. The model also indicates how monetary policy may affect financial fragility, thus highlighting the trade-off between financial stability and economic efficiency.Received: 6 November 2003, Revised: 6 October 2004 JEL Classification Numbers: D52, E4, E5, G11, G21.C.A.E. Goodhart, P. Sunirand, D.P. Tsomocos: We are grateful to T.F. Bewley, S. Bhattacharya, F. Hahn, C. Mayer, H.S. Shin and seminar participants at the Bank of Austria, Bank of England, Bank of Norway, Bank for International Settlements, Brown University, the 7th Annual Macroeconomic Conference, Crete, EcoMod-IIOA International Conference, Brussels, the 2nd Oxford Finance Summer Symposium and Nuffield, Oxford, the Hong Kong Institute for Monetary Research, Purdue University, the University of Birmingham, the VI SAET Conference, Rhodes, Yale University, and especially an anonymous referee and H.M. Polemarchakis for helpful comments. The views expressed are those of the authors and do not necessarily reflect those of the Bank of England. Correspondence to: D.P. Tsomocos     

Banks,relative performance,and sequential contagion

We develop a multi-period general equilibrium model of bank deposit, credit, and interim inter-bank loan markets in which banks initially specialize in their choices of debtors, leading to under-diversification, but nevertheless become entwined via inter-bank markets, leading to the fortunes of one bank affecting the profits and default rates of the other in a sequential manner. Lack of (full) diversification among credit risks arises in our model owing to a relative profit argument in each banker’s utility function, which is otherwise risk- and default-averse. We examine its implications for the welfare of depositors and debtors. An erratum to this article can be found at