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Macroeconomic Conditions and Leverage in Monetary Financial Institutions: Comparing European countries and Luxembourg

Author

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  • Gaston Giordana
  • Ingmar Schumacher
Abstract
In this article we study the interaction between leading macroeconomic indicators (industrial production, stock prices, consumer sentiment and real interest rates) and financial sector leverage in major European countries. We base our analysis on monthly, country-aggregated panel VAR models for the pre-crisis period January 2003 to August 2008, and the crisis period September 2008 to June 2011. We find little evidence for a relationship between macroeconomic variables and leverage in the pre-crisis period, with only real interest rates having a negative short-term impact on leverage growth. We find positive feedback loops between sentiment and stock prices as well as MFI assets in the pre-crisis period, and a positive impact of real interest rate changes on equity and asset growth. Thus, balance sheet expansions were driven by sentiment and stock prices, while real interest changes allowed MFIs to profit from higher spreads. During the crisis period (starting in September 2008), we observe a countercyclical impact from leverage on sentiment and stock prices, while sentiment and stock prices bear a pro-cyclical impact on leverage. In contrast to this, MFI leverage in Luxembourg is negatively impacted by stock prices, suggesting significant impacts from marking-to-market. We conclude that leverage drives expectations of financial instability (via e.g. default expectations), while sentiment and stock prices drive financial institutions? investment decisions (via e.g. collateral value effects).

Suggested Citation

  • Gaston Giordana & Ingmar Schumacher, 2012. "Macroeconomic Conditions and Leverage in Monetary Financial Institutions: Comparing European countries and Luxembourg," BCL working papers 77, Central Bank of Luxembourg.
    • Handle: RePEc:bcl:bclwop:bclwp077
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    References listed on IDEAS

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    Cited by:

    1. Jin, Xisong & Nadal De Simone, Francisco de A., 2014. "Banking systemic vulnerabilities: A tail-risk dynamic CIMDO approach," Journal of Financial Stability, Elsevier, vol. 14(C), pages 81-101.

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    More about this item

    Keywords

    leverage; macroeconomic conditions; Panel VAR; GMM estimation;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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