European Central Bank

In financial crises, the premium on liquid assets such as US Treasuries increases alongside credit spreads. This paper explains the link between the liquidity premium and spreads. We present a theory of endogenous bank fragility arising from a coordination friction among bank creditors. The theory’s implications reduce to a single constraint on banks, which is embedded in a quantitative macroeconomic model to investigate the transmission of shocks to spreads and economic activity. Shocks that reduce bank net worth exacerbate the coordination friction.

This paper presents the updated macroprudential stress test for the euro area banking system, comprising around 100 of the largest euro area credit institutions across 19 countries. The approach involves modelling banks’ reactions to changing economic conditions. It also examines the effects of adverse scenarios as defined for the European Banking Authority’s 2023 stress test on economies and the financial system as a whole by acknowledging a broad set of interactions and interdependencies between banks, other market participants and the real economy.

Large-Scale Asset Purchases can impact the price of securities directly, when securities are targeted by the central bank, or indirectly through portfolio re-balancing of private investors. We quantify both the direct and the portfolio re-balancing impact, emphasizing the role of investor heterogeneity. We use proprietary security-level data on asset holdings of different investors. We measure the direct impact on security level, finding that it is smaller for securities predominantly held by more price-elastic investors, funds and banks.

We construct a novel measure of bank performance, investigate its determinants, and show that it affects bank resilience, lending behaviour and real outcomes. Using confidential and granular data, we measure performance against a market-based benchmark portfolio that mimics individual banks’ interest rate and credit risk exposure. From 2015 to mid-2022, euro area banks underperformed market benchmarks by around e160 billion per year, amid substantial heterogeneity.