Macroeconomic shocks, firm leverage and bank risk

ABSTRACT

In this paper, we explore the transmission of risks induced by macroeconomic shocks from real economy to financial sector. We first construct a two-period general equilibrium model that includes households, firms and banks, to reveal the mechanism of macroeconomic shocks affecting bank risks. Based on a quarterly dataset of 14 major listed banks and their lending-related firm clients from 2017 to 2020, we empirically test the firm leverage channel through which macroeconomic shocks (Corona Virus Disease 2019 as an instance) affect bank risks. The results show that 1) The increase in the firm leverage will significantly push up the risk of banks that provide credit services for these firms;2) macroeconomic shocks could further intensify the positive correlation between firm leverage and bank risk;3) the previous findings are more prominent among joint-stock banks, state-owned and large enterprises. In addition, the impact of firm leverage on bank risk under macroeconomic shocks is more pronounced for the 50% and lower quantiles of the distribution. © 2022, Editorial Board of Journal of Systems Engineering Society of China. All right reserved.