Money and Banking Presentation

1.
To understand the progression of the model we first must look at the
landscape of global banking that is laid out as follows.
Three stages to the cross border banking sector flows. The following
model will examine the supply and demand for credit with respective
constraints at each stage.
2.
Regional bank
The analysis of this stage is broken down into the following steps
Finding dollar value of project at date
Finding probability of default of project, dj
For which we work to find the Standard normal for borrowers outcome,
from this we also get the probability of default
Bringing us to the contracting problem for the regional bank, where a
cap limits bank leverage to option value of default and induces the
bank to take on the good portfolio.
Then using this to find the realized vale of bank assets for good and
bad portfolio
The the objective function (max expected profit net of funding cost) of
the bank in and its notational debt ratio are stated
Using these and holding them to the incentive compatibility constraint
and solving for lemma 1 binds the constraint
Allowing us to find the Aggregated Supply of loans
Which brings us to the demand by corporate borrowers,
That rests on the breakeven cost of production
When solved for the funding rate and under incentive Compatibility
constraint, Asset realization follows distribution Fg(.) and so does
probability of default which we solve for
probability of default is (alpha)

Once solved for the probability of default by corporate borrowers we

see it depends on the exchange rate
Global banks
Well diversified but they do bear risk which cannot be diversified, these
are global shocks.
Now we have Zkj as the determinate variable of a regional borrower
defaulting and a linear combination of risk Yk
The sum of global and private credit receipt risk
Global banks have assets of (1 + f) L diversed across regions
Now we get the Wg distribution of default, as before in regional case.
And c.d.f of Wg
Then turn to the contracting problem for the risk neutral global bank,
maximizing expected profit subject to funding constraint arising from
contracting problem.
As before resulting in good and bad portfolio and their realized value of
assets
The good portfolio allows for full diversification
From this we can work the notational debt ratio of global banks this
time.
Defining its objective function
And holding Incentive Compatibility Constraint that entails keeping
leverage low enough that the higher option value of default does not
exceed the greater expected payoff of the good portfolio
Then Lemma 2, which is solved, implies that global banks probability of
default is zero
Therefore the participation constraint of the creditors to the global
bank, the funding rate is therefore the risk free rate
Using the lamma 2 and balance sheet identity we can solve for the
banks supply of wholesale lending to the market clearing condition
ThecorporateborrowershavecurrencymismatchasdepictedinFigure3,wherethey
holdlocalcurrencyassetsbutdollarliabilities.TotaldollarcreditisC,sothatcorporate

borrowersdemandfordollarsatthedate0spotmarketisC",
1#.Wepositan
exogenousdemandfordollarsonthespotmarketduetoothersectorsatdate0denoted
byD",
1#,sothatthespotexchangerate0isdeterminedbythemarketclearing
condition
Insummaryuptonow
First,wefixthebookequityoftheregionalandglobalbanks,ERandEGandtherisk
freeUSdollarinterestratei.Next,andareparametersthatdeterminetheshapeofthe
localandglobalbankassetrealizationdensity,andkandhareconstantsforpayoff
differencesinthemoralhazardproblem.Finally,thepayoffdensityoftheprojectsand
demandfunctionforspotdollarsareexogenous.
Giventheseexogenouselements,wecansolvethemodeluniquely.First,andare
uniquelydeterminedbytheunderlyingparametersofthecontractingproblem,asstated
inLemma1andLemma2.Theprobabilityofdefaultoftheborrowersprojectis
determinedgiventheexpectedexchangerateappreciation.Finally,thelendingratesrand
faredeterminedbymarketclearing.
Wesummarizetheresultintermsofthefollowingpropositionthatthemodelhasa
uniquesolutionasshown

Totalcreditintheregionscanbestatedas

andtotalcrossborderlendingis
Propostition4alsoaddresed

ThefunctionB(,,)establishesboundsonandforany
givenleveloffundamentalrisk,
andhencewecoulddubtheindifferencecurvesgeneratedbythe
Bfunctionastheleverageboundaryassociatedwithdifferent
levelsofoverallriskinthesystem.
Proposition4hasseveralclearcutempiricalimplications.When
increases,eitherduetoanexpectedappreciationoftheUSdollar,
ortoanincreaseinfundamentalrisksintheworldeconomy,

Proposition2necessitatesdeleveragingsomewhereintheglobal
bankingsystem.Eithertheglobalbanksmustdeleverage,orthe
regionalbanksmustdeleverage,orboth.
Eithertheglobalbanksmustdeleverage,ortheregionalbanks
mustdeleverage,orboth.
Inourempiricalsection,wedrawonourresultstohelpusto
interpretourempiricalfindings.

PanelRegressionsforBankCapitalFlows
Thespecificationfollowsourclosedformsolutionforbanking
sectorcapitalflowsgivenby
andtheempiricalpredictionsfrom.
Ourpanelregressionsarewithcountryfixedeffectsandclustered
standarderrorsatthecountrylevel:
Lc,q,y=0+iGlobalFactor(i)(q1ory1)+jLocalFactor(c,j)
(q1ory1)+InterestSpreadc,q1+ec,q