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EXPLOITING MACRO-ACCOUNTING INFORMATION FOR ASSET PRICING, SYSTEMIC RISK AND MONETARY POLICY ANALYSIS

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Effect of bank balance sheets on finance and economy

A bank's balance sheet provides a snapshot of operations and financial soundness, yet details such as assets and liabilities go largely ignored by macroeconomics and finance communities. An EU initiative has investigated balance sheets to gain insight into their impact on the financial industry and economy.

Society

Commercial bank balance sheets can lead to a better understanding of bank dynamics and market valuation as well as systemic risk. Such key macro-finance developments can prove invaluable in the pervading economic climate if not for their fragmentation. With this in mind, the EU-funded EMAIFAP (Exploiting macro-accounting information for asset pricing, systemic risk and monetary policy analysis) aimed to understand and measure the impact of bank leverage and asset risk position on their stock market valuation. It also worked on identifying balance sheet variables that are key to improving or mitigating systemic risk in the financial system and policy implications of the findings. Its third objective involved understanding and assessing the transmission mechanism of monetary policy into banks' balance sheets. To achieve its aims, the project thoroughly investigated the effect of leverage and connectedness between bank dealers on European contagion in the credit default swap market. It studied the impact bank-specific factors have on an institution's solvency risk and its contribution to systemic risk. The project team also studied the impact of commonality in mutual fund holdings on stock market contagion. Findings showed that the connectedness of key players in stock and credit markets fuel systemic risk or financial instability. They also demonstrated that these connections and their consequences on the valuation of financial assets can be identified. This facilitates the development of more optimal tools to mitigate such effects. More research under EMAIFAP also shed light on the causes of systemic risk and how monetary policy is transferred to banks, and from banks to businesses and then consumers. This has instigated debate among policymakers and economic researchers about the need to re-orient the regulatory framework toward a macro-prudential perspective in the post-financial crisis world.

Keywords

Balance sheets, finance, economy, macro-accounting, EMAIFAP

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