Options
Taxation, Banking, and Sovereign Risk
Type
applied research project
Start Date
01 April 2013
End Date
31 March 2015
Status
ongoing
Keywords
Corporate Finance
Taxation of Banks
Bank Regulation
Sovereign Debt
Financial Contagion
Banking Union
Description
Since the recent financial crisis, banking has become one of the key topics Drawing on the literature in banking, corporate finance, and public economics, our research project will primarily develop and analyze theoretical models to investigate three related research topics: First, con-necting to our previous research in corporate finance, we will examine how the reallocation of capital from large, overinvesting to small, innovative but credit constrained firms will affect productivity and boost efficiency in the economy. This part will especially focus on the role of dividend, capital gains and corporate taxes. Second, we will investigate the taxation of banks, including the effect of the debt-bias of corporate income taxes on the bank's capital structure. Given the banks' leverage choices and risk-taking incentives, we will also discuss whether and how Pigovian taxation might be complementary to bank regulation. Third, we aim to explore the interaction of bank stability and sovereign debt and examine the role of a European ‘banking union' from a public economics (fiscal federalism) perspective, thereby emphasizing the scope for centralized bank regulation and supervision. Importantly, this analysis will highlight the channels of risk spillover across banks, between the financial and public sectors, and between countries through international banking lending. A welfare comparison of the decentralized equilibrium to a first best allocation will characterize the precise nature of market
distortions, such as a tendency towards excessive leverage and risk-taking in the
banking sector, and identify the possibilities for welfare-increasing policy interventions.
In addition to theoretical work, model calibration will provide numerical examples, and an empirical analysis will test and quantify some theoretical predictions.
The existing literature analyzes the role of banks in the economy, primarily liquidity
insurance and moni-toring. Although banks alleviate financial frictions during normal times, they can be a major source of instability during crisis times. The major reason is the inherent fragility of a bank's balance sheet due to ma-turity transformation and high leverage. Consequently, banks are particularly vulnerable to shocks and susceptible to runs and contagion which calls for regulation and, possibly, Pigovian taxation. Interbank lending and the possibility of fire sales give rise to contagion across banks. Most importantly, banking crises may spill over to the public sector because of the need to bail out distressed banks and the fiscal cost of recessions triggered by financial crises. Rising public debt, in turn, tends to undermine investors' confidence in government solvency and may trigger a public debt crisis. A rising risk premium and declining value of sovereign debt holdings lead to a further deterioration of banks' balance sheets. Conversely, the financial sector may amplify a public debt crisis due to high sovereign bond holdings of domestic banks and the importance of government bonds as collateral. This mechanism can also lead to international contagion through the banking sector. A banking union involves centralized regulation, supervision, and resolution of distressed banks and internalizes international spillovers of national
regulation. It could help to break the vicious link between bank and sovereign risk, but also holds the potential of substantial cross-country transfers if not appropriately designed.
distortions, such as a tendency towards excessive leverage and risk-taking in the
banking sector, and identify the possibilities for welfare-increasing policy interventions.
In addition to theoretical work, model calibration will provide numerical examples, and an empirical analysis will test and quantify some theoretical predictions.
The existing literature analyzes the role of banks in the economy, primarily liquidity
insurance and moni-toring. Although banks alleviate financial frictions during normal times, they can be a major source of instability during crisis times. The major reason is the inherent fragility of a bank's balance sheet due to ma-turity transformation and high leverage. Consequently, banks are particularly vulnerable to shocks and susceptible to runs and contagion which calls for regulation and, possibly, Pigovian taxation. Interbank lending and the possibility of fire sales give rise to contagion across banks. Most importantly, banking crises may spill over to the public sector because of the need to bail out distressed banks and the fiscal cost of recessions triggered by financial crises. Rising public debt, in turn, tends to undermine investors' confidence in government solvency and may trigger a public debt crisis. A rising risk premium and declining value of sovereign debt holdings lead to a further deterioration of banks' balance sheets. Conversely, the financial sector may amplify a public debt crisis due to high sovereign bond holdings of domestic banks and the importance of government bonds as collateral. This mechanism can also lead to international contagion through the banking sector. A banking union involves centralized regulation, supervision, and resolution of distressed banks and internalizes international spillovers of national
regulation. It could help to break the vicious link between bank and sovereign risk, but also holds the potential of substantial cross-country transfers if not appropriately designed.
Leader contributor(s)
Member contributor(s)
Kogler, Michael
Funder(s)
Range
Institute/School
Range (De)
Institut/School
Principal
Schweizerischer Nationalfonds zur Förderung der wissenschaftlichen Forschung, Projekt 100018_146685
Eprints ID
221794