A Hybrid model of the banking systemRoger Rissi
A hybrid model of the banking and the macroeconomic system is used to analyze the impact of capital and minimum reserve requirements on bank profitability. A system dynamics implementation of a macroeconomic model allows superimposing a macroeconomic structure on an agent-based model of the banking system. The former is used to evaluate the impact of business cycles and monetary policy on the banking system. The latter is modelled using an agent-based approach to take heterogeneity and interactions among market participants (agents) into account. The simulation study finds that Return on Equity (ROE) of banks are cyclical, decreasing during a period of negative demand shocks and rebound after the shock has disappeared. In addition, the results illustrate ‘political’ or ‘regulatory cycles’: if the macro prudential regulator misjudges the economic cycle and therefore incurs a prediction error, counter-cyclical measures affect the banking system negatively, resulting in significant negative impacts on bank default- and insolvency-frequencies as well as their ROE.