Title page

Contents

Abstract 3

Non-technical summary 4

1. Introduction 6

2. The shifts: changes in risk within banking 10

2.1. Measuring bank asset risk 10

2.2. Trends in the risk of bank assets 14

2.3. Trends in bank leverage and equity risk 17

3. The shocks: macro risks arising from banking 22

3.1. Bank asset returns and future macroeconomic outcomes 22

3.2. Mechanisms 25

3.3. The time-varying cost of banking crises 32

4. Conclusion 35

References 36

Appendix 40

A. Risks within banking: additional material 40

B. Macro risks arising from banking: additional material 44

Acknowledgements 49

Table 1. Long-run changes in bank asset risk, leverage, and equity risk 20

Table 2. Bank asset returns and future GDP growth: before and after WW2 25

Table 3. Bank asset returns and future GDP growth: different leverage and volatility regimes 28

Table 4. Bank equity returns and future GDP growth: different leverage regimes 29

Figure 1. Long-run trends in the risk of bank assets 14

Figure 2. Trends in bank asset risk exposures 15

Figure 3. Trends in macroeconomic risks relevant for banking 17

Figure 4. Trends in banking system leverage 18

Figure 5. Trends in bank equity risk 19

Figure 6. Combined measures of banking system risk 21

Figure 7. Bank asset returns, non-financial returns, and future GDP growth: rolling regression coefficients 23

Figure 8. Bank asset returns and future GDP growth: different leverage and volatility regimes 27

Figure 9. Bank asset returns and future GDP growth: asymmetry and non-linearity 31

Figure 10. Bank asset returns and future GDP growth: asymmetry at different leverage levels 32

Figure 11. GDP response to systemic banking crises and recessions: before and after WW2 33

Figure 12. GDP response to systemic banking crises: different leverage regimes 35

Table A.1. Correlations between bank asset risk, equity risk and leverage 43

Table A.2. Response of GDP to systemic banking crises and recessions, before and after WW2 47

Table A.3. Output growth after banking crises: different leverage regimes 48

Figure A.1. Correlations between different measures of asset risk 40

Figure A.2. Alternative bank asset return measures 40

Figure A.3. Long-run trends in financial risks 41

Figure A.4. Bank equity risk factors 41

Figure A.5. Frequency of bank equity crashes and banking crises 42

Figure A.6. Bank asset returns and future GDP growth, rolling regression coefficients at different horizons 44

Figure A.7. Bank and non-financial dividend predictability 45

Figure A.8. Predictive power of changes in bank asset values for future GDP growth across crisis and leverage regimes 46