The Impact of Macro Economic Shocks on Asset and Liability Management in the Banking System; A DSGE Approach

Purpose: Examining the interaction between the banking sector, particularly asset-liability management in the banking system, and the other sectors of the macro-economy is of special importance. This research aims to enrich the literature on this subject and apply it to the Iranian economy and banking system. The main focus of the study, unlike other research that focuses on economic variables, is on the banking sector. It has been attempted to harmonize and align the banking sector especially with the Iranian banking system so that the banking system managers and policymakers can optimize the asset and liability management of banks in interaction with the macroeconomic sectors efficiently
Methodology: The model described in this research is an extension of the models proposed by various researchers. In this model, the economy consists of several agents, each of which maximizes its own objective function subject to budget constraints. There are two types of households in the model including savers and borrowers. There are also two types of firms including intermediary producers and final goods producers. Intermediary firms operate under monopolistic competition and can set prices. They rent physical capital from capital goods firms and sell their intermediary goods to final goods producers. Final goods producers operate under perfect competition but with fixed prices. They purchase intermediate goods, package them into undifferentiated final goods, and sell them to households. Intermediary firms can partially finance their investment by borrowing from banks with surplus resources. The banking system in this research is based on the developed model of Gerali et al. (2010), Dib (2010), and Giri (2018). Retail banking is directly connected to firms and households. Banks with surplus resources may provide their surplus funds to banks with deficits through interbank channels to meet their funding needs. Surplus banks receive deposits from saver households and may invest a portion of their deposits in the interbank market or in government bonds. Monetary policy is also regulated by the central bank.
Findings and Discussion: We measured the effects of four macroeconomic shocks on asset-liability management variables using our DSGE model.
Total factor production shock: A positive productivity shock can have a positive effect on the bank capital in the short term. This is because increasing productivity can lead to higher economic growth, which can increase banks' profitability and, thus, increase their accumulated profits. By maintaining more profits of banks, their capital situation improves. In the long term, however, this trend decreases and approaches its stable conditions. A positive shock increases the productivity of economic activities and leads to an increase in the demand for loans, investments and consumer goods. This, in turn, leads to an increase in bank deposits, as people deposit some of their surplus savings in the banking system. A positive productivity shock leads to an increase in the interbank rate because banks increase their liquidity to finance new lending and investment opportunities that result from improved economic conditions.
Monetary policy shock: A positive monetary policy shock can lead to an increase in economic growth and confidence in the economy, which can lead to an increase in savings and ultimately support the level of deposits. The interbank interest rate will decrease with a positive monetary policy shock.
Investment shock: An increase of investment in the short term has a positive effect on bank capital because banks may see an increase in demand for loans and other financial services. This can lead to higher profits and capital accumulation for banks, which can support their financial health and stability. However, if the investment shock does not continue in the long term or leads to increased risk-taking by banks, it can eventually destroy their capital and threaten the financial stability. The amount of deposits is also affected by the investment shock, similar to loans.
Public expenditure shock: A public expenditure shock leads to an increase in government spending on infrastructure or other projects that stimulate economic activities and increase bank lending, leading to higher bank profits and an increase in bank capital in the long run. The increase in public spending in the short term that is financed through higher taxes can reduce the disposable income for households and businesses. This leads to a decrease in savings and a decrease in the deposits in banks. In the long run, however, the public expenditure shock through increased government borrowing leads to higher interest rates and tighter monetary policies, which reduce economic activities and reduce deposits. A positive public spending shock induces an increase in the interbank rate in the short term because an increase in government spending can create upward pressure on the inflation, which, in turn, can cause an increase in the interbank rate. In the long term, the increase in public spending can cause more economic growth, which, in turn, can increase the demand for loans and deposits, and finally the interbank rate due to the competition of banks.
Conclusions and policy implications: The research findings indicate that macroeconomic shocks have noticeable effects on key variables such as bank capital, loans, deposits, interbank arrears, policy rates, and interbank interest rates. Specifically, it was found that a positive productivity shock leads to an increase in loans and deposits in the long run, while a positive monetary policy shock results in a decrease in policy rates and an increase in interbank liquidity. Additionally, a positive government expenditure shock has an expansionary effect on bank lending and may lead to a reduction in interest rates in the long term. This study provides insights into how macroeconomic shocks can influence the asset and liability management of banks, which can be valuable information for policymakers and regulators to maintain financial stability. In general, the research findings demonstrate that the banking system is sensitive to macroeconomic conditions, and a comprehensive understanding of these relationships is vital for proper bank risk management.