The collateral constraint and its impacts on the banking performance and macroeconomic variables

Collateral constraints cause an asymmetry in the relationship between the assets of firms and households and economic activities and are a central mechanism to explain the economic volatility. When housing wealth is high, collateral constraints are slack, and the sensitivity of borrowing and spending to changes in house prices is small. Conversely, when housing wealth is low, collateral constraints are tight, and borrowing and spending move with house prices in a more pronounced manner. Collateral constraint leads to a kind of friction in the financial markets and affects the behavior of households and firms as well as the performance of the banking system. The type of mortgage collateral can be one of the limitations of financing for firms in the economy. The Basel II agreement emphasizes the importance of the type and the amount of collateral for lower performing firms. Contrary to the Basel I agreement, which treats firms equally in this regard, the Basel II agreement stipulates that, if a bank engages in a riskier activity, it must invest more of its capital in order to maintain the bank's stability. Increasing the risk of the borrower customer increases the amount of overdue receivables of the bank and increases the amount of storage in the bank's capital. In this case, when the amount of non-current facilities in the bank increases, the only source that the bank can use to return its resources is the relevant documents. Therefore, the bank prefers to enforce some collateral. The purpose of this article is to investigate the role of collateral constraints in the banking system and their impacts on the performance of the banking system. Regarding collateral constraints, the trend of research in the literature following Kiyotaki and Moore (1997) has stressed the importance of the link between the value of borrowers’ collateral and their access to funds in amplifying the economy’s response to shocks. The core of our analysis is a standard monetary DSGE model augmented to include a housing collateral constraint along the line set by Kiyotaki and Moore (ibid), Iacoviello (2005), and Liu et al., (2013).   We discuss the collateral constraint effect on banking system and macroeconomic variables in two steps. First, we construct a general equilibrium model and estimate it with Bayesian likelihood methods. The estimated model implies that collateral constraints become slack during economic volatility. In this study, a dynamic stochastic general equilibrium model is used for the period of 1990-2020. Different central banks consider different combinations of pricing-based policies, collateral and quantitative restrictions to manage their credit supply. In general, the conditions that justify the use of these options are mainly based on the preferences of central banks regarding credit and systemic risk, liquidity management technologies and the cost of credit documents. In order to model the collateral credit limit, two scenarios have been considered. In the first one, it is assumed that the banking system does not show any reaction to the performance of the credit-receiving enterprise. But, in the second scenario, the corporate profit function is included in order to show the impact of the bank participation in the loans granted by the banking system and the real participation in economic activities. The theoretical and empirical results of this research show that changes in the prices of assets can produce asymmetries that are economically and statistically significant. We now consider whether these asymmetries are also important for gauging the effects of policies aimed at the credit market. The results obtained from the credit shock in the model and the comparison of the model scenarios have shown that, if the bank considers itself as a real partner in the credit activity, it is far from the situation in which to act only as a financial intermediary. Also, if the firm is unable to repay its debt, it will be more profitable and its effects on macroeconomic variables such as production, investment and reduction of bank operating costs will be better. In this paper, we provide a theoretical framework for the analysis of banking system performances in the presence of financial frictions and in the form of collateral constraints and a monopolistically competitive banking sector. In our economy, consumers are divided into households and firms who serve respectively as savers and borrowers. The resulting credit flows are intermediated by banks, which have some monopolistic power in the loans market and set optimal lending rates accordingly. The results obtained from the credit shock in the model and the comparison of the model scenarios have shown, if the firm is unable to repay the debt, it will be more profitable and its effects on macroeconomic variables such as production, investment and reduction of banking operating costs will be better. According to the results, it is suggested that the country's banks refrain from applying formal contracts in the form of banking contracts only due to short-term returns; instead, they should implement banking contracts in a real way and participate in the bank's activities in the long run. They will, thus, have a relatively higher profitability.