DO RISK PREMIA PROTECT AGAINST BANKING CRISES?

This paper examines the question to what extent premia for macroeconomic risks inbanking are sufficient to avoid banking crises. We investigate a competitive bankingsystem embedded in an overlapping-generations model subject to repeatedmacroeconomic shocks. We show that even if banks fully incorporate macroeconomicrisks into their pricing of loans, a banking system may enter bankruptcy with probabilityone. A major cause for this default is that risk premia of a competitive banking systemmay become too small if the capital base is low.[...]