This paper incorporates banks into a multi-country dynamic stochastic general equilibrium model. There are saving banks and investment banks. Saving banks collect deposits from households and make loans to investment banks (via an inter-bank market); investment banks fund physical investment project. Both types of banks have to meet prudential capital requirements. The model accounts for key episodes during the current financial crisis. A negative shock to the value of physical capital induces a fall in bank lending, which magnifies considerably the effect of the shock on real activity. The model also explains key facts about international business cycles during 'normal' times better than conventional multi-country macro models--in particular, it allows to better explain the close correlation between US and European business cycles.
