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Juan-Rubio Ramirez
- 27 January 2021
- RESEARCH BULLETIN - No. 80Details
- Abstract
- Episodes such as the current coronavirus (COVID-19) crisis might lead to a significant rise in borrower defaults and, consequently, weakness in the banking sector. Having well-capitalised banks makes the financial system more resilient to such episodes. We assess how much capital would be optimal for banks to hold, taking into consideration the risk of banking crises driven by borrower defaults (which we term “twin default crises”).
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation - Network
- Research Task Force (RTF)
- 25 May 2020
- WORKING PAPER SERIES - No. 2414Details
- Abstract
- We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to non-diversifiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside but significant downside risk of loan portfolio returns (Nagel and Purnanandam, 2020). This helps to reproduce the frequency and severity of twin defaults: simultaneously high firm and bank failures. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is 5pp higher than under standard default risk models which underestimate the impact of borrower default on bank solvency.
- JEL Code
- G01 : Financial Economics→General→Financial Crises
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy