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Firm-bank linkages and optimal policies after a rare disaster

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  • Segura, Anatoli
  • Villacorta, Alonso

Abstract

We study optimal government support following a rare disaster that creates heterogeneous firm liquidity needs. Firms’ increase in debt reduces their output due to moral hazard. Banks are subject to a minimum capital requirement that limits deposit insurance costs upon bad aggregate shocks. Without government support, firms’ moral hazard and banks’ funding frictions reinforce each other amplifying output losses. Optimal support is implemented with firm-specific transfers combined with the provision of aggregate risk insurance through a capital requirement relaxation and a public preferred equity stake in banks. Our results shed light on suboptimality features in the actual policy responses to Covid-19 lockdowns.

Suggested Citation

  • Segura, Anatoli & Villacorta, Alonso, 2023. "Firm-bank linkages and optimal policies after a rare disaster," Journal of Financial Economics, Elsevier, vol. 149(2), pages 296-322.
    • Handle: RePEc:eee:jfinec:v:149:y:2023:i:2:p:296-322
    DOI: 10.1016/j.jfineco.2023.05.002
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    More about this item

    Keywords

    Rare disasters; Covid-19; Lockdown; Firms’ debt; Moral hazard; Bank equity; Aggregate risk; Government policies;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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