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The capital crunch in New England

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  • Joe Peek
  • Eric S. Rosengren

Abstract

The increase in real estate lending was a major reason for the rapid expansion of New England banks during the 1980s. When nominal real estate prices began to decline in New England, collateral became impaired and many loans stopped performing. The consequent increased provision for expected loan losses (loan loss reserves) caused a rapid deterioration in bank capital throughout the region. ; Having just lost a significant proportion of their capital, many banks tried to satisfy their capital/asset ratio requirements by shrinking their institutions. This article discusses why banks facing binding capital constraints will shrink more than unconstrained banks when an adverse capital shock occurs. It shows that New England banks with low capital/asset ratios are in fact shrinking their institutions faster than better capitalized institutions, and that this behavior has been particularly apparent in those liability categories that are marginal sources of funds for most banks.

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File URL: http://www.bostonfed.org/economic/neer/neer1992/neer392b.pdf
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Bibliographic Info

Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

Volume (Year): (1992)
Issue (Month): May ()
Pages: 21-31

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Handle: RePEc:fip:fedbne:y:1992:i:may:p:21-31

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Keywords: Capital ; New England;

References

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  1. Allan D. Brunner & Diana Hancock & Mary M. McLaughlin, 1992. "Recent developments affecting the profitability and practices of commercial banks," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jul, pages 459-483.
  2. John R. Walter, 1991. "Loan loss reserves," Economic Review, Federal Reserve Bank of Richmond, issue Jul, pages 20-30.
  3. Ben S. Bernanke, 1992. "The bank credit crunch," Proceedings 369, Federal Reserve Bank of Chicago.
  4. King, Stephen R, 1986. "Monetary Transmission: Through Bank Loans or Bank Liabilities?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(3), pages 290-303, August.
  5. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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Citations

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Cited by:
  1. Charles W. Calomiris & Athanasios Orphanides & Steven A. Sharpe, 1994. "Leverage as a state variable for employment, inventory accumulation, and fixed investment," Finance and Economics Discussion Series 94-24, Board of Governors of the Federal Reserve System (U.S.).
  2. Pecchenino, Rowena A., 1998. "Risk averse bank managers: Exogenous shocks, portfolio reallocations and market spillovers," Journal of Banking & Finance, Elsevier, vol. 22(2), pages 161-174, February.
  3. Joe Peek & Eric S. Rosengren, 1995. "Bank regulatory agreements and real estate lending," Working Papers 95-2, Federal Reserve Bank of Boston.
  4. Chakraborty, Suparna & Allen, Linda, 2007. "Revisiting the Level Playing Field: International Lending Responses to Divergences in Japanese Bank Capital Regulations from the Basel Accord," MPRA Paper 1805, University Library of Munich, Germany.
  5. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1994. "The Financial Accelerator and the Flight to Quality," NBER Working Papers 4789, National Bureau of Economic Research, Inc.
  6. Mark Hooker & Michael Knetter, 1994. "Unemployment Effects of Military Spending: Evidence from a Panel of States," NBER Working Papers 4889, National Bureau of Economic Research, Inc.
  7. Brunner, Allan D & Kamin, Steven B, 1998. "Bank Lending and Economic Activity in Japan: Did 'Financial Factors' Contribute to the Recent Downturn?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 3(1), pages 73-89, January.
  8. Cara Lown & Stavros Peristiani & Kenneth J. Robinson, 1999. "What was behind the M2 breakdown?," Financial Industry Studies Working Paper 99-2, Federal Reserve Bank of Dallas.
  9. Robert Tannenwald, 1993. "How dependent are New England's mid-sized firms on the region's largest bank holding companies?," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 35-48.
  10. David C. Wheelock, 2006. "What happens to banks when house prices fall? U.S. regional housing busts of the 1980s and 1990s," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 413-430.
  11. Houston, Joel & James, Christopher & Marcus, David, 1997. "Capital market frictions and the role of internal capital markets in banking," Journal of Financial Economics, Elsevier, vol. 46(2), pages 135-164, November.

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