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Banking Crisis and Borrower Productivity

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  • KOBAYASHI Keiichiro
  • YANAGAWA Noriyuki

Abstract

In this paper, we propose a theoretical model in which a banking crisis (or bank distress) causes declines in aggregate productivity. When borrowing firms need additional bank loans to continue their businesses, a high probability of bank failure discourages ex ante investments (e.g., R&D investment) by firms that enhance their productivity. In a general equilibrium setting, we also show that there may be multiple equilibria: one in which bank distress continues and borrower productivity is low, and in the other, banks are healthy and borrower productivity is high. We show that the bank capital requirement may be effective in eliminating the bad equilibrium and may lead the economy to the good equilibrium in which the productivity of borrowing firms and the aggregate output are both high and the probability of bank failure is low.

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Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 08003.

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Length: 29 pages
Date of creation: Feb 2008
Date of revision:
Handle: RePEc:eti:dpaper:08003

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References

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  1. Harold L. Cole & Lee E. Ohanian & Ron Leung, 2005. "Deflation and the international Great Depression: a productivity puzzle," Staff Report 356, Federal Reserve Bank of Minneapolis.
  2. Levine, Ross & Zervos, Sara, 1996. "Stock markets, banks, and economic growth," Policy Research Working Paper Series 1690, The World Bank.
  3. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December.
  4. Ross Levine, 1997. "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature, American Economic Association, vol. 35(2), pages 688-726, June.
  5. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
  6. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Morrison, Alan & White, Lucy, 2004. "Crises and Capital Requirements in Banking," CEPR Discussion Papers 4364, C.E.P.R. Discussion Papers.
  8. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  9. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, vol. 60(2), pages 615-647, 04.
  10. Harold L. Cole & Lee E. Ohanian, 1999. "The Great Depression in the United States from a neoclassical perspective," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-24.
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Cited by:
  1. HOSONO Kaoru, 2009. "Financial Crisis, Firm Dynamics and Aggregate Productivity in Japan," Discussion papers 09012, Research Institute of Economy, Trade and Industry (RIETI).

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