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Banks' Precautionary Capital and Credit Crunches

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  • Fabian Valencia

Abstract

Periods of banking distress are often followed by sizable and long-lasting contractions in bank credit. They may be explained by a declined demand by financially impaired borrowers (the conventional financial accelerator) or by lower supply by capital-constrained banks, a "credit crunch". This paper develops a bank model to study credit crunches and their real effects. In this model, banks maintain a precautionary level of capital that serves as a smoothing mechanism to avert disruptions in the supply of credit when hit by small shocks. However, for larger shocks, highly persistent credit crunches may arise even when the impulse is a one time, non-serially correlated event. From a policy perspective, the model justifies the use of public funds to recapitalize banks following a significant deterioration in their capital position.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/248.

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Length: 35
Date of creation: 01 Oct 2008
Date of revision:
Handle: RePEc:imf:imfwpa:08/248

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Keywords: Banking; Banking crisis; Bank credit; External shocks; Liquidity management; Financial risk; Economic models; bank capital; recapitalization; credit market; stockholders; capital markets; credit market imperfections; banking crises; bank recapitalization; banking system; bank relationship; imperfect capital markets; deposit insurance; capital position; capital injection; cost of capital; transmission of monetary policy; equity participation; capital structure; capital crunch; banking industry; bank deposit; stock market; bank lending; retained earnings; bankrupt; bank behavior; banking sector; exogenous shocks; equity finance; bank loan; credit rationing; bank balance sheets; bank runs; banks ? solvency; bank of canada; probability of default; insurance premium; bank asset; banking distress; mature markets; deposit insurance premium; bank solvency; liability management; moral hazard; bank crisis;

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References

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Citations

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Cited by:
  1. Giorgio Szego, 2010. "Crash 08 a regulatory debacle to be mended," FMG Special Papers sp189, Financial Markets Group.
  2. Agénor, P.-R. & Alper, K. & Pereira da Silva, L., 2009. "Capital requirements and business cycles with credit market imperfections," Policy Research Working Paper Series 5151, The World Bank.
  3. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
  4. Luc Laeven, 2011. "Banking Crises: A Review," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 17-40, December.
  5. Fabian Valencia, 2010. "Bank Capital and Uncertainty," IMF Working Papers 10/208, International Monetary Fund.
  6. Fabian Valencia, 2011. "Monetary Policy, Bank Leverage, and Financial Stability," IMF Working Papers 11/244, International Monetary Fund.

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