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Forbearance and Prompt Corrective Action

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  • Narayana Kocherlakota
  • Ilhyock Shim

    ()
    (Monetary and Eocnomic Department Bank for International Settlements`)

Abstract

This article investigates whether a bank regulator should terminate problem banks promptly or exercise forbearance. We construct a dynamic model economy in which entrepreneurs pledge collateral, borrow from banks, and invest in long-term projects. We assume that collateral value has aggregate risk over time, that in any period entrepreneurs can abscond with the projects but lose the collateral, and that depositors can withdraw deposits. We show that optimal regulation exhibits forbearance if the ex-ante probability of collapse in collateral value is sufficiently low, but exhibits prompt termination of problem banks if this probability is sufficiently high. Copyright 2007 The Ohio State University.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 324.

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Date of creation: 2005
Date of revision:
Handle: RePEc:red:sed005:324

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Related research

Keywords: risky collateral; limited enforcement; banking regulation; optimal social contract.;

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References

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  1. Christopher Sleet & Bruce D. Smith, 2000. "Deposit insurance and lender-of-last-resort functions," Proceedings, Federal Reserve Bank of Cleveland, pages 518-579.
  2. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  3. Dekle, Robert & Kletzer, Kenneth, 2003. "The Japanese Banking Crisis and Economic Growth: Theoretical and Empirical Implications of Deposit Guarantees and Weak Financial Regulation," Santa Cruz Department of Economics, Working Paper Series qt0t6321ds, Department of Economics, UC Santa Cruz.
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Cited by:
  1. Xavier Freixas & Bruno Maria Parigi, 2007. "Banking Regulation and Prompt Corrective Action," CESifo Working Paper Series 2136, CESifo Group Munich.
  2. Robert E. Hall, 2008. "Equity Depletion from Government-Guaranteed Debt," NBER Working Papers 14581, National Bureau of Economic Research, Inc.
  3. Cristina Arellano & Narayana Kocherlakota, 2008. "Internal Debt Crises and Sovereign Defaults," Levine's Bibliography 122247000000001880, UCLA Department of Economics.
  4. Vollmer, Uwe & Wiese, Harald, 2013. "Minimum capital requirements, bank supervision and special resolution schemes. Consequences for bank risk-taking," Journal of Financial Stability, Elsevier, vol. 9(4), pages 487-497.
  5. Ilhyock Shim, 2006. "Dynamic prudential regulation: Is prompt corrective action optimal?," BIS Working Papers 206, Bank for International Settlements.
  6. Eijffinger, Sylvester C W & Nijskens, Rob, 2011. "Complementing Bagehot: Illiquidity and insolvency resolution," CEPR Discussion Papers 8603, C.E.P.R. Discussion Papers.
  7. Ilhyock Shim & Goetz von Peter, 2007. "Distress selling and asset market feedback," BIS Working Papers 229, Bank for International Settlements.

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