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Financial Risk Capacity

Author

Listed:
  • Saki Bigio
  • Adrien d'Avernas

Abstract

Financial crises are particularly severe and lengthy when banks fail to recapitalize after bearing large losses. We present a model that explains the slow recovery of bank capital and economic activity. Banks provide intermediation in markets with information asymmetries. Large equity losses force banks to tighten intermediation, which exacerbates adverse selection. Adverse selection lowers bank profit margins, which slows both the internal growth of equity and equity injections. This mechanism generates financial crises characterized by persistent low growth. The lack of equity injections during crises is a coordination failure that is solved when the decision to recapitalize banks is centralized.

Suggested Citation

  • Saki Bigio & Adrien d'Avernas, 2021. "Financial Risk Capacity," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(4), pages 142-181, October.
    • Handle: RePEc:aea:aejmac:v:13:y:2021:i:4:p:142-81
    DOI: 10.1257/mac.20160286
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    Citations

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    Cited by:

    1. Francesco Ferrante, 2015. "Risky Mortgages, Bank Leverage and Credit Policy," Finance and Economics Discussion Series 2015-110, Board of Governors of the Federal Reserve System (U.S.).
    2. Kame Babilla, Thierry U., 2023. "Digital innovation and financial access for small and medium-sized enterprises in a currency union," Economic Modelling, Elsevier, vol. 120(C).
    3. Mark Gertler & Nobuhiro Kiyotaki, 2015. "Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy," American Economic Review, American Economic Association, vol. 105(7), pages 2011-2043, July.
    4. Neuhann, Daniel, 2016. "Macroeconomic effects of secondary market trading," ESRB Working Paper Series 25, European Systemic Risk Board.
    5. Javier Bianchi, 2016. "Efficient Bailouts?," American Economic Review, American Economic Association, vol. 106(12), pages 3607-3659, December.
    6. Roberto Robatto, 2019. "Systemic Banking Panics, Liquidity Risk, and Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 34, pages 20-42, October.
    7. Alejandro Justiniano & Giorgio E. Primiceri & Andrea Tambalotti, 2019. "Credit Supply and the Housing Boom," Journal of Political Economy, University of Chicago Press, vol. 127(3), pages 1317-1350.
    8. House, Christopher L. & Masatlioglu, Yusufcan, 2015. "Managing markets for toxic assets," Journal of Monetary Economics, Elsevier, vol. 70(C), pages 84-99.
    9. Gertler, M. & Kiyotaki, N. & Prestipino, A., 2016. "Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1345-1425, Elsevier.
    10. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
    11. Neuhann, Daniel, 2017. "Macroeconomic effects of secondary market trading," Working Paper Series 2039, European Central Bank.
    12. Zhiguo He & Arvind Krishnamurthy, 2019. "A Macroeconomic Framework for Quantifying Systemic Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(4), pages 1-37, October.
    13. Fukui, Masao, 2018. "Asset Quality Cycles," Journal of Monetary Economics, Elsevier, vol. 95(C), pages 97-108.
    14. Lawrence Christiano & Daisuke Ikeda, 2014. "Leverage Restrictions in a Business Cycle Model," Central Banking, Analysis, and Economic Policies Book Series, in: Sofía Bauducco & Lawrence Christiano & Claudio Raddatz (ed.),Macroeconomic and Financial Stability: challenges for Monetary Policy, edition 1, volume 19, chapter 7, pages 215-216, Central Bank of Chile.
    15. Gaston Navarro & Julio Blanco, 2016. "Equilibrium Default and the Unemployment Accelerator," 2016 Meeting Papers 1502, Society for Economic Dynamics.
    16. Joseph Mullins & Gaston Navarro & Julio Blanco, 2013. "Equilibrium Default and Slow Recoveries," 2013 Meeting Papers 694, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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