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COVID-19, bank risk, and capital regulation: The aggregate shock and social distancing

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  • Guo, Wen-Chung
  • Tseng, Ping-Lun

Abstract

In this study, we introduce a novel spatial framework to examine the impact of the aggregate shock and social distancing policies stemming from the COVID-19 pandemic on banks' incentives to monitor entrepreneurs. Our findings reveal that banks raise their loan rates to compensate for losses caused by the aggregate shock, which, in turn, enhances their monitoring efforts. However, the default probability still rises. The government's expansionary monetary policy, implemented in response to the COVID-19 crisis, can help mitigate these effects. Additionally, social distancing measures have led to either increased customer service or higher preparation costs for entrepreneurs seeking loans, both of which ultimately benefit the banks' monitoring efforts. We further explore social welfare analysis, the role of capital regulation, and several other relevant extensions.

Suggested Citation

  • Guo, Wen-Chung & Tseng, Ping-Lun, 2023. "COVID-19, bank risk, and capital regulation: The aggregate shock and social distancing," The Quarterly Review of Economics and Finance, Elsevier, vol. 92(C), pages 155-173.
    • Handle: RePEc:eee:quaeco:v:92:y:2023:i:c:p:155-173
    DOI: 10.1016/j.qref.2023.09.004
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    More about this item

    Keywords

    COVID-19; Bank monitoring efforts; Aggregate shock; Social distancing; Capital regulation;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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