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The capital crunch in New England

  • Joe Peek
  • Eric S. Rosengren

The increase in real estate lending was a major reason for the rapid expansion of New England banks during the 1980s. When nominal real estate prices began to decline in New England, collateral became impaired and many loans stopped performing. The consequent increased provision for expected loan losses (loan loss reserves) caused a rapid deterioration in bank capital throughout the region. ; Having just lost a significant proportion of their capital, many banks tried to satisfy their capital/asset ratio requirements by shrinking their institutions. This article discusses why banks facing binding capital constraints will shrink more than unconstrained banks when an adverse capital shock occurs. It shows that New England banks with low capital/asset ratios are in fact shrinking their institutions faster than better capitalized institutions, and that this behavior has been particularly apparent in those liability categories that are marginal sources of funds for most banks.

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File URL: http://www.bostonfed.org/economic/neer/neer1992/neer392b.pdf
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Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

Volume (Year): (1992)
Issue (Month): May ()
Pages: 21-31

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Handle: RePEc:fip:fedbne:y:1992:i:may:p:21-31
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  1. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. John R. Walter, 1991. "Loan loss reserves," Economic Review, Federal Reserve Bank of Richmond, issue Jul, pages 20-30.
  3. Allan D. Brunner & John V. Duca & Mary McLaughlin, 1991. "Recent developments affecting the profitability and practices of commercial banks," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jul, pages 505-527.
  4. Ben S. Bernanke, 1992. "The bank credit crunch," Proceedings 369, Federal Reserve Bank of Chicago.
  5. King, Stephen R, 1986. "Monetary Transmission: Through Bank Loans or Bank Liabilities?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(3), pages 290-303, August.
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