IDEAS home Printed from https://ideas.repec.org/a/wly/jmoncb/v39y2007i5p1107-1129.html

Forbearance and Prompt Corrective Action

Author

Listed:
  • NARAYANA R. KOCHERLAKOTA
  • ILHYOCK SHIM

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.

Suggested Citation

  • Narayana R. Kocherlakota & Ilhyock Shim, 2007. "Forbearance and Prompt Corrective Action," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1107-1129, August.
    • Handle: RePEc:wly:jmoncb:v:39:y:2007:i:5:p:1107-1129
    DOI: 10.1111/j.1538-4616.2007.00059.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1538-4616.2007.00059.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1538-4616.2007.00059.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Maximilian J.B. Hall, 1998. "Financial Reform in Japan," Books, Edward Elgar Publishing, number 1552, August.
    2. Dekle, Robert & Kletzer, Kenneth, 2003. "The Japanese banking crisis and economic growth: Theoretical and empirical implications of deposit guarantees and weak financial regulation," Journal of the Japanese and International Economies, Elsevier, vol. 17(3), pages 305-335, September.
    3. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
    4. Christopher Sleet & Bruce Smith, 2000. "Deposit insurance and lender-of-last-resort functions," Proceedings, Federal Reserve Bank of Cleveland, pages 518-579.
    5. Kocherlakota Narayana R, 2001. "Risky Collateral and Deposit Insurance," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-20, February.
    6. Ilhyock Shim, 2011. "Dynamic Prudential Regulation: Is Prompt Corrective Action Optimal?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(8), pages 1625-1661, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ilhyock Shim & Goetz Von Peter, 2007. "Distress Selling and Asset Market Feedback," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 16(5), pages 243-291, December.
    2. Eijffinger, Sylvester & Nijskens, Rob, 2011. "Complementing Bagehot: Illiquidity and insolvency resolution," CEPR Discussion Papers 8603, C.E.P.R. Discussion Papers.
    3. Daly, Kevin & Batten, Jonathan A. & Mishra, Anil V. & Choudhury, Tonmoy, 2019. "Contagion risk in global banking sector," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 63(C).
    4. Arellano, Cristina & Kocherlakota, Narayana, 2014. "Internal debt crises and sovereign defaults," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 68-80.
    5. Xi Chen & Michael Funke, 2013. "Real-Time Warning Signs of Emerging and Collapsing Chinese House Price Bubbles," National Institute Economic Review, National Institute of Economic and Social Research, vol. 223(1), pages 39-48, February.
    6. Xavier Freixas & Jean-Charles Rochet, 2012. "Taming SIFIs," Economics Working Papers 1328, Department of Economics and Business, Universitat Pompeu Fabra.
    7. Marcella Lucchetta & Michele Moretto & Bruno Maria Parigi, 2018. "Systematic Risk, Bank Moral Hazard, and Bailouts," CESifo Working Paper Series 6878, CESifo.
    8. Chuang‐Chang Chang & San‐Lin Chung & Ruey‐Jenn Ho & Yu‐Jen Hsiao, 2022. "Revisiting the valuation of deposit insurance," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(1), pages 77-103, January.
    9. Robert E. Hall, 2008. "Equity Depletion from Government-Guaranteed Debt," NBER Working Papers 14581, National Bureau of Economic Research, Inc.
    10. Ilhyock Shim, 2011. "Dynamic Prudential Regulation: Is Prompt Corrective Action Optimal?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(8), pages 1625-1661, December.
    11. Loveland, Robert, 2016. "How prompt was regulatory corrective action during the financial crisis?," Journal of Financial Stability, Elsevier, vol. 25(C), pages 16-36.
    12. Xavier Freixas & Bruno Maria Parigi, 2007. "Banking Regulation and Prompt Corrective Action," CESifo Working Paper Series 2136, CESifo.
    13. Bosma, Jakob J., 2016. "Dueling policies: Why systemic risk taxation can fail," European Economic Review, Elsevier, vol. 87(C), pages 132-147.
    14. Tonmoy Choudhury & Simone Scagnelli & Jaime Yong & Zhaoyong Zhang, 2021. "Non-Traditional Systemic Risk Contagion within the Chinese Banking Industry," Sustainability, MDPI, vol. 13(14), pages 1-16, July.
    15. Masahiko Egami & Tadao Oryu, 2013. "An Excursion-Theoretic Approach to Regulator's Bank Reorganization Problem," Papers 1311.3019, arXiv.org.
    16. Eijffinger, Sylvester & Nijskens, Rob, 2012. "A dynamic analysis of bank bailouts and constructive ambiguity," CEPR Discussion Papers 8953, C.E.P.R. Discussion Papers.
    17. Xavier Freixas & Jean-Charles Rochet, 2013. "Taming Systemically Important Financial Institutions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45, pages 37-58, August.
    18. Masahiko Egami & Tadao Oryu, 2015. "An Excursion-Theoretic Approach to Regulator’s Bank Reorganization Problem," Operations Research, INFORMS, vol. 63(3), pages 527-539, June.
    19. Prateek Sharma, 2022. "Management quality, M-rating, and bank failures," SN Business & Economics, Springer, vol. 2(2), pages 1-32, February.
    20. 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.
    21. Marcella Lucchetta & Michele Moretto & Bruno M. Parigi, 2019. "Optimal bailouts, bank’s incentive and risk," Annals of Finance, Springer, vol. 15(3), pages 369-399, September.
    22. Capponi, Agostino & Dooley, John M. & Oet, Mikhail V. & Ong, Stephen J., 2017. "Capital and resolution policies: The US interbank market," Journal of Financial Stability, Elsevier, vol. 30(C), pages 229-239.
    23. Marcella Lucchetta & Michele Moretto & Bruno Maria Parigi, 2018. "Systematic Risk, Bank Moral Hazard, and Bailouts," CESifo Working Paper Series 6878, CESifo.
    24. David VanHoose, 2007. "Market Discipline and Supervisory Discretion in Banking: Reinforcing or Conflicting Pillars of Basel II?," NFI Working Papers 2007-WP-06, Indiana State University, Scott College of Business, Networks Financial Institute.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jean Tirole, 2011. "Illiquidity and All Its Friends," Journal of Economic Literature, American Economic Association, vol. 49(2), pages 287-325, June.
    2. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
    3. David VanHoose, 2007. "Market Discipline and Supervisory Discretion in Banking: Reinforcing or Conflicting Pillars of Basel II?," NFI Working Papers 2007-WP-06, Indiana State University, Scott College of Business, Networks Financial Institute.
    4. Charles M. Kahn & William Roberds, 2009. "Payments Settlement: Tiering in Private and Public Systems," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(5), pages 855-884, August.
    5. Bruinshoofd Allard & Kool Clemens, 2002. "The Determinants of Corporate Liquidity in the Netherlands," Research Memorandum 014, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
    6. Gary Robinson, 2017. "Pragmatic financialisation: the role of the Japanese Post Office," New Political Economy, Taylor & Francis Journals, vol. 22(1), pages 61-75, January.
    7. Paul Pelzl & María Teresa Valderrama, 2019. "Capital regulations and the management of credit commitments during crisis times," DNB Working Papers 661, Netherlands Central Bank, Research Department.
    8. Chatterji, Shurojit & Ghosal, Sayantan, 2010. "Liquidity, moral hazard and bank crises," CAGE Online Working Paper Series 27, Competitive Advantage in the Global Economy (CAGE).
    9. Raddatz, Claudio, 2006. "Liquidity needs and vulnerability to financial underdevelopment," Journal of Financial Economics, Elsevier, vol. 80(3), pages 677-722, June.
    10. Fabio Castiglionesi & Wolf Wagner, 2012. "Turning Bagehot on His Head: Lending at Penalty Rates When Banks Can Become Insolvent," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(1), pages 201-219, February.
    11. Shekhar Aiyar & Charles W. Calomiris & Tomasz Wieladek, 2015. "How to Strengthen the Regulation of Bank Capital: Theory, Evidence, and A Proposal," Journal of Applied Corporate Finance, Morgan Stanley, vol. 27(1), pages 27-36, March.
    12. Lubello, Federico & Petrella, Ivan & Santoro, Emiliano, 2019. "Bank assets, liquidity and credit cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 265-282.
    13. Kevin F. Kiernan & Vladimir Yankov & Filip Zikes, 2021. "Liquidity Provision and Co-insurance in Bank Syndicates," Finance and Economics Discussion Series 2021-060, Board of Governors of the Federal Reserve System (U.S.).
    14. repec:spo:wpmain:info:hdl:2441/3l2vounfl99nvqsr0k24sn3k5l is not listed on IDEAS
    15. Berger, Allen N. & Boot, Arnoud W.A., 2024. "Financial intermediation services and competition analyses: Review and paths forward for improvement," Journal of Financial Intermediation, Elsevier, vol. 57(C).
    16. Hajime Tomura, 2010. "Liquidity Transformation and Bank Capital Requirements," Staff Working Papers 10-22, Bank of Canada.
    17. Volodymyr Babich & Simone Marinesi & Gerry Tsoukalas, 2021. "Does Crowdfunding Benefit Entrepreneurs and Venture Capital Investors?," Manufacturing & Service Operations Management, INFORMS, vol. 23(2), pages 508-524, March.
    18. Matthew Canzoneri & Robert Cumby & Behzad Diba, 2015. "Monetary Policy and the Natural Rate of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(2-3), pages 383-414, March.
    19. Charles M. Kahn & William Roberds, 2002. "Payments settlement under limited enforcement: Private versus public systems," FRB Atlanta Working Paper 2002-33, Federal Reserve Bank of Atlanta.
    20. Brutti, Filippo, 2008. "Legal enforcement, public supply of liquidity and sovereign risk," MPRA Paper 13949, University Library of Munich, Germany.
    21. Munehisa Kasuya, 2003. "Regime-Switching Approach to Monetary Policy Effects: Empirical Studies using a Smooth Transition Vector Autoregressive Model," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.

    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:jmoncb:v:39:y:2007:i:5:p:1107-1129. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.