Forbearance and Prompt Corrective Action
This paper 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 losing 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.
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- 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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- 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 Center for International Economics, Working Paper Series qt0t6321ds, Center for International Economics, UC Santa Cruz.
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