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Why Are Banks Not Recapitalized During Crises?

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Abstract

I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks reduce private lending to further increase their holdings of domestic government bonds, lowering sovereign yields and supporting the home sovereign debt capacity. The model rationalizes, in the context of the eurozone periphery, the increase in domestic government bond holdings, the reduction of bank credit supply, and the prolonged fragility of the financial sector.

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  • Matteo Crosignani, 2017. "Why Are Banks Not Recapitalized During Crises?," Finance and Economics Discussion Series 2017-084, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2017-84
    DOI: 10.17016/FEDS.2017.084
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    Cited by:

    1. Spyros Alogoskoufis & Sam Langfield, 2020. "Regulating the Doom Loop," International Journal of Central Banking, International Journal of Central Banking, vol. 16(4), pages 251-292, September.
    2. Böhm, Hannes & Eichler, Stefan, 2020. "Avoiding the fall into the loop: Isolating the transmission of bank-to-sovereign distress in the Euro Area," Journal of Financial Stability, Elsevier, vol. 51(C).
    3. Crosignani, Matteo & Faria-e-Castro, Miguel & Fonseca, Luís, 2020. "The (Unintended?) consequences of the largest liquidity injection ever," Journal of Monetary Economics, Elsevier, vol. 112(C), pages 97-112.
    4. Christophe Destais & Frederik Eidam & Friedrich Heinemann, 2019. "The design of a sovereign debt restructuring mechanism for the euro area: Choices and trade-offs," CEPII Policy Brief 2019-25, CEPII research center.
    5. Matías Lamas & Javier Mencía, 2018. "What drives sovereign debt portfolios of banks in a crisis context?," Working Papers 1843, Banco de España.
    6. Laura Blattner & Luisa Farinha & Francisca Rebelo, 2017. "When Losses Turn Into Loans: The Cost of Undercapitalized Banks," 2017 Papers pbl215, Job Market Papers.
    7. Anand, Kartik & Mankart, Jochen, 2020. "Sovereign risk and bank fragility," Discussion Papers 54/2020, Deutsche Bundesbank.
    8. Kirschenmann, Karolin & Korte, Josef & Steffen, Sascha, 2020. "A zero-risk weight channel of sovereign risk spillovers," Journal of Financial Stability, Elsevier, vol. 51(C).
    9. Kirschenmann, Karolin & Korte, Josef & Steffen, Sascha, 2017. "The zero risk fallacy? Banks' sovereign exposure and sovereign risk spillovers," ZEW Discussion Papers 17-069, ZEW - Leibniz Centre for European Economic Research.
    10. Alexander Popov, 2020. "Discussion of Saka," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(S1), pages 307-311, October.
    11. Capponi, Agostino & Corell, Felix & Stiglitz, Joseph E., 2022. "Optimal bailouts and the doom loop with a financial network," Journal of Monetary Economics, Elsevier, vol. 128(C), pages 35-50.
    12. Böhm, Hannes & Eichler, Stefan, 2018. "Avoiding the fall into the loop: Isolating the transmission of bank-to-sovereign distress in the euro area and its drivers," IWH Discussion Papers 19/2018, Halle Institute for Economic Research (IWH).
    13. Diana Bonfim & Leonor Queiró & Luísa Farinha, 2021. "Heterogeneity in loan pricing: the role of bank capital," Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies, Banco de Portugal, Economics and Research Department.
    14. Mark Mink & Rodney Ramcharan & Iman van Lelyveld, 2020. "How Banks Respond to Distress: Shifting Risks in Europe’s Banking Union," Tinbergen Institute Discussion Papers 20-006/IV, Tinbergen Institute.
    15. Mark Mink & Rodney Ramcharan & Iman van Lelyveld, 2020. "How banks respond to distress: Shifting risks in Europe's banking union," Working Papers 669, DNB.
    16. Peleg Lazar, Sharon & Raviv, Alon, 2019. "The risk spiral: The effects of bank capital and diversification on risk taking," International Review of Financial Analysis, Elsevier, vol. 65(C).
    17. Corbisiero, Giuseppe, 2022. "Bank lending, collateral, and credit traps in a monetary union," European Economic Review, Elsevier, vol. 144(C).
    18. Vivek Sharma & Edgar Silgado-Gómez, 2019. "Sovereign Spread Volatility and Banking Sector," CEIS Research Paper 454, Tor Vergata University, CEIS, revised 08 Mar 2019.
    19. Böhm, Hannes & Eichler, Stefan, 2019. "Avoiding the Fall into the Loop: Isolating the Transmission of Bank-to-Sovereign Distress in the Euro Area and its Drivers," VfS Annual Conference 2019 (Leipzig): 30 Years after the Fall of the Berlin Wall - Democracy and Market Economy 203515, Verein für Socialpolitik / German Economic Association.

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    More about this item

    Keywords

    Bank Capital; Bank Credit; Government Bonds; Risk-Shifting; Sovereign Crises;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • 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

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