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Financial Risk Capacity

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  • Saki Bigio
  • Adrien d'Avernas

Abstract

Financial crises are particularly severe and lengthy when banks fail to recapitalize after bearing large losses. We present a model that explains the slow recovery of bank capital and economic activity. Banks provide intermediation in markets with information asymmetries. Large equity losses force banks to tighten intermediation, which exacerbates adverse selection. Adverse selection lowers bank profit margins which slows both the internal growth of equity and equity injections. This mechanism generates financial crises characterized by persistent low growth. The lack of equity injections during crises is a coordination failure that is solved when the decision to recapitalize banks is centralized.

Suggested Citation

  • Saki Bigio & Adrien d'Avernas, 2019. "Financial Risk Capacity," NBER Working Papers 26561, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:26561
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    Cited by:

    1. Javier Bianchi, 2016. "Efficient Bailouts?," American Economic Review, American Economic Association, vol. 106(12), pages 3607-3659, December.
    2. Alejandro Justiniano & Giorgio E. Primiceri & Andrea Tambalotti, 2019. "Credit Supply and the Housing Boom," Journal of Political Economy, University of Chicago Press, vol. 127(3), pages 1317-1350.
    3. Lawrence Christiano & Daisuke Ikeda, 2014. "Leverage Restrictions in a Business Cycle Model," Central Banking, Analysis, and Economic Policies Book Series, in: Sofía Bauducco & Lawrence Christiano & Claudio Raddatz (ed.), Macroeconomic and Financial Stability: challenges for Monetary Policy, edition 1, volume 19, chapter 7, pages 215-216, Central Bank of Chile.
    4. Mark Gertler & Nobuhiro Kiyotaki, 2015. "Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy," American Economic Review, American Economic Association, vol. 105(7), pages 2011-2043, July.
    5. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
    6. Zhiguo He & Arvind Krishnamurthy, 2012. "A macroeconomic framework for quantifying systemic risk," Working Paper Research 233, National Bank of Belgium.
    7. Joseph Mullins & Gaston Navarro & Julio Blanco, 2013. "Equilibrium Default and Slow Recoveries," 2013 Meeting Papers 694, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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