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Why Are Banks Not Recapitalized During Crises?

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  • Matteo Crosignani

    () (NYU Stern School of Business)

Abstract

I develop a model where governments might prefer to have an undercapitalized domestic financial sector during crises. Weak banks optimally tilt their sovereign bond portfolio towards domestic securities that are positively correlated with banks’ other sources of revenues. Governments anticipate this gambling-forresurrection motive and therefore face a trade-off when setting capital regulation. Undercapitalized banks act as buyers of last resort for home public debt at the cost of crowding-out private lending. Following recapitalizations, governments may face lower debt capacity and higher sovereign yields. European stress test data support the proposed mechanism as high leverage banks increased domestic government bond holdings relative to low leverage banks during the crisis. The general equilibrium model can rationalize, in the context of the Eurozone periphery, the increased banks’ holdings of domestic public debt, the ecreasing private lending, and the prolonged undercapitalization of the banking sector.

Suggested Citation

  • Matteo Crosignani, 2015. "Why Are Banks Not Recapitalized During Crises?," Working Papers 203, Oesterreichische Nationalbank (Austrian Central Bank).
  • Handle: RePEc:onb:oenbwp:203
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    References listed on IDEAS

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    1. repec:nbr:nberch:13342 is not listed on IDEAS
    2. Garcia-de-Andoain, Carlos & Heider, Florian & Hoerova, Marie & Manganelli, Simone, 2016. "Lending-of-last-resort is as lending-of-last-resort does: Central bank liquidity provision and interbank market functioning in the euro area," Journal of Financial Intermediation, Elsevier, vol. 28(C), pages 32-47.
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    4. Matteo Crosignani & Miguel Faria-e-Castro & Luís Fonseca, 2016. "The (unintended?) consequences of the largest liquidity injection ever," ESRB Working Paper Series 31, European Systemic Risk Board.
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    Citations

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    Cited by:

    1. Matteo Crosignani & Miguel Faria-e-Castro & Luís Fonseca, 2016. "The (unintended?) consequences of the largest liquidity injection ever," ESRB Working Paper Series 31, European Systemic Risk Board.
    2. Acharya, Viral & Pierret, Diane & Steffen, Sascha, 2016. "Lender of last resort versus buyer of last resort: The impact of the European Central Bank actions on the bank-sovereign nexus," ZEW Discussion Papers 16-019, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    3. Carlo Altavilla & Marco Pagano & Saverio Simonelli, 2017. "Bank Exposures and Sovereign Stress Transmission," Review of Finance, European Finance Association, vol. 21(6), pages 2103-2139.
    4. van der Kwaak, Christiaan, 2017. "Financial Fragility and Unconventional Central Bank Lending Operations," Research Report 17005-EEF, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    5. Buch, Claudia M. & Koetter, Michael & Ohls, Jana, 2016. "Banks and sovereign risk: A granular view," Journal of Financial Stability, Elsevier, vol. 25(C), pages 1-15.
    6. Anil Ari, 2015. "Sovereign Risk and Bank Risk-Taking," Working Papers 202, Oesterreichische Nationalbank (Austrian Central Bank).
    7. Fratianni, Michele & Marchionne, Francesco, 2017. "Bank asset reallocation and sovereign debt," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 47(C), pages 15-32.
    8. Luís Fonseca & Matteo Crosignani & Miguel Faria-e-Castro, 2015. "Central Bank Interventions, Demand for Collateral, and Sovereign Borrowing Costs," Working Papers w201509, Banco de Portugal, Economics and Research Department.
    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 - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    10. Viral V. Acharya & Sascha Steffen, 2016. "Capital Markets Union in Europe: Why other Unions must lead the Way," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 152(IV), pages 319-329, December.
    11. Orkun Saka, 2017. "Domestic banks as lightning rods? Home bias during the Eurozone crisis," LEQS – LSE 'Europe in Question' Discussion Paper Series 122, European Institute, LSE.
    12. Matteo Crosignani & Miguel Faria-e-Castro & Luís Fonseca, 2015. "The Portuguese Banking System during the Sovereign Debt Crisis," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
    13. Vlassopoulos, Thomas & C. Andreeva, Desislava, 2016. "Home bias in bank sovereign bond purchases and the bank-sovereign nexus," Working Paper Series 1977, European Central Bank.
    14. Laura Blattner & Luisa Farinha & Francisca Rebelo, 2017. "When Losses Turn Into Loans: The Cost of Undercapitalized Banks," 2017 Papers pbl215, Job Market Papers.

    More about this item

    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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