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Recapitalization in an Economy with State-Owned Banks - A DSGE Framework

Author

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  • Ghosh, Saurabh
  • Gopalakrishnan, Pawan
  • Satija, Sakshi

Abstract

We simulate a DSGE model with state owned banks to analyze the impact of bank recapitalization as a policy action in response to loan defaults by firms. As a special case, we calibrate the model to India, an emerging economy with state-owned banks facing a minimum investment requirement in safe assets and a sectoral lending requirement. We analyze two different scenarios of government infused recapitalization - an unconditional transfer to banks and an "equity in exchange for transfer". Our analysis shows that a government infused recapitalization in response to a negative TFP shock may increase output in the short run. However, there is a welfare loss in both cases, although higher for the unconditional transfers as compared with the "equity in exchange for transfer". Our analysis suggests that while bank recapitalization is a welcome move to kick-start credit creation, capital formation and growth, especially during a cyclical downturn, there is need for appropriate policy vigil to protect the quality of public expenditure in the social sector that matters for welfare in the long run.

Suggested Citation

  • Ghosh, Saurabh & Gopalakrishnan, Pawan & Satija, Sakshi, 2019. "Recapitalization in an Economy with State-Owned Banks - A DSGE Framework," MPRA Paper 96981, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:96981
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    File URL: https://mpra.ub.uni-muenchen.de/96981/1/MPRA_paper_96981.pdf
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    Keywords

    Bank recapitalization; SLR requirements; Emerging Market Economies; Financial Frictions; state owned banks;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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