Twin Defaults and Bank Capital Requirements

Javier Suarez, Caterina Mendicino, Kalin Nikolov, Rubio-Ramírez, Juan Francisco and Dominik Supera

No 14427, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to non-diverfisiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside but significant downside risk of loan portfolio returns (Nagel and Purnanandam, 2020). This helps to reproduce the frequency and severity of twin defaults: simultaneously high firm and bank failures. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is 5pp higher than under standard default risk models which underestimate the impact of borrower default on bank solvency.

Keywords: Financial intermediation; Macroprudential policy; Default risk; Bank assets returns (search for similar items in EconPapers)
JEL-codes: E3 E44 G01 G21 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-ban, nep-dge, nep-fdg, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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