Recapitalization, Bailout, and Long-run Welfare in a Dynamic Model of Banking

Andrea Modena ()
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Andrea Modena: Institute for Financial Economics and Statistics, Department of Economics, University of Bonn

No 2020:23, Working Papers from Department of Economics, University of Venice "Ca' Foscari"

Abstract: This paper studies the link between bank recapitalization and welfare in a dynamic production economy. The model features financial frictions because banks benefit of a cost advantage at monitoring firms and face costly equity issuance. The competitive equilibrium outcome is inefficient because agents do not internalize the effects banks' capitalization over the allocation of capital, its price and, in turn, firms' investments. It follows, individual recapitalizations are sub-optimal and bailout policies may benefit social welfare in the long run. Bailouts improve capital allocation in states where aggregate banks are poorly capitalized, therefore enhancing their market valuation, fostering investments, and stabilizing the economy recovery path.

Keywords: Banks; bailout; general equilibrium; financial frictions; recapitalization; welfare (search for similar items in EconPapers)
JEL-codes: D51 G21 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2020
New Economics Papers: this item is included in nep-ban, nep-dge and nep-fdg
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Persistent link: https://EconPapers.repec.org/RePEc:ven:wpaper:2020:23

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