Bank capital forbearance and serial gambling

Natalya Martynova, Enrico Perotti and Javier Suarez

No 56/2020, Discussion Papers from Deutsche Bundesbank

Abstract: We analyze the strategic interaction between undercapitalized banks and a supervisor who may intervene by preventive recapitalization. Supervisory forbearance emerges because political and fiscal costs undermine supervisors' commitment to intervene. When supervisors have lower credibility, banks' incentives to voluntary recapitalize are lower and supervisors may end up intervening more. Importantly, when intervention capacity is constrained (e.g. for fiscal reasons), private recapitalization decisions become strategic complements, producing equilibria with extremely high forbearance and high systemic costs. Anticipating forbearance in response to diffuse undercapitalization, banks may ex ante choose more correlated risks, a form of "serial gambling" undermining the supervisory response.

Keywords: bank supervision; bank recapitalization; forbearance (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdps:562020

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