Recapitalization, bailout, and long-run welfare in a dynamic model of banking

Andrea Modena

No 292, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

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 inecient because agents do not internalize the e↵ects 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)
Date: 2020
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-fdg
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:292

DOI: 10.2139/ssrn.3712211

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