Risky Firms and Fragile Banks: Implications for Macroprudential Policy

Tommaso Gasparini, Vivien Lewis, Stéphane Moyen and Stefania Villa

Working papers from Banque de France

Abstract: Increases in firm default risk raise the default probability of banks while decreasing output and inflation in US data. To rationalize the empirical evidence, we analyse firm risk shocks in a New Keynesian model where entrepreneurs and banks engage in a loan contract and both are subject to default risk. In the model, a wave of corporate defaults leads to losses on banks' balance sheets; banks respond by selling assets and reducing credit provision. A highly leveraged banking sector exacerbates the contractionary effects of firm defaults. We show that high minimum capital requirements jointly implemented with a countercyclical capital buffer are effective in dampening the adverse consequences of firm risk shocks.

Keywords: Bank Default; Capital Buffer; Firm Risk; Macroprudential Policy (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 E61 G28 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2024
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-fdg, nep-ifn, nep-inv, nep-mac, nep-mon and nep-rmg
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https://www.banque-france.fr/system/files/2024-03/WP944_0.pdf

Related works:
Working Paper: Risky firms and fragile banks: implications for macroprudential policy (2024)
Working Paper: Risky firms and fragile banks: Implications for macroprudential policy (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:944

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