Forbearance and prompt corrective action

Ilhyock Shim and Narayana Kocherlakota

No 177, BIS Working Papers from Bank for International Settlements

Abstract: This paper investigates whether a bank regulator should terminate problem banks promptly or exercise forbearance. We construct a dynamic model economy in which entrepreneurs pledge collateral, borrow from banks, and invest in long-term projects. We assume that collateral value has aggregate risk over time, that in any period entrepreneurs can abscond with the projects but losing the collateral, and that depositors can withdraw deposits. We show that optimal regulation exhibits forbearance if the ex-ante probability of collapse in collateral value is sufficiently low, but exhibits prompt termination of problem banks if this probability is sufficiently high.

Keywords: risky collateral; limited enforcement; banking regulation; optimal social contract (search for similar items in EconPapers)
JEL-codes: D81 G21 G28 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2005-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Forbearance and Prompt Corrective Action (2007)
Journal Article: Forbearance and Prompt Corrective Action (2007)
Working Paper: Forbearance and Prompt Corrective Action (2005)
Working Paper: Forbearance and Prompt Corrective Action (2005)
Working Paper: Forbearance and Prompt Corrective Action (2005)
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