Misdiagnosing Bank Capital Problems

Paul Klemperer and Jeremy Bulow

No 16680, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Banks' reluctance to repair their balance sheets, combined with deposit insurance and regulatory forbearance in recognizing greater risks and losses, can lead to solvency problems that look like liquidity (bank-run) crises. Regulatory forbearance incentivizes banks to both retain risky loans and reject new good opportunities. With sufficient regulatory forbearance, partially-insured banks act exactly as if they are fully insured. Stress tests certify that uninsured creditors will be paid, not that banks are solvent, and have ambiguous effects on the efficiency of investment.

Keywords: Bank capital; Regulatory capital; Capital requirements; Regulatory forbearance; Bank runs; Solvency runs; Liquidity runs; Stress tests; Financial crisis (search for similar items in EconPapers)
JEL-codes: G10 G21 G28 G32 (search for similar items in EconPapers)
Date: 2021-10
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Related works:
Working Paper: Misdiagnosing Bank Capital Problems (2021)
Working Paper: Misdiagnosing Bank Capital Problems (2021)
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