Risky firms and fragile banks: implications for macroprudential policy

Tommaso Gasparini, Vivien Lewis, Moyen, Stéphane and Stefania Villa

No 18915, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 buffers; Firm risk; Macroprudential policy (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 E61 G28 (search for similar items in EconPapers)
Date: 2024-03
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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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