Financial Risk Capacity
American Economic Journal: Macroeconomics
vol. 13,
no. 4, October 2021
(pp. 142-81)
Abstract
Financial crises are particularly severe and lengthy when banks fail to recapitalize after bearing large losses. We present a model that explains the slow recovery of bank capital and economic activity. Banks provide intermediation in markets with information asymmetries. Large equity losses force banks to tighten intermediation, which exacerbates adverse selection. Adverse selection lowers bank profit margins, which slows both the internal growth of equity and equity injections. This mechanism generates financial crises characterized by persistent low growth. The lack of equity injections during crises is a coordination failure that is solved when the decision to recapitalize banks is centralized.Citation
Bigio, Saki, and Adrien d'Avernas. 2021. "Financial Risk Capacity." American Economic Journal: Macroeconomics, 13 (4): 142-81. DOI: 10.1257/mac.20160286Additional Materials
JEL Classification
- D82 Asymmetric and Private Information; Mechanism Design
- E32 Business Fluctuations; Cycles
- E44 Financial Markets and the Macroeconomy
- G01 Financial Crises
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- L25 Firm Performance: Size, Diversification, and Scope
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