Working Paper: CEPR ID: DP13617
Authors: Natalya Martynova; Enrico Perotti; Javier Suarez
Abstract: We analyze the strategic interaction between undercapitalized banks and a supervisor who may intervene by preventive recapitalization. Supervisory forbearance emerges because of a commitment problem, reinforced by fiscal costs and constrained capacity. Private incentives to comply are lower when supervisors have lower credibility, especially for highly levered banks. Less credible supervisors (facing higher cost of intervention) end up intervening more banks, yet producing higher forbearance and systemic costs of bank distress. Importantly, when public intervention capacity is constrained, private recapitalization decisions become strategic complements, leading to equilibria with extremely high forbearance and high systemic costs of bank failure.
Keywords: bank supervision; bank recapitalization; forbearance
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| supervisory credibility (M54) | private recapitalization choices (G32) |
| lower supervisory credibility (D73) | higher systemic costs (H51) |
| public intervention capacity is constrained (H76) | banks' recapitalization decisions act as strategic complements (G28) |
| banks' recapitalization decisions act as strategic complements (G28) | high levels of forbearance and systemic costs (G28) |
| higher political and reputational costs (D73) | increased public recapitalizations (H81) |
| increased public recapitalizations (H81) | greater systemic losses (P44) |