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Banks' Precautionary Capital and Credit Crunches

Author/Editor: Valencia, Fabian
Authorized for Distribution: October 1, 2008
Electronic Access: Free Full Text (PDF file size is 3,019KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: Periods of banking distress are often followed by sizable and long-lasting contractions in bank credit. They may be explained by a declined demand by financially impaired borrowers (the conventional financial accelerator) or by lower supply by capital-constrained banks, a "credit crunch". This paper develops a bank model to study credit crunches and their real effects. In this model, banks maintain a precautionary level of capital that serves as a smoothing mechanism to avert disruptions in the supply of credit when hit by small shocks. However, for larger shocks, highly persistent credit crunches may arise even when the impulse is a one time, non-serially correlated event. From a policy perspective, the model justifies the use of public funds to recapitalize banks following a significant deterioration in their capital position.
 
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Series: Working Paper No. 08/248
Subject(s): Banking crisis | Bank credit | External shocks | Liquidity management | Financial risk | Economic models
Author's keyword(s): Banking | financial frictions | credit crunch | dynamic programming
 
English  
    Published:   October 1, 2008        
            Format:   Paper
    Stock No:   WPIEA2008248   Pages:   35
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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