Banks’ Precautionary Capital and Persistent Credit Crunches
IMF Working Papers, October 1, 2008
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- Banks’ Precautionary Capital and Persistent Credit Crunches
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Bibliographic details
- Authors: Fabian Valencia
- Published: October 1, 2008
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451871067.001
Summary and main findings
- Periods of banking distress are often followed by sizable and long-lasting contractions in bank credit.
- Contractions may be driven by:
- declined demand by financially impaired borrowers (the conventional financial accelerator), or
- lower supply by capital-constrained banks, a "credit crunch".
- The paper develops a bank model to study credit crunches and their real effects.
- In the 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.
- For larger shocks, highly persistent credit crunches may arise even when the impulse is a one time, non-serially correlated event.
Policy implications and recommendations
- The model justifies the use of public funds to recapitalize banks following a significant deterioration in their capital position.
- Precautionary capital held by banks can mitigate short-run disruptions but may be insufficient against large shocks, motivating policy intervention.
Subject, keywords, and authorship
- By Fabian Valencia
- Date: October 1, 2008
- Subject: Bank credit, Banking, Credit, Loans, Solvency
- Keywords: credit crunch, financial structure, precautionary motive, WP