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Banks’ Precautionary Capital and Persistent Credit Crunches

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  • Mr. Fabian Valencia
Abstract
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.

Suggested Citation

  • Mr. Fabian Valencia, 2008. "Banks’ Precautionary Capital and Persistent Credit Crunches," IMF Working Papers 2008/248, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2008/248
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    References listed on IDEAS

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    Cited by:

    1. Mr. Fabian Valencia & Mr. Luc Laeven, 2008. "Systemic Banking Crises: A New Database," IMF Working Papers 2008/224, International Monetary Fund.
    2. Agénor, P.-R. & Alper, K. & Pereira da Silva, L., 2012. "Capital requirements and business cycles with credit market imperfections," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 687-705.
    3. Luc Laeven, 2011. "Banking Crises: A Review," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 17-40, December.
    4. Mr. Fabian Valencia, 2011. "Monetary Policy, Bank Leverage, and Financial Stability," IMF Working Papers 2011/244, International Monetary Fund.
    5. Kupiec, Paul & Lee, Yan & Rosenfeld, Claire, 2017. "Does bank supervision impact bank loan growth?," Journal of Financial Stability, Elsevier, vol. 28(C), pages 29-48.
    6. Mr. Fabian Valencia, 2010. "Bank Capital and Uncertainty," IMF Working Papers 2010/208, International Monetary Fund.

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