Banks’ Precautionary Capital and Persistent Credit Crunches

October 1, 2008

Preview Citation

Format: Chicago

Fabian Valencia. Banks’ Precautionary Capital and Persistent Credit Crunches, (USA: International Monetary Fund, 2008) accessed November 23, 2024

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.

Subject: Bank credit, Banking, Credit, Loans, Solvency

Keywords: Credit crunch, Financial structure, Precautionary motive, WP

Publication Details

Pages:

35
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2008/248
Stock No:

WPIEA2008248
ISBN:

9781451871067
ISSN:

1018-5941

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