Should Banks Be Recapitalized?

FRB Richmond Economic Quarterly, Vol. 87, No. 4, Fall 2001, pp. 71-96

26 Pages Posted: 30 Nov 2012

See all articles by Douglas W. Diamond

Douglas W. Diamond

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Date Written: 2001

Abstract

When a bank is a relationship lender, its financial health affects its borrowers’ access to credit. If regulators or depositors might close a bank, it will take any action necessary to remain open. This leads to excessive foreclosure of the bank’s relationship-based loans or to the bank’s inability to collect existing loans due to its fear of accounting losses if it forecloses. Recapitalization of banks possessing relationship-based loans can be good policy. However, providing a positive but too small amount of capital can be worse than providing none. There is no reason to provide subsidized capital to banks without relationship-based loans.

Suggested Citation

Diamond, Douglas W., Should Banks Be Recapitalized? (2001). FRB Richmond Economic Quarterly, Vol. 87, No. 4, Fall 2001, pp. 71-96, Available at SSRN: https://ssrn.com/abstract=2182663

Douglas W. Diamond (Contact Author)

University of Chicago - Booth School of Business ( email )

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