Banks Paying for Banks: A Dynamic General Equilibrium Perspective

Abstract

This paper presents a dynamic general equilibrium approach to analysing recent policy proposals on a resolution fund for direct recapitalisation of banks financed by banks. The model incorporates endogenous risk inherent in any economic activity due to imperfect information and incomplete financial markets, giving rise to dependence on banking finance and the possibility of default. Financial intermediaries could assume this risk ex-ante and support economic activity in expectation of ex-post monetary refinancing and recapitalisation. The downside of such policies and practices would be the resulting financial repression, i.e. erosion of household savings, and the instalment of moral hazard incentives in the economic decisions of banks and enterprises. In this setting we explore the short and long-term consequences of a burden-sharing scheme whereby banks contribute towards their own refinancing and recapitalisation.

Keywords: bail-ins, burden-sharing, regulatory forbearance, financial intermediation, endogenous partial default, imperfect information and incomplete markets.

JEL Classification: E5, D5