Twin Defaults and Bank Capital Requirements

73 Pages Posted: 19 Feb 2020 Last revised: 30 Dec 2020

See all articles by Caterina Mendicino

Caterina Mendicino

European Central Bank (ECB) - Directorate General Research

Kalin Nikolov

European Central Bank (ECB)

Juan Rubio Ramírez

Emory University

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Dominik Supera

University of Pennsylvania - The Wharton School

Multiple version iconThere are 3 versions of this paper

Date Written: October 1, 2019

Abstract

We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to non-diversifiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside but significant downside risk of loan portfolio returns (Nagel and Purnanandam, 2020). This helps to reproduce the frequency and severity of twin defaults: simultaneously high firm and bank failures. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is 5pp higher than under standard default risk models which underestimate the impact of borrower default on bank solvency.

Keywords: Financial Intermediation, Macroprudential Policy, Default Risk, Bank Assets Returns.

JEL Classification: E44, G01, G21

Suggested Citation

Mendicino, Caterina and Nikolov, Kalin and Rubio Ramírez, Juan and Suarez, Javier and Supera, Dominik, Twin Defaults and Bank Capital Requirements (October 1, 2019). Available at SSRN: https://ssrn.com/abstract=3536486 or http://dx.doi.org/10.2139/ssrn.3536486

Caterina Mendicino

European Central Bank (ECB) - Directorate General Research ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Kalin Nikolov

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Juan Rubio Ramírez

Emory University ( email )

201 Dowman Drive
Atlanta, GA 30322
United States

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Dominik Supera (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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