Twin Defaults and Bank Capital Requirements

77 Pages Posted: 3 Mar 2020 Last revised: 11 Feb 2021

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; Foundation for Applied Economic Research (FEDEA); Federal Reserve Banks - Federal Reserve Bank of Atlanta; BBVA Research

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: February 2020

Abstract

We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to non-diverfisiable 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.

JEL Classification: E3, 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 (February 2020). CEPR Discussion Paper No. DP14427, Available at SSRN: https://ssrn.com/abstract=3547360

Caterina Mendicino (Contact Author)

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

Foundation for Applied Economic Research (FEDEA)

Jorge Juan 46
Madrid, 28001
Spain

Federal Reserve Banks - Federal Reserve Bank of Atlanta

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BBVA Research

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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
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1000 Brussels
Belgium

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

Dominik Supera

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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