Firm-Bank Linkages and Optimal Policies in a Lockdown

45 Pages Posted: 16 Jun 2020 Last revised: 21 Sep 2020

Date Written: June 2020

Abstract

We develop a novel framework that features loss amplification through firm-bank linkages. We use it to study optimal intervention in a lockdown that creates cash shortfalls to firms, which must borrow from banks to avoid liquidation. Firms' increase in debt reduces firms' output due to moral hazard. Banks need safe collateral to raise funds. Without intervention, aggregate risk constrains bank lending, increasing its cost and amplifying output losses. Optimal government support must provide sufficient aggregate risk insurance, and can be implemented with transfers to firms and fairly-priced guarantees on banks' debt. Non-priced bank debt guarantees and loan guarantees are suboptimal.

Keywords: COVID-19, Financial Intermediation, firm's leverage, Government interventions, liquidity

JEL Classification: G01, G20, G28

Suggested Citation

Segura Velez, Anatoli and Villacorta, Luis Alonso and Villacorta, Luis Alonso, Firm-Bank Linkages and Optimal Policies in a Lockdown (June 2020). Available at SSRN: https://ssrn.com/abstract=3628158

Anatoli Segura Velez (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Luis Alonso Villacorta

UC Santa Cruz ( email )

Santa Cruz, CA 95064
United States

Stanford University ( email )

Stanford, CA 94305
United States

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