Inefficient Bank Recapitalization, Bailout, and Post-Crisis Recoveries
48 Pages Posted: 16 Oct 2020 Last revised: 28 Nov 2022
Date Written: November 25, 2022
We study bailouts in a macroeconomic model where banks provide services that facilitate firms' investments but limit their own leverage to prevent costly recapitalizations. This precautionary motive can generate financial crises, in which banks' limited intermediation capacity discourages investments and dampens growth. Bank recapitalizations are constrained-inefficient because they do not internalize that, in the aggregate, higher equity buffers allow for more intermediation, favouring investments and accelerating recoveries. System-wide bailouts can mitigate this inefficiency and improve long-run welfare as long as their positive effect on banks' equity value outweighs their negative impact on risk-taking incentives.
Keywords: bailout; efficiency; financial crisis, general equilibrium; recovery; welfare
JEL Classification: D51, G21
Suggested Citation: Suggested Citation