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Optimal bank leverage and recapitalization in crowded markets

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  • Christoph Bertsch
  • Mike Mariathasan

Abstract

We study optimal bank leverage and recapitalization in general equilibrium when the supply of specialized investment capital is imperfectly elastic. Assuming incomplete insurance against capital shortfalls and segmented financial markets, ex-ante leverage is inefficiently high, leading to excessive insolvencies during systemic capital shortfall events. Recapitalizations by equity issuance are individually and socially optimal. Additional frictions can turn asset sales individually but not necessarily socially optimal. Our results hold for different bankruptcy protocols and we offer testable predictions for banks' capital structure management. Our model provides a rationale for macroprudential capital regulation that does not require moral hazard or informational asymmetries.

Suggested Citation

  • Christoph Bertsch & Mike Mariathasan, 2021. "Optimal bank leverage and recapitalization in crowded markets," BIS Working Papers 923, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:923
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    More about this item

    Keywords

    Bank capital; recapitalization; macroprudential regulation; incomplete markets; financial market segmentation; constrained inefficiency;
    All these keywords.

    JEL classification:

    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • D6 - Microeconomics - - Welfare Economics
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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