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Misdiagnosing Bank Capital Problems

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  • Klemperer, Paul
  • Bulow, Jeremy

Abstract

Banks' reluctance to repair their balance sheets, combined with deposit insurance and regulatory forbearance in recognizing greater risks and losses, can lead to solvency problems that look like liquidity (bank-run) crises. Regulatory forbearance incentivizes banks to both retain risky loans and reject new good opportunities. With sufficient regulatory forbearance, partially-insured banks act exactly as if they are fully insured. Stress tests certify that uninsured creditors will be paid, not that banks are solvent, and have ambiguous effects on the efficiency of investment.

Suggested Citation

  • Klemperer, Paul & Bulow, Jeremy, 2021. "Misdiagnosing Bank Capital Problems," CEPR Discussion Papers 16680, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16680
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    Keywords

    Bank capital; Regulatory capital; Capital requirements; Regulatory forbearance; Bank runs; Solvency runs; Liquidity runs; Stress tests; Financial crisis;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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