Paper by Enrico Perotti and Natalya Martynova published in the Journal of Financial Economics

Abstract

We analyze the strategic interaction between undercapitalized banks and a supervisor in a recovery and resolution framework in which early recapitalizations can prevent later disorderly failures. Capital forbearance emerges because reputational, political, economic and fiscal costs undermine supervisors’ commitment to publicly resolve the banks that miss the request to privately recover. Under a weaker resolution threat, banks’ incentives to recover are lower and supervisors may end up having to resolve more banks. When marginal resolution costs steeply increase with the scale of the intervention, private recovery actions become strategic complements, producing too-many-to-resolve equilibria with high forbearance and high systemic costs.

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Article Citation

Natalya Martynova, Enrico Perotti, and Javier Suarez, ““Capital forbearance in the bank recovery and resolution game," Volume 146, Issue 3, December 2022, Pages 884-904, doi.org/10.1016/j.jfineco.2022.09.006.