Javier Suarez - CEMFI

"Capital Forbearance in the Bank Recovery and Resolution Game", together with Natalya Martynova and Enrico Perotti

Abstract

We analyze the strategic interaction between undercapitalized banks and a supervisor in the context of 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 resolution capacity is constrained (e.g. for fiscal reasons), private recovery actions become strategic complements, producing equilibria with extremely high forbearance and high systemic costs.

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