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Forbearance and Prompt Corrective Action
Author(s) -
KOCHERLAKOTA NARAYANA R.,
SHIM ILHYOCK
Publication year - 2007
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2007.00059.x
Subject(s) - forbearance , collateral , pledge , commit , business , value (mathematics) , ex ante , action (physics) , monetary economics , economics , actuarial science , finance , computer science , macroeconomics , law , political science , physics , quantum mechanics , database , machine learning
This article investigates whether a bank regulator should terminate problem banks promptly or exercise forbearance. We construct a dynamic model economy in which entrepreneurs pledge collateral, borrow from banks, and invest in long‐term projects. We assume that collateral value has aggregate risk over time, that in any period entrepreneurs can abscond with the projects but lose the collateral, and that depositors can withdraw deposits. We show that optimal regulation exhibits forbearance if the ex‐ante probability of collapse in collateral value is sufficiently low, but exhibits prompt termination of problem banks if this probability is sufficiently high.