Recapitalization in an Economy with State-Owned Banks—A DSGE Framework

Saurabh Ghosh, Pawan Gopalakrishnan, Sakshi Satija
2020 Theoretical Economics Letters  
What are the quantitative effects of a government infused bank recapitalization in response to loan defaults? We analyze two different scenarios of government infused recapitalization using a dynamic stochastic general equilibrium (DSGE) model, calibrated to an emerging market economy with state owned banks. The first is an unconditional transfer and the second is an "equity in exchange for transfer" to banks. We show that a government infused recapitalization in response to a negative
more » ... a negative productivity shock may increase output in the short run. However, there is welfare loss, which is higher in the case of unconditional transfers. Our analysis suggests that bank recapitalization facilitates credit creation, capital formation and growth, especially during a cyclical downturn. There is however a need for appropriate policy vigil to protect the quality of public expenditure in the social sector that matters for welfare in the long run. ing sector reform measures included in the Basel III regulation relates to improving the quality and quantity of banks' capital, aimed to make the financial system more resilient, reduce the cost of borrowing, and promote economic growth (see BCBS regulation papers on Basel IIIl, 2010 [2] [3]). Therefore, because of the increased capital requirements under Basel III regulations, and to account for the erosion of capital during GFC defaults, banks have required fresh bouts of recapitalization. Historically, several large recapitalization measures were undertaken both in advanced and emerging economies during the post-GFC period. For advanced
doi:10.4236/tel.2020.101015 fatcat:pvadaxeqm5gynmb4oi3nm2ieyy