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

Ghosh, Saurabh and Gopalakrishnan, Pawan and Satija, Sakshi (2019): Recapitalization in an Economy with State-Owned Banks - A DSGE Framework.

Abstract

We simulate a DSGE model with state owned banks to analyze the impact of bank recapitalization as a policy action in response to loan defaults by firms. As a special case, we calibrate the model to India, an emerging economy with state-owned banks facing a minimum investment requirement in safe assets and a sectoral lending requirement. We analyze two different scenarios of government infused recapitalization - an unconditional transfer to banks and an "equity in exchange for transfer". Our analysis shows that a government infused recapitalization in response to a negative TFP shock may increase output in the short run. However, there is a welfare loss in both cases, although higher for the unconditional transfers as compared with the "equity in exchange for transfer". Our analysis suggests that while bank recapitalization is a welcome move to kick-start credit creation, capital formation and growth, especially during a cyclical downturn, there is need for appropriate policy vigil to protect the quality of public expenditure in the social sector that matters for welfare in the long run.

• Item Type: MPRA Paper
• Language: English
• Keywords: Bank recapitalization, SLR requirements, Emerging Market Economies, Financial Frictions, state owned banks
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy

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