TITLE:
Recapitalization in an Economy with State-Owned Banks—A DSGE Framework
AUTHORS:
Saurabh Ghosh, Pawan Gopalakrishnan, Sakshi Satija
KEYWORDS:
Bank Recapitalization, Statutory Liquidity Ratio (SLR) Requirements, Emerg-ing Market Economies, Financial Frictions, State Owned Banks
JOURNAL NAME:
Theoretical Economics Letters,
Vol.10 No.1,
February
28,
2020
ABSTRACT: 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 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.