Forbearance and Prompt Corrective Action

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  • 1 January 2005
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      • Published in RePEc
Abstract
This paper 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 losing 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. (This abstract was borrowed from another version of this item.) (This abstract was borrowed from another version of this item.)
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