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Twin Defaults and Bank Capital Requirements

Caterina Mendicino (European Central Bank)


We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to non-diversifiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside but significant downside risk of loan portfolio returns (Nagel and Purnanandam, 2020). This helps to reproduce the frequency and severity of twin defaults: simultaneously high firm and bank failures. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is 5pp higher than under standard default risk models which underestimate the impact of borrower default on bank solvency.


Financial Intermediation, Macroprudential Policy, Default Risk, Bank Assets Returns.;

Codes JEL

  • E44: Financial Markets and the Macroeconomy
  • G01: Financial Crises
  • G21: Banks • Depository Institutions • Micro Finance Institutions • Mortgages


Caterina Mendicino (European Central Bank), « Twin Defaults and Bank Capital Requirements », 2nd Sustainable Finance Center Conference, TSE, Toulouse, 2021.

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2nd Sustainable Finance Center Conference, TSE, Toulouse, 2021