Playing to be the last bankrupt

A macroprudential approach that enforces collective bank credit expansion can break the cycle of credit contraction, falling incomes, and rising delinquencies.

The COVID‑19 recession exposed the limits of conventional and unconventional monetary policy at the zero lower bound, as even long‑term risk‑free rates approached zero. Quantitative easing and forward guidance proved less effective than in 2008, leaving spending weak.

The historical experience shows that the first filers may not be rescued. Chance of bailout rises as a bank remains solvent until the government steps in.

By coordinating banks and using leverage‑based tools, central banks can stimulate demand without relying solely on QE, restoring monetary traction in future crises.

Macroprudential policy can break this spiral by compelling collective bank action. Raising leverage requirements in downturns would force banks to extend credit, sustaining spending and income, reducing defaults, and stabilizing the financial system. Central banks must therefore assume the role of coordinating credit expansion to prevent the self-reinforcing collapse of private lending in deep recessions..

Monetary Policy Is Desperate

The COVID‑19 pandemic caused an unprecedented global economic contraction. Traditional monetary policy tools proved largely impotent at the zero lower bound (ZLB). Unconventional policies like quantitative easing (QE) and forward guidance—effective during the 2008 Global Financial Crisis (GFC)—proved less effective in 2020, as long-term interest rates were already near zero before the shock (IMF, 2020; Gagnon et al., 2020).

By March 2020, the U.S. 10‑year Treasury yield fell below 1%, leaving little room for QE to further stimulate demand (Federal Reserve Bank of St. Louis, 2020). This contrasts with 2008, when QE successfully pushed long-term rates down to the ZLB. With conventional and unconventional tools constrained, central banks faced a desperate need for alternative mechanisms to boost spending.

Macroprudential Tools as Stimulus

Macroprudential policies were initially designed to cool overheated economies, limiting credit growth and financial risk by imposing capital and liquidity buffers on banks (Borio, 2014; IMF, 2014). These buffers successfully reduced over-leveraging during the 2010s.

However, the same framework can also be reversed to heat up an overcooled economy.

Requiring banks to raise leverage in recessions—effectively lending more per unit of capital—would directly stimulate spending. Expanded credit supply would:

1. Raise business revenues,

2. Reduce delinquencies, and

3. Strengthen bank capital through higher disposable income in the economy.

This procyclical use of macroprudential tools could recreate the monetary transmission mechanism that traditional interest rate cuts can no longer provide.

Banks Must Act Collectively in Recessions

The current reality is the opposite. Without regulatory enforcement, each bank plays to be the last bankrupt—cutting credit to protect its own capital against surging delinquencies (Acharya & Steffen, 2020).

• As revenues collapse, firms become insolvent in accounting terms.

• Banks, seeking to survive individually, ration credit.

• Credit contraction leads to layoffs and spending cuts, further reducing aggregate income.

• Falling income triggers more delinquencies, weakening banks even further.

This vicious spiral—credit rationing feeding delinquencies—mirrors the self-reinforcing panics of early 20th‑century banking crises. In 1907, J.P. Morgan famously locked bankers in his library to coordinate a rescue; today, central banks must assume this coordinating role (Friedman & Schwartz, 1963).

Breaking the Spiral

Even the most resilient banks can fail if collective action is absent. In a severe downturn:

• No single bank wants to expand credit first.

• All banks shrink credit, deepening the recession.

• Government bailouts often arrive after initial failures.

Central banks, as the modern “lenders of collective action,” must enforce countercyclical credit expansion. This could involve:

• Temporarily reducing capital requirements,

• Imposing a minimum credit growth rate, or

• Injecting contingent capital into banks to facilitate lending.

By breaking the credit‑delinquency spiral, central banks can prevent a recession from cascading into a systemic banking crisis.

Conclusion

“Playing to Be the Last Bankrupt” perfectly describes banks’ survivalist strategy in recessions. Left to their own devices, banks ration credit, triggering spending collapses and self‑fulfilling defaults.

When conventional and unconventional monetary policies are exhausted, macroprudential stimulus offers a viable escape. By coordinating collective bank lending, central banks can sustain spending, stabilize incomes, and halt the spiral of delinquencies—ensuring that no bank needs to win the race to be the last one standing.

References

• Acharya, V. V., & Steffen, S. (2020). The risk of being a fallen angel and the corporate dash for cash in the midst of COVID. CEPR Discussion Paper No. DP14795.

• Borio, C. (2014). The financial cycle and macroeconomics: What have we learnt? Journal of Banking & Finance, 45, 182–198.

• Federal Reserve Bank of St. Louis. (2020). 10-Year Treasury Constant Maturity Rate [DGS10]. https://fred.stlouisfed.org

• Friedman, M., & Schwartz, A. J. (1963). A Monetary History of the United States, 1867–1960. Princeton University Press.

• Gagnon, J., Raskin, M., Remache, J., & Sack, B. (2020). Large-scale asset purchases by the Federal Reserve: Did they work? Federal Reserve Bank of New York Staff Report.

• International Monetary Fund (IMF). (2014). Staff Guidance Note on Macroprudential Policy: Detailed Guidance on Instruments. https://www.imf.org