Capital Regulation and Credit Fluctuations

Jean Rochet and Hans Gersbach

No 9077, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We provide a rationale for imposing counter-cyclical capital ratios on banks. In our simple model, bankers cannot pledge the entire future revenues to investors, which limits borrowing in good and bad times. Complete markets do not sufficiently stabilize credit fluctuations, as banks allocate too much borrowing capacity to good states and too little to bad states. As a consequence, bank credit, output, capital prices or wages are excessively volatile. Imposing a (stricter) capital ratio in good states corrects the misallocation of the borrowing capacity, increases expected output and can be beneficial to all agents in the economy. Although in our economy, all agents are risk-neutral, counter-cyclical capital ratios are an effective stabilization tool. To ensure this effectiveness, capital ratios have to be based on ex ante equity capital, as classical capital ratios can be bypassed.

Keywords: Complete markets; Credit fluctuations; Macroprudential regulation; Misallocation of borrowing capacity (search for similar items in EconPapers)
JEL-codes: D86 G21 G28 (search for similar items in EconPapers)
Date: 2012-08
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (12)

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