Risk Weighted Capital Regulation and Government Debt

Eva Schliephake ()

No 130011, FEMM Working Papers from Otto-von-Guericke University Magdeburg, Faculty of Economics and Management

Abstract: Microprudential capital requirements are designed to reduce the excessive risk taking of banks. If banks are required to use more equity funding for risky assets they invest more funds into safe assets. This paper analyzes a government that simultaneously regulates the banking sector and borrows from it. I argue that a government may have the incentive to use capital requirements to alleviate its budget burden. The risk weights for risky assets may be placed relatively too high compared to the risk weight on government bonds. This could have a negative impact on welfare. The supply of loans for the risky sector shrinks, which may have a negative impact on long term growth. Moreover, the government may be tempted to increase its debt level due to better funding conditions, which increases the risk of a future sovereign debt crisis. A short term focused government may be tempted to neglect the risk and, thereby, may introduce systemic risk in the banking sector.

Keywords: Capital Requirement Regulation; Government Debt (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2013-06
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:mag:wpaper:130011

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