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Capital Requirements in a Quantitative Model of Banking Industry Dynamics

Pablo D'Erasmo

No 476, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on bank risk taking, commercial bank failure, and market structure. We propose a market structure where big, dominant banks interact with small, competitive fringe banks. The paper extends our previous work by letting banks accumulate securities like treasury bills and to undertake short-term borrowing when there are cash flow shortfalls. A nontrivial size distribution of banks arises out of endogenous entry and exit, as well as banks' buffer stocks of securities. We find that a 50% rise in capital requirements leads to a 45% reduction in exit rates of small banks and a more concentrated industry. Aggregate loan supply falls by 8.71% and interest rates rise by 50 basis points. The lower exit rate causes the tax/output rate necessary to fund deposit insurance to drop in half. Higher interest rates, on the other hand, result in a higher default frequency as well as a lower level of intermediated output. We also use the model to study the effect of lowering the rate different sized banks are charged when borrowing on their lending behavior studied by Kashyap and Stein (2001).

Date: 2014
New Economics Papers: this item is included in nep-ban, nep-cba and nep-dge
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Related works:
Working Paper: Capital Requirements in a Quantitative Model of Banking Industry Dynamics (2019) Downloads
Working Paper: Capital Requirements in a Quantitative Model of Banking Industry Dynamics (2018) Downloads
Working Paper: Capital requirements in a quantitative model of banking industry dynamics (2014) Downloads
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