Capital requirements for government bonds: Implications for bank behaviour and financial stability

Ulrike Neyer and André Sterzel

No 275, DICE Discussion Papers from Heinrich Heine University Düsseldorf, Düsseldorf Institute for Competition Economics (DICE)

Abstract: This paper analyses whether the introduction of capital requirements for bank government bond holdings increases financial stability by making the banking sector more resilient to sovereign debt crises. Using a theoretical model, we show that a sudden increase in sovereign default risk may lead to liquidity issues in the banking sector. Our model reveals that in combination with a central bank acting as a lender of last resort, capital requirements for government bonds increase the shock-absorbing capacity of the banking sector and thus the financial stability. The driving force is a regulation-induced change in bank investment behaviour.

Keywords: bank capital regulation; government bonds; sovereign risk; financial contagion; lender of last resort. (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn and nep-rmg
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:dicedp:275

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