Do Bank Capital Requirements Make Resource Allocation Suboptimal?

Sangkyun Park
Additional contact information
Sangkyun Park: The U.S. Office of Management and Budget, USA

Journal of Economic Analysis, 2022, vol. 1, issue 2, 35-49

Abstract: Bank capital requirements would entail large social costs if they made resource allocation suboptimal and banking services costly by unduly limiting the banks’ ability to lend. This paper considers three main factors that may make capital requirements relevant, namely, deposit insurance subsidies, stock valuation errors, and tax shields derived from debt financing. The theoretical model analyzes the combined effects of the three factors on the banks’ incentives to make fairly priced loans, which should also be socially optimal loans. A key finding is that the long-term cost of capital requirements is likely to be very small when deposit insurance is underpriced. Increased funding costs resulting from higher capital requirements are absorbed by shareholders of banks, rather than passed on to borrowers. Under some reasonable assumptions, higher capital requirements improve resource allocation by countervailing distortionary effects of deposit insurance subsidies. Short-term adjustment costs can still be large, but it should be relatively easy to mitigate the short-term effects.

Keywords: Costs of Capital Requirements; Deposit Insurance; Stock mispricing; Tax shields (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.anserpress.org/journal/jea/1/2/11/pdf (application/pdf)
https://www.anserpress.org/journal/jea/1/2/11 (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bba:j00001:v:1:y:2022:i:2:p:35-49:d:23

Access Statistics for this article

Journal of Economic Analysis is currently edited by Ramona Wang

More articles in Journal of Economic Analysis from Anser Press
Bibliographic data for series maintained by Ramona Wang ().