Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model

Juliane Begenau
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Juliane Begenau: Harvard Business School

No 687, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: This paper presents a quantitative dynamic general equilibrium model in which households' liquidity preference change the standard intuition of how higher bank capital requirements affect the economy. The mechanism is that a reduction in the supply of safe and liquid assets in the form of bank debt increases bank lending through a general equilibrium effect. I embed this mechanism in a two-sector business cycle model in which banks provide liquidity and have excessive risk-taking incentives. I quantify this model using data from the National Income and Product Accounts and banks' regulatory filings. Welfare is maximized at 14% equity as a share of risk-weighted assets. This level of capital requirement trades-off a reduction in the provision of safe and liquid assets against an increase in lending and a reduction in risk-taking by banks.

Date: 2015
New Economics Papers: this item is included in nep-ban and nep-dge
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:687

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