A theoretical foundation for prudential authorities decision making

Cristina Badarau and Corentin Roussel

International Economics, 2022, issue 172, 421-462

Abstract: In the aftermath of the Global Financial Crisis, financial regulation uses micro and macroprudential rules, most of the time motivated by empirical studies. This article suggests a theoretical explanation for countercyclical and progressive capital requirements that incorporate micro- and macro-prudential stabilization objectives. The Capital Adequacy Ratio (CAR) imposed to individual banks by a Prudential Authority (PA) would thus represent an optimal regulation whose aim is to avoid individual and systemic risk accumulation by imposing minimal constraints to financial institutions. This corresponds to the implementation of optimal time-varying prudential capital requirements to banks, with non-linear structure, that allows PA to take progressive countercyclical actions in order to ensure financial stability. We also test the mechanism in a DSGE model and show that it would be more suitable for the financial and real stability compared to the existing fixed prudential ratios.

Keywords: Prudential regulation model; Optimal CAR; Time-varying capital requirements; DSGE model (search for similar items in EconPapers)
JEL-codes: E44 G21 G28 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:cii:cepiie:2022-q3-172-33

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