Capital requirements, risk choice, and liquidity provision in a business-cycle model

Juliane Begenau

Journal of Financial Economics, 2020, vol. 136, issue 2, 355-378

Abstract: This paper develops a dynamic general equilibrium model to quantify the effects of bank capital requirements. Households’ preferences for liquid assets imply a liquidity premium on deposits. The banking sector supplies deposits and has excessive risk-taking incentives. I show that the scarcity of deposits created by an increased capital requirement can reduce the cost of capital for banks and increase bank lending. A higher capital requirement also increases banks’ monitoring incentives, which improves the efficiency of banks’ activities. Under reasonable parameterizations, the marginal benefit of a higher capital requirement related to this channel significantly exceeds the marginal cost, indicating that US capital requirements have been suboptimally low.

Keywords: Capital requirement; Bank regulation; Bank loan supply; Safe asset demand (search for similar items in EconPapers)
JEL-codes: E44 G21 G28 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (83)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:136:y:2020:i:2:p:355-378

DOI: 10.1016/j.jfineco.2019.10.004

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