Cyclical adjustment of capital requirements: A simple framework

Rafael Repullo

Journal of Financial Intermediation, 2013, vol. 22, issue 4, 608-626

Abstract: We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.

Keywords: Banking regulation; Basel II; Capital requirements; Procyclicality (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (56)

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Related works:
Working Paper: Cyclical adjustment of capital requirements: a simple framework (2013)
Working Paper: Cyclical Adjustment of Capital Requirements. A Simple Framework (2012)
Working Paper: Cyclical Adjustment of Capital Requirements: A Simple Framework (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:22:y:2013:i:4:p:608-626

DOI: 10.1016/j.jfi.2013.09.001

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