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Capital requirements in a model of bank runs: The 2008 run on repo

Luis Simon

Latin American Journal of Central Banking (previously Monetaria), 2021, vol. 2, issue 3

Abstract: Capital requirements involve a trade-off between financial intermediation and financial stability. I analyze this trade-off in a macroeconomic model that allows for systemic bank runs, à la Gertler and Kiyotaki (2015). I show that fixed capital requirements make the economy more prone to runs because they slow down the recovery and reduce welfare compared to the laissez-faire benchmark. On the other hand, appropriately chosen countercyclical capital requirements can increase financial stability and welfare. To weigh the costs and benefits of this policy, I estimate the probability of a systemic shock to the financial sector using a novel measure derived from CDS data and find it to be around 0.5% per year prior to the 2007-09 financial crisis. I then show that implementing a countercyclical capital requirement that would have prevented the run on repo markets in 2008 would have cost 3% of steady-state bank capital and less than 0.1% in consumption terms.

Keywords: Financial crises; Bank runs; Capital requirements (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.latcb.2021.100038

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Latin American Journal of Central Banking (previously Monetaria) is currently edited by Manuel Ramos-Francia

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