The bridge between macro and micro banking regulation

Claudio de Moraes () and Helder de Mendonça ()

Journal of Economic Studies, 2017, vol. 44, issue 2, 214-225

Abstract: Purpose - The purpose of this paper is to discuss more efficient mechanisms of regulation in the financial system. Design/methodology/approach - The authors developed a theoretical two-period model of financial flows (FFs) that considers households, banks, and a social planner. Findings - It is important to highlight that different from other studies that do not distinguish between financial crisis and financial instability, the authors assume financial instability does not mean crisis, but represents a deviation in the behavior of the aggregate financial intermediation and in the financial operations of each bank from the equilibrium. Practical implications - The practical implication of the model is the proposition of an efficient policy for financial stability based on forward-looking financial regulations. Social implications - An important result is that bank failures occur when banks do not maintain sufficient resources to support the liquidity constraint from the interbank market. Another result is that the central bank reacts, via exchange of reserves with the market, to financial instability. This behavior on the part of the central bank is inefficient because the banks will assume that in the case of failure they will be “saved;” thus it creates an adverse incentive (moral hazard) that can amplify the risk over the entire financial system. Originality/value - The originality of the model is the proposition of an efficient policy for financial stability based on a forward-looking financial regulation. In this strategy the regulator acts in advance (ex ante) to minimize the mismatch of FFs in relation to the flow balance. This manner of acting is a counterpoint to the financial regulation based on capital requirement.

Keywords: Financial stability; Central bank; Macroprudential policy; E58; G38 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:jespps:jes-09-2015-0159

DOI: 10.1108/JES-09-2015-0159

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