Why Do We Need Countercyclical Capital Requirements?

Esa Jokivuolle (), Ilkka Kiema () and Timo Vesala ()

Journal of Financial Services Research, 2014, vol. 46, issue 1, 55-76

Abstract: We show that risk-based capital requirements can eliminate the market failure, caused by asymmetric information between entrepreneurs and banks, which distorts the efficient allocation of low-risk and high-risk investment projects among entrepreneurs. If project success probabilities decline in recessions, optimal capital requirements will have to be lower because the size of the market failure changes. This provides a new rationale for keeping risk-based capital requirements higher in good times and lowering them in bad times. Copyright Springer Science+Business Media New York 2014

Keywords: Bank regulation; Basel III; Capital requirements; Credit risk; Crises; Procyclicality; D41; D82; G14; G21; G28 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (7)

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DOI: 10.1007/s10693-013-0169-z

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