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Aggregate Bank Capital and Credit Dynamics

Nataliya Klimenko, Sebastian Pfeil (), Jean Rochet () and Gianni De Nicolo
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Nataliya Klimenko: University of Zurich
Gianni De Nicolo: International Monetary Fund and CESifo

No 16-42, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We develop a novel dynamic model of banking showing that aggregate bank capital is an important determinant of bank lending. In our model commercial banks finance their loans with deposits and equity, while facing equity issuance costs. Because of this financial friction, banks build equity buffers to absorb negative shocks. Aggregate bank capital determines the dynamics of lending. Notably, the equilibrium loan rate is a decreasing function of aggregate capitalization. The competitive equilibrium is constrained inefficient, because banks do not internalize the consequences of individual lending decisions for the future loss-absorbing capacity of the banking sector. In particular, we find that unregulated banks lend too much. Imposing a minimum capital ratio helps tame excessive lending, which enhances stability of the banking system.

Keywords: macro-model with a banking sector; aggregate bank capital; pecuniary externality; capital requirements (search for similar items in EconPapers)
JEL-codes: E21 E32 F44 G21 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
Date: 2016-06
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