Cyclical Adjustment of Capital Requirements. A Simple Framework

Rafael Repullo

Working Papers from CEMFI

Abstract: We present a simple 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)
JEL-codes: E44 G21 G28 (search for similar items in EconPapers)
Date: 2012-05
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cta and nep-rmg
References: View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Cyclical adjustment of capital requirements: A simple framework (2013)
Working Paper: Cyclical adjustment of capital requirements: a simple framework (2013)
Working Paper: Cyclical Adjustment of Capital Requirements: A Simple Framework (2012)
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