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Capital Regulation and Risk Sharing: Commentary

Douglas Gale ()

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: Minimum capital requirements are one of the three "pillars" of macro-prudential regulation. As a result of the financial crisis of 2008-09, there have been proposals to increase the amount of capital banks are required to hold. A capital structure that contains a substantial amount of equity has a number of advantages. It reduces the bank's vulnerability to market freezes; it reduces the risk of contagion to other financial institutions; it reduces the subsidy provided by deposit insurance; and, as we have recently seen, shareholders are less likely to be bailed out by government than debt holders. But while it may be optimal to have a substantial amount of equity in the capital structure, the crucial question is "How much?" Will banks choose the right capital structure, left to themselves, or does the government have to force them to raise more capital?

Date: 2010-07
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