Cyclical adjustment of capital requirements: a simple framework

Rafael Repullo

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We present a 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)
Pages: 32 pages
Date: 2013-09-27
New Economics Papers: this item is included in nep-ban, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (54)

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http://eprints.lse.ac.uk/60969/ Open access version. (application/pdf)

Related works:
Journal Article: Cyclical adjustment of capital requirements: A simple framework (2013)
Working Paper: Cyclical Adjustment of Capital Requirements. A Simple Framework (2012)
Working Paper: Cyclical Adjustment of Capital Requirements: A Simple Framework (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:60969

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