A New Capital Regulation For Large Financial Institutions

Luigi Zingales and Oliver Hart

No 2009.124, Working Papers from Fondazione Eni Enrico Mattei

Abstract: We design a new, implementable capital requirement for large financial institutions (LFIs) that are too big to fail. Our mechanism mimics the operation of margin accounts. To ensure that LFIs do not default on either their deposits or their derivative contracts, we require that they maintain an equity cushion sufficiently great that their own credit default swap price stays below a threshold level, and a cushion of long term bonds sufficiently large that, even if the equity is wiped out, the systemically relevant obligations are safe. If the CDS price goes above the threshold, the LFI regulator forces the LFI to issue equity until the CDS price moves back down. If this does not happen within a predetermined period of time, the regulator intervenes. We show that this mechanism ensures that LFIs are always solvent, while preserving some of the disciplinary effects of debt.

Keywords: Banks; Capital Requirement; Too Big to Fail (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2009-12
New Economics Papers: this item is included in nep-ban, nep-bec, nep-reg and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37)

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Related works:
Journal Article: A New Capital Regulation for Large Financial Institutions (2011)
Working Paper: A New Capital Regulation For Large Financial Institutions (2009)
Working Paper: A New Capital Regulation For Large Financial Institutions (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:fem:femwpa:2009.124

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