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Bank Liquidity and Capital Regulation in General Equilibrium

John Driscoll () and Francisco Covas ()

No 2014-85, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We develop a nonlinear dynamic general equilibrium model with a banking sector and use it to study the macroeconomic impact of introducing a minimum liquidity standard for banks on top of existing capital adequacy requirements. The model generates a distribution of bank sizes arising from differences in banks' ability to generate revenue from loans and from occasionally binding capital and liquidity constraints. Under our baseline calibration, imposing a liquidity requirement would lead to a steady-state decrease of about 3 percent in the amount of loans made, an increase in banks' holdings of securities of at least 6 percent, a fall in the interest rate on securities of a few basis points, and a decline in output of about 0.3 percent. Our results are sensitive to the supply of safe assets: the larger the supply of such securities, the smaller the macroeconomic impact of introducing a minimum liquidity standard for banks, all else being equal. Finally, we show that relaxing the liquidity requirement under a situation of financial stress dampens the response of output to aggregate shocks.

Keywords: macroprudential policy; idiosyncratic risk; incomplete markets; liquidity requirements; capital requirements; Bank regulation (search for similar items in EconPapers)
JEL-codes: G21 G28 E13 D52 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2014-09-12, Revised 2014-09-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
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