Capital Buffers in a Quantitative Model of Banking Industry Dynamics

P. Dean Corbae and Pablo D'Erasmo

No 21-24, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: We develop a model of banking industry dynamics to study the quantitative impact of regulatory policies on bank risk taking and market structure as well as the feedback effect of market structure on the efficacy of policy. Since our model is matched to U.S. data, we propose a market structure where big banks with market power interact with small, competitive fringe banks. Banks face idiosyncratic funding shocks in addition to aggregate shocks which affect the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks’ buffer stock of net worth. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on financial stability. We then conduct a series of policy counterfactuals motivated by those proposed in the Dodd-Frank Act (size and state dependent capital requirements and liquidity requirements). We find that regulatory policies can have an important impact on banking market structure, which, along with selection effects, can generate changes in allocative efficiency and stability.

Keywords: macroprudential policy; bank size distributions; industry dynamics with imperfect competition. (search for similar items in EconPapers)
JEL-codes: E44 G21 L11 (search for similar items in EconPapers)
Pages: 74
Date: 2021-06-11
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
Note: Supersedes Working Paper 14-13 – Capital Requirements in a Quantitative Model of Banking Industry Dynamics
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Citations: View citations in EconPapers (2)

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DOI: 10.21799/frbp.wp.2021.24

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