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Optimal Bank Capitalization in Crowded Markets

Christoph Bertsch () and Mike Mariathasan ()

No 312, Working Paper Series from Sveriges Riksbank (Central Bank of Sweden)

Abstract: We study banks’ optimal equity buffer in general equilibrium and their response to under-capitalization. Making progress towards a “pecking order theory” for private recapitalizations, our benchmark model identifies equity issuance as individually and socially optimal, compared to deleveraging, as well as conditions that invert the individually optimal ranking. Imperfectly elastic supply of capital, incomplete insurance markets and costly bankruptcies give rise to inefficiently high leverage ex-ante, and to excessive capital shortfalls and insolvencies ex-post. Abstracting from moral hazard and informational asymmetries, we therefore provide a novel rationale for macroprudential capital regulation and new testable implications about banks’ capital structure management.

Keywords: Bank capital; recapitalization; macroprudential regulation; incomplete markets; financial market segmentation; constrained inefficiency (search for similar items in EconPapers)
JEL-codes: D50 D60 G21 G28 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2015-09-01, Revised 2017-12-01
New Economics Papers: this item is included in nep-ban and nep-rmg
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