Risky Bank Lending and Optimal Capital Adequacy Regulation

Jaromir Benes and Michael Kumhof

No 2011/130, IMF Working Papers from International Monetary Fund

Abstract: We study the welfare properties of a New Keynesian monetary economy with an essential role for risky bank lending. Banks lend funds deposited by households to a financial accelerator sector, and face penalties for maintaining insufficient net worth. The loan contract specifies an unconditional lending rate, which implies that banks can make loan losses. Their main response is to raise lending rates to rebuild net worth. Prudential rules that adjust minimum capital adequacy requirements in response to loan losses significantly increase welfare. But the gains from eliminating limited liability and moral hazard would be an order of magnitude larger.

Keywords: WP; capital investment; interest rate; Bank lending; lending risk; financial accelerator; optimal monetary policy; optimal prudential policy; bank capital adequacy; welfare analysis; adequacy regulation; steady state bank equity; capital investment investment funds; loan loss; bank capital; loan gap; optimization problem; debt contract; bank net worth; capital goods; shock bank; recovery rate; Mutual funds; Capital adequacy requirements; Loans; Stocks; Central bank policy rate (search for similar items in EconPapers)
Pages: 27
Date: 2011-06-01
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Citations: View citations in EconPapers (49)

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