Lending Standards and Countercyclical Capital Requirements under Imperfect Information

Pedro Gete and Natalie Tiernan

MPRA Paper from University Library of Munich, Germany

Abstract: We propose a quantitative model of lending standards with two reasons for inefficient credit: lenders' moral hazard from deposit insurance or government guarantees, and imperfect information about the persistence of asset price growth, which generates incorrect but rational beliefs in the lenders. We calibrate the model to match recent credit boom-bust episodes. Then we study which patterns of real estate price growth and banks' beliefs could serve as early warning indicators of a crisis. Finally, we propose a Value-at-Risk (VaR) rule to implement the capital requirements. The VaR framework ensures that the probability of banks not having enough equity to cover their losses is maintained at a certain level. Capital requirements should be state-contingent and lean against lenders' beliefs by tightening after periods of asset price growth. However, the relationship between asset price growth and financial risk is not monotone and this should be integrated in the setting of the capital requirements and early warning indicators.

Keywords: Lending Standards; Capital Requirements; Leverage Rules; VaR; Basel III (search for similar items in EconPapers)
JEL-codes: E44 G2 G21 G28 (search for similar items in EconPapers)
Date: 2014-03
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cta, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:54486

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