Optimal Capital Regulation
Josef Schroth and
Stéphane Moyen ()
No 828, 2017 Meeting Papers from Society for Economic Dynamics
We study constrained-efficient bank capital regulation in a model with market-imposed equity requirements. Banks hold equity buffers to insure against sudden loss of funding access. However, bank equity is privately costly in the model such that banks choose only partial self-insurance. Equity requirements are occasionally binding as a result. Constrained-efficient regulation requires banks to build up additional equity buffers and compensates them for the cost of equity with a permanent increase in lending margins. When buffers are depleted regulation relaxes market-imposed equity requirements by raising bank future prospects via temporarily elevated lending margins.
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