Optimal Capital Regulation

Josef Schroth and Stéphane Moyen

No 828, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: 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.

Date: 2017
New Economics Papers: this item is included in nep-rmg
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Working Paper: Optimal Capital Regulation (2017)
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