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Dynamic Bank Capital Regulation in Equilibrium

Douglas Gale (), Andrea Gamba and Marcella Lucchetta
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Marcella Lucchetta: Universita Ca' Foscari

No 680, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We study optimal bank regulation in an economy with aggregate uncertainty. Bank liabilities are used as “money” and hence earn lower returns than equity. In laissez faire equilibrium, banks maximize market value, trading off the funding advantage of debt against the risk of costly default. The capital structure is not socially optimal because external costs of distress are not internalized by the banks. The constrained efficient allocation is characterized as the solution to a planner’s problem. Efficient regulation is procyclical, but countercyclical relative to laissez faire. We show that simple leverage constraints can get the decentralized economy close to the constrained efficient outcome.

New Economics Papers: this item is included in nep-ban and nep-dge
Date: 2018
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