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The Effects of Capital Requirements on Good and Bad Risk Taking

Nathaniel Pancost and Roberto Robatto
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Nathaniel Pancost: University of Texas at Austin McCombs Sc

No 638, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We study optimal capital requirement regulation in a dynamic quantitative model in which deposits facilitate real economic activity and thus the value of deposits is microfounded. We identify a novel general equilibrium effect that drives a wedge between the private value of deposits (i.e., the value to price-taking agents, measured by the deposit premium) and the social value of deposits (i.e., the value that matters for regulation). The wedge reduces the social value of deposits, and as a result, the optimal capital requirement is substantially higher than in comparable models in the literature. Nonetheless, even when the marginal social value of deposits is very low, setting capital requirements too high is suboptimal.

Date: 2019
New Economics Papers: this item is included in nep-ban, nep-cba and nep-dge
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