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Cyclical adjustment of capital requirements: a simple framework

Repullo, Rafael (2013) Cyclical adjustment of capital requirements: a simple framework. SRC Discussion Paper (No 3). Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Abstract

We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.systemicrisk.ac.uk/
Additional Information: © 2013 Systemic Risk Centre, The London School of Economics and Political Science
Divisions: Systemic Risk Centre
Subjects: H Social Sciences > HG Finance
JEL classification: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation
Sets: Research centres and groups > Systemic Risk Centre
Date Deposited: 18 Feb 2015 10:10
Last Modified: 20 Apr 2019 00:15
Projects: ES/K002309/1
Funders: Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/60969

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