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Capital requirements, risk choice, and liquidity provision in a business-cycle model

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  • Begenau, Juliane

Abstract

This paper develops a dynamic general equilibrium model to quantify the effects of bank capital requirements. Households’ preferences for liquid assets imply a liquidity premium on deposits. The banking sector supplies deposits and has excessive risk-taking incentives. I show that the scarcity of deposits created by an increased capital requirement can reduce the cost of capital for banks and increase bank lending. A higher capital requirement also increases banks’ monitoring incentives, which improves the efficiency of banks’ activities. Under reasonable parameterizations, the marginal benefit of a higher capital requirement related to this channel significantly exceeds the marginal cost, indicating that US capital requirements have been suboptimally low.

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  • Begenau, Juliane, 2020. "Capital requirements, risk choice, and liquidity provision in a business-cycle model," Journal of Financial Economics, Elsevier, vol. 136(2), pages 355-378.
    • Handle: RePEc:eee:jfinec:v:136:y:2020:i:2:p:355-378
    DOI: 10.1016/j.jfineco.2019.10.004
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    More about this item

    Keywords

    Capital requirement; Bank regulation; Bank loan supply; Safe asset demand;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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