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Why Do We Need Countercyclical Capital Requirements?

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  • Esa Jokivuolle
  • Ilkka Kiema
  • Timo Vesala

Abstract

We show that risk-based capital requirements can eliminate the market failure, caused by asymmetric information between entrepreneurs and banks, which distorts the efficient allocation of low-risk and high-risk investment projects among entrepreneurs. If project success probabilities decline in recessions, optimal capital requirements will have to be lower because the size of the market failure changes. This provides a new rationale for keeping risk-based capital requirements higher in good times and lowering them in bad times. Copyright Springer Science+Business Media New York 2014

Suggested Citation

  • Esa Jokivuolle & Ilkka Kiema & Timo Vesala, 2014. "Why Do We Need Countercyclical Capital Requirements?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 46(1), pages 55-76, August.
    • Handle: RePEc:kap:jfsres:v:46:y:2014:i:1:p:55-76
    DOI: 10.1007/s10693-013-0169-z
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    Cited by:

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    4. Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Research Discussion Papers 4/2017, Bank of Finland.
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    6. Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Bank of Finland Research Discussion Papers 4/2017, Bank of Finland.

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    More about this item

    Keywords

    Bank regulation; Basel III; Capital requirements; Credit risk; Crises; Procyclicality; D41; D82; G14; G21; G28;
    All these keywords.

    JEL classification:

    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • 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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