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Why Do We Need Countercyclical Capital Requirements?

Author

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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:

    1. Joseph G. Haubrich, 2020. "How Cyclical Is Bank Capital?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 58(1), pages 27-38, August.
    2. Koch, Timothy W. & Waggoner, Daniel F. & Wall, Larry D., 2018. "Incentive compensation, accounting discretion and bank capital," Journal of Economics and Business, Elsevier, vol. 95(C), pages 119-140.
    3. repec:zbw:bofrdp:2017_004 is not listed on IDEAS
    4. Silvo, Aino, 2017. "House prices, lending standards, and the macroeconomy," Research Discussion Papers 4/2017, Bank of Finland.
    5. Stefanie Behncke, 2023. "Effects of Macroprudential Policies on Bank Lending and Credit Risks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 63(2), pages 175-199, April.
    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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