Taming Housing and Financial Market Instability: The Effect of Heterogeneous Banking Regulations

As a response to the latest financial crisis, the Basel Committee published the Basel III accords which intensify micro- and introduce macro-prudential instruments to enhance the resilience of the financial market. One crucial aspect that the regulatory reforms do not address is the diversity of the banking sector. We introduce a heterogeneous agent-based model that develops a housing and a capital market to assess the ability of Basel III rules to mitigate mutual feedback effects and dampen instability. Computational experiments reveal that the most stable markets are achieved if the financial market is diversified and consists of different types of financial intermediaries that need to comply with type-specific capital adequacy requirements. The results point out that capital adequacy requirements are, in principle, effective in stabilizing the banking sector. However, the stability of housing and share prices and the solidity of the banking sector can be increased if capital adequacy requirements are aligned to the individual business models of financial intermediaries and their institutional frameworks. These findings advocate in favor of a diversified banking sector and heterogeneous capital adequacy requirements.