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Capital Regulation with Two Banking Sectors: Cyclicality and Implementation

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  • TAEJIN KIM
  • VISHAL MANGLA

Abstract

We present a capital regulation policy in a model in which banks can choose to be unregulated, by operating in the shadow banking sector, when the cost of being regulated (restriction on portfolio risk) exceeds the benefit (cheaper funding/insurance). We show that the welfare maximizing capital requirement policy can be procyclical: lower requirement during booms and higher requirement during recessions. Our policy specifies the level of capital requirement as a function of the observed relative size of the unregulated and regulated banking sectors. This specification achieves the optimal aggregate risk exposure by obtaining the right mix of the two sectors.

Suggested Citation

  • Taejin Kim & Vishal Mangla, 2019. "Capital Regulation with Two Banking Sectors: Cyclicality and Implementation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(2-3), pages 485-537, March.
    • Handle: RePEc:wly:jmoncb:v:51:y:2019:i:2-3:p:485-537
    DOI: 10.1111/jmcb.12596
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    References listed on IDEAS

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