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Macroprudential capital requirements with non-bank finance

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  • Dempsey, Kyle P.

Abstract

I analyze the impact of raising capital requirements on the quantity, composition, and riskiness of aggregate investment in a model in which firms borrow from both bank and non-bank lenders. The bank funds loans with insured deposits and costly equity, monitors borrowers, and must maintain a minimum capital to asset ratio. Non-banks have deep pockets and competitively price loans. A tight capital requirement on the bank reduces risk-shifting and decreases bank leverage, reducing the risk of costly bank failure. In response, though, the bank can change both price and non-price contract terms. This may induce firms to substitute out of bank finance, leading to a theoretically ambiguous effect on the profile of aggregate investment. Quantitatively, I find that the bank's incentive to insure itself against issuing costly equity and competition from the non-bank sector mutes the long run impact of raising capital requirements. Increasing the capital requirement from 8% to 26% eliminates bank failures with effectively no change in the quantity or riskiness of aggregate investment. JEL Classification: G2, E5, E6, E32, E44

Suggested Citation

  • Dempsey, Kyle P., 2020. "Macroprudential capital requirements with non-bank finance," Working Paper Series 2415, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20202415
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    Cited by:

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    2. Xiang, Haotian, 2022. "Corporate debt choice and bank capital regulation," Journal of Economic Dynamics and Control, Elsevier, vol. 144(C).
    3. Wei, Jianxing & Xu, Tong, 2024. "Banking supervision with loopholes," European Economic Review, Elsevier, vol. 161(C).
    4. C. Bora Durdu & Molin Zhong, 2023. "Understanding Bank and Nonbank Credit Cycles: A Structural Exploration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(1), pages 103-142, February.
    5. Eduardo Dávila & Ansgar Walther, 2021. "Corrective Regulation with Imperfect Instruments," NBER Working Papers 29160, National Bureau of Economic Research, Inc.
    6. Michael S. Barr, 2022. "Why Bank Capital Matters: At the American Enterprise Institute, Washington, D.C. (virtual) December 1st 2022," Speech 95822, Board of Governors of the Federal Reserve System (U.S.).

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    More about this item

    Keywords

    banking; business cycles; capital requirements;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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