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Capital Buffers in a Quantitative Model of Banking Industry Dynamics

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  • Dean Corbae
  • Pablo D'Erasmo

Abstract

We develop a model of banking industry dynamics to study the quantitative impact of regulatory policies on bank risk taking and market structure as well as the feedback effect of market structure on the efficacy of policy. Since our model is matched to U.S. data, we propose a market structure where big banks with market power interact with small, competitive fringe banks. Banks face idiosyncratic funding shocks in addition to aggregate shocks which affect the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks’ buffer stock of net worth. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on financial stability. We then conduct a series of policy counterfactuals motivated by those proposed in the Dodd-Frank Act (size and state dependent capital requirements and liquidity requirements). We find that regulatory policies can have an important impact on banking market structure, which, along with selection effects, can generate changes in allocative efficiency and stability.

Suggested Citation

  • Dean Corbae & Pablo D'Erasmo, 2021. "Capital Buffers in a Quantitative Model of Banking Industry Dynamics," Working Papers 21-24, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:92688
    DOI: 10.21799/frbp.wp.2021.24
    Note: Supersedes Working Paper 14-13 – Capital Requirements in a Quantitative Model of Banking Industry Dynamics
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    Cited by:

    1. Skander Van den Heuvel, 2019. "The Welfare Effects of Bank Liquidity and Capital Requirements," 2019 Meeting Papers 325, Society for Economic Dynamics.
    2. Sears, Louis S. & Lawell, C.Y. Cynthia Lin & Torres, Gerald & Walter, M. Todd, 2022. "Moment-based Markov Equilibrium Estimation of High-Dimension Dynamic Games: An Application to Groundwater Management in California," 2022 Annual Meeting, July 31-August 2, Anaheim, California 322187, Agricultural and Applied Economics Association.

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    More about this item

    Keywords

    macroprudential policy; bank size distributions; industry dynamics with imperfect competition.;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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