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Optimal Regulation of Bank Capital and Liquidity: How to Calibrate New International Standards

Author

Listed:
  • Ray Barrell

    (National Institute of Economic and Social Research)

  • E Philip Davis

    (National Institute of Economic and Social Research and Brunel University)

  • Tatiana Fic

    (National Institute of Economic and Social Research)

  • Dawn Holland

    (National Institute of Economic and Social Research)

  • Simon Kirby

    (National Institute of Economic and Social Research)

  • Iana Liadze

    (National Institute of Economic and Social Research)

Abstract

Raising capital adequacy standards and introducing binding liquidity requirements can have beneficial effects if they reduce the probability of a costly financial crisis, but may also reduce GDP by raising borrowing costs for households and companies. In this paper, we estimate both benefits and costs of raising capital and liquidity, with the benefits being in terms of reduction in the probability of banking crises, while the costs are defined in terms of the economic impact of higher spreads for bank customers. We note that both of these results are contrary to the Modigliani-Miller theorem of irrelevance of the debt-equity choice. The result shows a positive net benefit from regulatory tightening, for a range of 2-6 percentage points increase in capital and liquidity ratios, depending on underlying assumptions.

Suggested Citation

  • Ray Barrell & E Philip Davis & Tatiana Fic & Dawn Holland & Simon Kirby & Iana Liadze, 2009. "Optimal Regulation of Bank Capital and Liquidity: How to Calibrate New International Standards," Occasional Papers 38, Financial Services Authority.
    • Handle: RePEc:fsa:occpap:38
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    File URL: http://www.fsa.gov.uk/pubs/occpapers/op38.pdf
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    Cited by:

    1. Beau Soederhuizen & Bert van Stiphout-Kramer & Harro van Heuvelen & Rob Luginbuhl, 2021. "Optimal capital ratios for banks in the euro area," CPB Discussion Paper 429, CPB Netherlands Bureau for Economic Policy Analysis.

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    Keywords

    bank; capital; financial regulation; prudential policy; credit; lending;
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