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The effects of capital requirements on good and bad risk-taking

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  • Pancost, N. Aaron
  • Robatto, Roberto

Abstract

We study optimal capital requirement regulation in a dynamic quantitative model in which nonfinancial firms, as well as households, hold deposits. Firms hold deposits for precautionary reasons and to facilitate the acquisition of production inputs. Our theoretical analysis identifies a novel general equilibrium channel that operates through firms’ deposits and mitigates the cost of increasing capital requirements. We calibrate our model and find that the optimal capital requirement is 18.7% but only 13.6% in a comparable model in which only households hold deposits. Our novel channel accounts for most of the difference. JEL Classification: E21, G21, G32

Suggested Citation

  • Pancost, N. Aaron & Robatto, Roberto, 2019. "The effects of capital requirements on good and bad risk-taking," ESRB Working Paper Series 104, European Systemic Risk Board.
    • Handle: RePEc:srk:srkwps:2019104
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    Cited by:

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    2. Ahmad Peivandi & Mohammad Abbas Rezaei & Ajay Subramanian, 2023. "Optimal design of bank regulation under aggregate risk," Mathematics and Financial Economics, Springer, volume 17, number 2, December.

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    More about this item

    Keywords

    capital requirements; deposit insurance; idiosyncratic risk; safe assets;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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