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Should bank capital requirements be less risk-sensitive because of credit constraints?

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  • Ambrocio, Gene
  • Jokivuolle, Esa

Abstract

We consider optimal capital requirements for banks' lending activities when the potential trade-off between financial stability and economic (productivity) growth is taken into account. Both sides of the trade-off are affected by banks' credit allocation, which in turn is affected by the risk weights used to set capital requirements on bank loans. We find that when firms are credit constrained, the optimal risk weights are flatter than those that are only set to safeguard against bank failures and their social costs. This provides an additional rationale for capital requirements to be less 'risk-sensitive'. Differences in company productivity have a further effect on the profile of optimal risk weights, and may amplify the 'flattening' effect.

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  • Ambrocio, Gene & Jokivuolle, Esa, 2017. "Should bank capital requirements be less risk-sensitive because of credit constraints?," Bank of Finland Research Discussion Papers 10/2017, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2017_010
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    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
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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