Bank capital in the short and in the long run

How far should capital requirements be raised to ensure a resilient banking system without imposing undue costs on the real economy? Capital requirement increases make banks safer and are beneficial in the long run but entail transition costs because they reduce credit supply and aggregate demand on impact. In the baseline scenario of a quantitative macro-banking model, 25% of the long-run welfare gains are lost due to transitional costs. The strength of monetary policy accommodation and bank riskiness are key determinants of the trade-off between the short-run costs and long-run benefits from capital requirement changes.