A New Capital Regulation For Large Financial Institutions
AbstractWe design a new, implementable capital requirement for large financial institutions (LFIs) that are too big to fail. Our mechanism mimics the operation of margin accounts. To ensure that LFIs do not default on either their deposits or their derivative contracts, we require that they maintain a capital cushion sufficiently great that their own credit default swap price stays below a threshold level. If this level is violated the LFI regulator forces the LFI to issue equity until the CDS price moves back below the threshold. If this does not happen within a predetermined period of time, the regulator intervenes. We show that this mechanism ensures that LFIs are solvent with probability one, while preserving the disciplinary effects of debt.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7298.
Date of creation: Jun 2009
Date of revision:
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Other versions of this item:
- Luigi Zingales, 2011. "A New Capital Regulation for Large Financial Institutions," American Law and Economics Review, Oxford University Press, vol. 13(2), pages 453-490.
- Luigi Zingales & Oliver Hart, 2009. "A New Capital Regulation For Large Financial Institutions," Working Papers 2009.124, Fondazione Eni Enrico Mattei.
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-06-17 (All new papers)
- NEP-BAN-2009-06-17 (Banking)
- NEP-BEC-2009-06-17 (Business Economics)
- NEP-REG-2009-06-17 (Regulation)
- NEP-RMG-2009-06-17 (Risk Management)
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