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Capital Regulation and Credit Fluctuations

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  • Gersbach, Hans
  • Rochet, Jean-Charles

Abstract

We provide a rationale for imposing counter-cyclical capital ratios on banks. In our simple model, bankers cannot pledge the entire future revenues to investors, which limits borrowing in good and bad times. Complete markets do not sufficiently stabilize credit fluctuations, as banks allocate too much borrowing capacity to good states and too little to bad states. As a consequence, bank credit, output, capital prices or wages are excessively volatile. Imposing a (stricter) capital ratio in good states corrects the misallocation of the borrowing capacity, increases expected output and can be beneficial to all agents in the economy. Although in our economy, all agents are risk-neutral, counter-cyclical capital ratios are an effective stabilization tool. To ensure this effectiveness, capital ratios have to be based on ex ante equity capital, as classical capital ratios can be bypassed.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9077.

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Date of creation: Aug 2012
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Handle: RePEc:cpr:ceprdp:9077

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Related research

Keywords: Complete Markets; Credit Fluctuations; Macroprudential Regulation; Misallocation of Borrowing Capacity;

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Cited by:
  1. Thierry Tressel & Thierry Verdier, 2014. "Optimal Prudential Regulation of Banks and the Political Economy of Supervision," IMF Working Papers 14/90, International Monetary Fund.
  2. Gete, Pedro & Tiernan, Natalie, 2014. "Lending Standards and Countercyclical Capital Requirements under Imperfect Information," MPRA Paper 54486, University Library of Munich, Germany.

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