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Banking-on-the-Average Rules

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Abstract

In this paper, we argue for a regulatory framework under which a bank’s required level of equity capital depends on the equity capital of its peers. Such bankingon- the-average rules are transparent and could also be combined with the current regulatory framework. In addition, we argue that banking-on-the-average rules ensure the build-up of bank equity capitals in booms and thus avoid excessive leverage. Prudent banks can impose prudency on other banks. In a simple model of a banking system, we show that a banking-on-the-average framework can deliver the socially optimal solution because it induces banks to abstain from gambling. Moreover, it alleviates socially harmful consequences of conventional equity-capital rules, which may induce banks to excessively cut back on lending or liquidate desirable long-term investment projects in downturns.

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Bibliographic Info

Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 09/107.

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Length: 22 pages
Date of creation: Mar 2009
Date of revision:
Handle: RePEc:eth:wpswif:09-107

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Keywords: banking on the average; equity-capital requirements; banking system; banking crisis;

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References

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  1. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  2. Scott, Hal S. (ed.), 2005. "Capital Adequacy beyond Basel: Banking, Securities, and Insurance," OUP Catalogue, Oxford University Press, number 9780195169713, September.
  3. Van den Heuvel, Skander J., 2008. "The welfare cost of bank capital requirements," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 298-320, March.
  4. Gersbach, Hans & Hahn, Volker, 2010. "Banking-on-the-Average Rules," CEPR Discussion Papers 7819, C.E.P.R. Discussion Papers.
  5. Gersbach, Hans, 2009. "Private Insurance Against Systemic Crises?," CEPR Discussion Papers 7342, C.E.P.R. Discussion Papers.
  6. Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
  7. Tolga Ediz & Ian Michael & William Perraudin, 1998. "The impact of capital requirements on U.K. bank behaviour," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 15-22.
  8. Gersbach, Hans, 2004. "Financial Intermediation with Contingent Contracts and Macroeconomic Risks," CEPR Discussion Papers 4735, C.E.P.R. Discussion Papers.
  9. Heid, Frank, 2007. "The cyclical effects of the Basel II capital requirements," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3885-3900, December.
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Cited by:
  1. Athanasoglou, Panayiotis & Ioannis, Daniilidis & Manthos, Delis, 2013. "Bank procyclicality and output: Issues and policies," MPRA Paper 50830, University Library of Munich, Germany.
  2. Gersbach, Hans & Hahn, Volker, 2010. "Banking-on-the-Average Rules," CEPR Discussion Papers 7819, C.E.P.R. Discussion Papers.
  3. Panayiotis P. Athanasoglou & Ioannis Daniilidis, 2011. "Procyclicality in the banking industry: causes, consequences and response," Working Papers 139, Bank of Greece.
  4. Balistreri, Edward J. & Hillberry, Russell H. & Rutherford, Thomas F., 2010. "Trade and welfare: Does industrial organization matter?," Economics Letters, Elsevier, vol. 109(2), pages 85-87, November.

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