AbstractIn 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 InfoPaper 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.
Length: 22 pages
Date of creation: Mar 2009
Date of revision:
banking on the average; equity-capital requirements; banking system; banking crisis;
Other versions of this item:
- 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-2009-04-05 (All new papers)
- NEP-BAN-2009-04-05 (Banking)
- NEP-CBA-2009-04-05 (Central Banking)
- NEP-REG-2009-04-05 (Regulation)
- NEP-RMG-2009-04-05 (Risk Management)
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