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Optimal Regulation of Bank Capital and Liquidity: How to Calibrate New International Standards

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Author Info

  • Ray Barrell

    (National Institute of Economic and Social Research)

  • E Philip Davis

    (National Institute of Economic and Social Research and Brunel University)

  • Tatiana Fic

    (National Institute of Economic and Social Research)

  • Dawn Holland

    (National Institute of Economic and Social Research)

  • Simon Kirby

    (National Institute of Economic and Social Research)

  • Iana Liadze

    (National Institute of Economic and Social Research)

Abstract

Raising capital adequacy standards and introducing binding liquidity requirements can have beneficial effects if they reduce the probability of a costly financial crisis, but may also reduce GDP by raising borrowing costs for households and companies. In this paper, we estimate both benefits and costs of raising capital and liquidity, with the benefits being in terms of reduction in the probability of banking crises, while the costs are defined in terms of the economic impact of higher spreads for bank customers. We note that both of these results are contrary to the Modigliani-Miller theorem of irrelevance of the debt-equity choice. The result shows a positive net benefit from regulatory tightening, for a range of 2-6 percentage points increase in capital and liquidity ratios, depending on underlying assumptions.

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File URL: http://www.fsa.gov.uk/pubs/occpapers/op38.pdf
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Bibliographic Info

Paper provided by Financial Services Authority in its series Occasional Papers with number 38.

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Length: 57 pages
Date of creation: Jul 2009
Date of revision:
Handle: RePEc:fsa:occpap:38

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Related research

Keywords: bank; capital; financial regulation; prudential policy; credit; lending;

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Cited by:
  1. Miles, David & Yang, Jing & Marcheggiano, Gilberto, 2011. "Optimal Bank Capital," Discussion Papers 31, Monetary Policy Committee Unit, Bank of England.
  2. Jochen Schanz & David Aikman & Paul Collazos & Marc Farag & David Gregory & Sujit Kapadia, 2011. "The long-term economic impact of higher capital levels," BIS Papers chapters, in: Bank for International Settlements (ed.), Macroprudential regulation and policy, volume 60, pages 73-81 Bank for International Settlements.
  3. Corder, Matthew & Weale, Martin, 2011. "Banking crises and recessions: what can leading indicators tell us?," Discussion Papers 33, Monetary Policy Committee Unit, Bank of England.
  4. Robert-Paul Berben & Beata Bierut & Jan Willem van den End & Jan Kakes, 2010. "Macro-effects of higher capital and liquidity requirements for banks," DNB Occasional Studies 803, Netherlands Central Bank, Research Department.
  5. Emanuel Kopp & Christian Ragacs & Stefan W. Schmitz, 2010. "The Economic Impact of Measures Aimed at Strengthening Bank Resilience – Estimates for Austria," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 20, pages 86-114, December.
  6. Maria Abascal & Luis Carranza & Mayte Ledo & Arnoldo Lopez Marmolejo, 2011. "Impact of Financial Regulation on Emerging Countries," Working Papers 1108, BBVA Bank, Economic Research Department.
  7. Panayiotis P. Athanasoglou & Ioannis Daniilidis, 2011. "Procyclicality in the banking industry: causes, consequences and response," Working Papers 139, Bank of Greece.

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