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Credit allocation, capital requirements and output

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Author Info

  • Jokivuolle, Esa

    ()
    (Bank of Finland Research)

  • Kiema, Ilkka

    ()
    (University of Helsinki)

  • Vesala, Timo

    ()
    (Danske Bank A/S, Finland)

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    Abstract

    We show how banks’ excessive risk-taking, stemming from informational asymmetries in loan markets, can lead to an excessive output loss when a recession starts. Risk-based capital requirements can alleviate the output loss by reducing excessive risk-taking in ‘normal’ times. Model simulations suggest that the differentiation of risk-weights in the Basel framework might be further increased in order to take full advantage of the allocational effects of capital requirements. Our analysis also provides a new rationale for the countercyclical elements of capital requirements.

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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 17/2010.

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    Length: 35 pages
    Date of creation: 01 Dec 2010
    Date of revision:
    Publication status: Forthcoming as Jokivuolle, Esa, Ilkka Kiema and Timo Vesala, 'Credit allocation, capital requirements and output' in Journal of Financial Services Research .
    Handle: RePEc:hhs:bofrdp:2010_017

    Contact details of provider:
    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: bank regulation; Basel III; capital requirements; credit risk; crises; procyclicality;

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    References

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    1. Repullo, Rafael, 2003. "Capital Requirements, Market Power and Risk-Taking in Banking," CEPR Discussion Papers 3721, C.E.P.R. Discussion Papers.
    2. Repullo, Rafael & Suarez, Javier, 2003. "Loan Pricing Under Basel Capital Requirements," CEPR Discussion Papers 3917, C.E.P.R. Discussion Papers.
    3. Rafael Repullo & Jesús Saurina & Carlos Trucharte, 2010. "Mitigating the pro-cyclicality of Basel II," Banco de Espa�a Working Papers 1028, Banco de Espa�a.
    4. Acharya, Viral V & Naqvi, Hassan, 2012. "The Seeds of a Crisis: A Theory of Bank Liquidity and Risk-Taking over the Business Cycle," CEPR Discussion Papers 8851, C.E.P.R. Discussion Papers.
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    14. 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.
    15. Gabriella Chiesa, . "Incentive-based Lending Capacity, Competition and Regulation in Banking," Working Papers 92, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    16. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
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