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Cyclical Implications of Changing Bank Capital Requirements in a Macroeconomic Framework

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  • Eduardo J.J. Ganapolsky
  • Mario Catalán
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    Abstract

    There is a widespread view that bank capital requirements should be loosened during recessions and tightened during expansions to avoid excessive credit and output swings. This view is based on a partial analysis that ignores the effects of capital requirement policies on the saving decisions of households, and, through this channel, on bank loans and output. We present an intertemporal general equilibrium framework that accounts for such effects and evaluate the optimal responses to loan supply and productivity (loan demand) shocks. In contrast to the standard view, we show that, when loan supply is reduced, increasing the capital requirement allows a faster recovery of households'' savings, loans, and output than a flat capital requirement policy. When productivity (loan demand) is reduced, lowering the capital requirement facilitates households'' dissaving and amplifies the output decline, but enhances welfare. Finally, we show that if productivity reductions are anticipated-rather than unanticipated-by regulators, lowering the capital requirement preemptively enhances welfare through greater intertemporal smoothing of households'' consumption and deposit holdings.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/168.

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    Length: 36
    Date of creation: 01 Aug 2005
    Date of revision:
    Handle: RePEc:imf:imfwpa:05/168

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    Related research

    Keywords: Deposit insurance; Banks; Economic models; Reserve requirements; capital requirement; capital requirements; banking; bank capital; bank loans; bank equity; banking system; bank regulators; insurance premium; insurance premiums; insurance industry; bank regulation; insurance system; bank lending; bank deposits; deposit insurance premium; basel accord; banking crises; return on equity; banking supervision; federal deposit insurance; banking industry; prudential regulation; bankruptcies; bank runs; capital mobility; bank risk; bank insolvencies; bank profit; financial supervision; bank credit; deposit insurance scheme; insurance contracts; bank capital standards; bank regulations;

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    1. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
    2. Rochet, Jean-Charles, 2004. "Macroeconomic shocks and banking supervision," Journal of Financial Stability, Elsevier, vol. 1(1), pages 93-110, September.
    3. Allen N. Berger & Richard J. Herring & Giorgio P. Szego, 1995. "The role of capital in financial institutions," Finance and Economics Discussion Series 95-23, Board of Governors of the Federal Reserve System (U.S.).
    4. Sebastian Edwards & Carlos A. Vegh, 1997. "Banks and Macroeconomics Disturbances under Predetermined Exchange Rates," NBER Working Papers 5977, National Bureau of Economic Research, Inc.
    5. Flannery, Mark J., 1991. "Pricing deposit insurance when the insurer measures bank risk with error," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 975-998, September.
    6. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group.
    7. Peek, Joe & Rosengren, Eric, 1995. "Bank regulation and the credit crunch," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 679-692, June.
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