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Market-Based Bank Capital Regulation

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  • Jeremy Bulow

    ()
    (Standford University, USA)

  • Paul Klemperer

    ()
    (Nuffield College, University of Oxford, UK)

Abstract

Today’s regulatory rules, especially the easily-manipulated measures of regulatory capital, have led to costly bank failures. We design a robust regulatory system such that (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals (because the simplicity and clarity of such rules prevents gaming by firms, and forbearance by regulators, as well as because of the efficiency role of prices). One key innovation is “ERNs” (equity recourse notes--superficially similar to, but importantly distinct from, “cocos”) which gradually "bail in" equity when needed. Importantly, although our system uses market information, it does not rely on markets being “right”.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2013/MBBCRFinalpaperSept.pdf
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Bibliographic Info

Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2013-W12.

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Length: 67 pages
Date of creation: 15 Sep 2013
Date of revision:
Handle: RePEc:nuf:econwp:1312

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Web page: http://www.nuff.ox.ac.uk/economics/

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