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The Welfare Cost of Banking Regulation

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  • TCHANA TCHANA, Fulbert

Abstract

The Basel Accords promote the adoption of capital adequacy requirements to increase the banking sector's stability. Unfortunately, this type of regulation can hamper economic growth by shifting banks' portfolios from more productive risky investment projects toward less productive but safer projects. This paper introduces banking regulation in an overlapping-generations model and studies how it affects economic growth, banking sector stability, and welfare. In this model, a banking crisis is the outcome of a productivity shock, and banking regulation is modeled as a constraint on the maximal share of banks' portfolios that can be allocated to risky assets. This model allows us to evaluate quantitatively the key trade-off, inherent in this type of regulation, between ensuring banking stability and fostering economic growth. The model implies an optimal level of regulation that prevents crises but at the same time is detrimental to growth. We find that the overall effect of optimal regulation on social welfare is positive when productivity shocks are sufficiently high and economic agents are sufficiently risk-averse.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 7588.

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Date of creation: 15 Oct 2007
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Handle: RePEc:pra:mprapa:7588

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Keywords: Overlapping Generations; Competitive Equilibrium; Economic Growth; Banking Regulation;

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Cited by:
  1. repec:cmj:journl:y:2013:i:29:gutu is not listed on IDEAS
  2. Lavinia Mihaela GUȚU & Vasile ILIE, 2013. "Banking supervision in European Union," SEA - Practical Application of Science, Fundația Română pentru Inteligența Afacerii, Editorial Department, Fundația Română pentru Inteligența Afacerii, Editorial Department, issue 2, pages 121-130, October.

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