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Dynamic Bank Capital Requirements

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  • Tetiana Davydiuk

    (Wharton School, University of Pennsylvania)

Abstract

The Basel III Accord requires countercyclical capital buffers to protect the banking system against potential losses associated with excessive credit growth and buildups of systemic risk. In this paper, I provide a rationale for time-varying capital requirements in a dynamic general equilibrium setting. An optimal policy trades off reduced inefficient lending with reduced liquidity provision. Quantitatively, I find that the optimal Ramsey policy requires a capital ratio that mostly varies between 4% and 6% and depends on economic growth, bank supply of credit, and asset prices. Specifically, a one standard deviation increase in the bank credit-to-GDP ratio (GDP) translates into a 0.1% (0.7%) increase in capital requirements, while each standard deviation increase in the liquidity premium leads to a 0.1% decrease. The welfare gain from implementing this dynamic policy is large when compared to the gain from having an optimal fixed capital requirement.

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  • Tetiana Davydiuk, 2017. "Dynamic Bank Capital Requirements," 2017 Meeting Papers 1328, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:1328
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    2. Joseph G. Haubrich, 2020. "How Cyclical Is Bank Capital?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 58(1), pages 27-38, August.
    3. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2020. "Default, Bailouts and the Vertical Structure of Financial Intermediaries," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 38, pages 154-180, October.
    4. Kai Ding & Enoch Hill & David Perez-Reyna, 2021. "Optimal capital requirements with noisy signals on banking risk," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(4), pages 1649-1687, June.
    5. Robin Dottling, 2018. "Bank Capital Regulation in a Zero Interest Environment," Tinbergen Institute Discussion Papers 18-016/IV, Tinbergen Institute, revised 11 Oct 2019.
    6. Couaillier, Cyril & Henricot, Dorian, 2023. "How do markets react to tighter bank capital requirements?," Journal of Banking & Finance, Elsevier, vol. 151(C).
    7. Miguel Faria-e-Castro, 2019. "A Quantitative Analysis of Countercyclical Capital Buffers," Working Papers 2019-008, Federal Reserve Bank of St. Louis, revised 01 Jan 2020.
    8. Skander Van den Heuvel, 2019. "The Welfare Effects of Bank Liquidity and Capital Requirements," 2019 Meeting Papers 325, Society for Economic Dynamics.
    9. Jermann, Urban & Xiang, Haotian, 2023. "Dynamic banking with non-maturing deposits," Journal of Economic Theory, Elsevier, vol. 209(C).
    10. Xiang, Haotian, 2022. "Corporate debt choice and bank capital regulation," Journal of Economic Dynamics and Control, Elsevier, vol. 144(C).
    11. Ahmad Peivandi & Mohammad Abbas Rezaei & Ajay Subramanian, 2023. "Optimal design of bank regulation under aggregate risk," Mathematics and Financial Economics, Springer, volume 17, number 2, June.
    12. Jingyi Zhang, 2020. "Shadow Banking and Optimal Capital Requirements," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 38, pages 296-325, October.
    13. Dempsey, Kyle P., 2020. "Macroprudential capital requirements with non-bank finance," Working Paper Series 2415, European Central Bank.

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