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Welfare analysis of bank capital requirements with endogenous default

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  • Garcia-Barragan, Fernando
  • Liu, Guangling

Abstract

This paper presents a tractable framework with endogenous default and evaluates the welfare implication of bank capital requirements. Using a dynamic general equilibrium model we analyze the social welfare response to a negative technology shock under different capital requirement regimes, Basel II and III. In Basel III, we consider alternative indicators, such as output gap and credit-to-output gap. We then consider the scenario where the default rate is augmented in different capital requirement regimes. We show that it is welfare improving by including the default rate as an additional indicator for all capital requirement regimes. A more aggressive reaction to default can effectively mitigate the negative effect of the shock on welfare and this attenuation effect works through the bank funding channel.

Suggested Citation

  • Garcia-Barragan, Fernando & Liu, Guangling, 2018. "Welfare analysis of bank capital requirements with endogenous default," Economic Modelling, Elsevier, vol. 73(C), pages 15-29.
    • Handle: RePEc:eee:ecmode:v:73:y:2018:i:c:p:15-29
    DOI: 10.1016/j.econmod.2018.03.002
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    Cited by:

    1. Carlos Alberto Zarazúa Juárez, 2021. "Macroprudential regulation as part of the Mexican policy toolkit," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 16(1), pages 1-27, Enero - M.
    2. Carlos Alberto Zarazúa Juárez, 2021. "Macroprudential regulation as part of the Mexican policy toolkit," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 16(1), pages 1-27, Enero - M.

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    More about this item

    Keywords

    Bank capital requirement; Default; Welfare;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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