Some Effects of Capital Regulation When There are Competing, Nonbank Lenders

Bank regulations introduced in response to the 2008–9 financial crisis have increasingly constrained banking firms' ability to keep risks on their balance sheets. The increase in minimum capital requirements (Basel III) has attracted much of the attention. The US Comprehensive Capital Analysis and Review (CCAR) intensifies the impact of higher minimum capital ratios by predicating capital assessments on the anticipated future losses from a bank's book of business. Beyond capital regulation, bank funding costs have risen due to higher FDIC premium rates for deposit insurance and an expanded assessment base. Most recently, minimum liquidity requirements is intended to reduce the banking system's ability to provide liquidity to the nonfinancial sector. The net effect of these changes will be to drive some lending and liquidity provision outside the traditional banking system. Higher liquidity and capital requirements have the immediate effect of transferring risk from taxpayers to bank shareholders, but they will also affect shareholders' risk-taking incentives. It therefore remains uncertain whether the banks' ensuing portfolio changes leave them more or less prone to default…