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Optimal Capital Regulation

Author

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  • Stéphane Moyen
  • Josef Schroth

Abstract

We study constrained-efficient bank capital regulation in a model with market-imposed equity requirements. Banks hold equity buffers to insure against sudden loss of access to funding. However, in the model, banks choose to only partially self-insure because equity is privately costly. As a result, equity requirements are occasionally binding. Constrained-efficient regulation requires banks to build up additional equity buffers and compensates them for the cost of equity with a permanent increase in lending margins. When buffers are depleted, regulation relaxes the market-imposed equity requirements by raising bank future prospects through temporarily elevated lending margins.

Suggested Citation

  • Stéphane Moyen & Josef Schroth, 2017. "Optimal Capital Regulation," Staff Working Papers 17-6, Bank of Canada.
  • Handle: RePEc:bca:bocawp:17-6
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Josef Schroth, 2019. "Macroprudential Policy with Capital Buffers," Staff Working Papers 19-8, Bank of Canada.
    2. Clancy, Daragh & Merola, Rossana, 2017. "Countercyclical capital rules for small open economies," Journal of Macroeconomics, Elsevier, vol. 54(PB), pages 332-351.
    3. Maarten van Oordt, 2018. "Calibrating the Magnitude of the Countercyclical Capital Buffer Using Market-Based Stress Tests," Staff Working Papers 18-54, Bank of Canada.

    More about this item

    Keywords

    Credit and credit aggregates; Financial Institutions; Financial stability; Financial system regulation and policies;

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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