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Optimal regulation of credit lines

Author

Listed:
  • José E. Gutiérrez

    (Banco de España)

Abstract

This paper presents a contract-theoretic model in which banks choose pre-arranged and ex post funding to finance firms’ liquidity needs through credit lines. When liquidity needs are high, pre-arranged funding is key to sustaining lending and reducing the number of firms going into liquidation. Yet, in the presence of a pecuniary externality on firms’ liquidation values, competitive banks choose insufficient pre-funding compared with a constrained social planner. Constrained efficiency can be restored using regulatory liquidity ratios. The optimal regulatory ratio depends on the frequency of high liquidity need conditions, the value lost after a firm’s liquidation, and the premium on pre-funding.

Suggested Citation

  • José E. Gutiérrez, 2023. "Optimal regulation of credit lines," Working Papers 2323, Banco de España.
    • Handle: RePEc:bde:wpaper:2323
    DOI: https://doi.org/10.53479/33492
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    More about this item

    Keywords

    credit lines; bank liquidity risk regulation; LCR; NSFR; Basel III;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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