In this paper, we introduce a new requirement for bank capital: banking-on-the-average rules. Under these rules a bank’s required level of equity capital is monotonically increasing in the realized equity capital of its peers. In a simple model we illustrate the workings of banking-on-the-average rules. We show that in booms these rules can prevent banks from taking excessive risks. Moreover, they alleviate the socially harmful procyclicality of conventional equity-capital rules, which may induce banks to cut back excessively on lending. Finally, we argue that under these rules prudent banks can impose prudency on other banks. In addition, banking-on-the-average rules ensure the build-up of bank equity capital in booms and thus avoid excessive leverage.
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- Scott, Hal S. (ed.), 2005. "Capital Adequacy beyond Basel: Banking, Securities, and Insurance," OUP Catalogue, Oxford University Press, number 9780195169713.
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Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
- Tolga Ediz & Ian Michael & William Perraudin, 1998. "The impact of capital requirements on U.K. bank behaviour," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 15-22.
- Gersbach, Hans, 2009. "Private Insurance Against Systemic Crises?," CEPR Discussion Papers 7342, C.E.P.R. Discussion Papers.
- Heid, Frank, 2007. "The cyclical effects of the Basel II capital requirements," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3885-3900, December.
- Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
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