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Market-Based Bank Capital Regulation


  • Bulow, Jeremy I.
  • Klemperer, Paul


Today’s regulatory rules, especially the easily-manipulated measures of regulatory capital, have led to costly bank failures. We design a robust regulatory system such that (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals (because the simplicity and clarity of such rules prevents gaming by firms, and forbearance by regulators, as well as because of the efficiency role of prices). One key innovation is “ERNs” (equity recourse notes--superficially similar to, but importantly distinct from, “cocos”) which gradually "bail in" equity when needed. Importantly, although our system uses market information, it does not rely on markets being “right”.

Suggested Citation

  • Bulow, Jeremy I. & Klemperer, Paul, 2013. "Market-Based Bank Capital Regulation," CEPR Discussion Papers 9618, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:9618

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    Cited by:

    1. Natasha Sarin & Lawrence H. Summers, 2016. "Understanding Bank Risk through Market Measures," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 47(2 (Fall)), pages 57-127.
    2. Wayne Passmore & Alexander H. von Hafften, 2017. "Are Basel's Capital Surcharges for Global Systemically Important Banks Too Small?," Finance and Economics Discussion Series 2017-021, Board of Governors of the Federal Reserve System (U.S.).
    3. Mark Egan & Stefan Lewellen & Adi Sunderam, 2017. "The Cross Section of Bank Value," NBER Working Papers 23291, National Bureau of Economic Research, Inc.
    4. Derviz, Alexis, 2014. "Collateral composition, diversification risk, and systemically important merchant banks," Journal of Financial Stability, Elsevier, vol. 14(C), pages 23-34.
    5. Franklin Allen & Itay Goldstein & Julapa Jagtiani & William W. Lang, 2016. "Enhancing Prudential Standards in Financial Regulations," Journal of Financial Services Research, Springer;Western Finance Association, vol. 49(2), pages 133-149, June.
    6. Kenjiro Hori & Jorge Martin Cerón, 2017. "Contingent Convertible Bonds: Payoff Structures and Incentive Effects," Birkbeck Working Papers in Economics and Finance 1711, Birkbeck, Department of Economics, Mathematics & Statistics.
    7. repec:bin:bpeajo:v:47:y:2016:i:2016-02:p:57-127 is not listed on IDEAS

    More about this item


    bail-in; bank; bank capital; bank crisis; capital requirements; contingent capital; contingent convertible bond; debt overhang; deposit insurance; living wills; regulatory capital; regulatory forbearance; SIFI; systemically important financial institution; too-big-to-fail;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • 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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