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Banking-on-the-Average Rules

In this paper, we argue for a regulatory framework under which a bank’s required level of equity capital depends on the equity capital of its peers. Such bankingon- the-average rules are transparent and could also be combined with the current regulatory framework. In addition, we argue that banking-on-the-average rules ensure the build-up of bank equity capitals in booms and thus avoid excessive leverage. Prudent banks can impose prudency on other banks. In a simple model of a banking system, we show that a banking-on-the-average framework can deliver the socially optimal solution because it induces banks to abstain from gambling. Moreover, it alleviates socially harmful consequences of conventional equity-capital rules, which may induce banks to excessively cut back on lending or liquidate desirable long-term investment projects in downturns.

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Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 09/107.

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Length: 22 pages
Date of creation: Mar 2009
Date of revision:
Handle: RePEc:eth:wpswif:09-107
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  1. Heid, Frank, 2007. "The cyclical effects of the Basel II capital requirements," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3885-3900, December.
  2. Gersbach, Hans, 2009. "Private Insurance Against Systemic Crises?," CEPR Discussion Papers 7342, C.E.P.R. Discussion Papers.
  3. 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.
  4. Hans Gersbach & Volker Hahn, 2009. "Banking-on-the-Average Rules," CER-ETH Economics working paper series 09/107, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
  5. Van den Heuvel, Skander J., 2008. "The welfare cost of bank capital requirements," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 298-320, March.
  6. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  7. 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.
  8. Gersbach, Hans, 2004. "Financial Intermediation with Contingent Contracts and Macroeconomic Risks," CEPR Discussion Papers 4735, C.E.P.R. Discussion Papers.
  9. Scott, Hal S. (ed.), 2005. "Capital Adequacy beyond Basel: Banking, Securities, and Insurance," OUP Catalogue, Oxford University Press, number 9780195169713, July.
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