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A Static Capital Buffer is Hard To Beat

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Abstract

In a model with endogenous risk-taking, deposit insurance and limited liability may lead banks to make risky loans that are socially inefficient. Capital requirements can prevent excessive risk-taking at the cost of reducing liquidity-producing bank deposits. A policy that sets capital requirements just high enough to prevent excessive risktaking will move capital requirements pro-, counter-, or a-cyclically depending on the shock source. However, such a policy requires full knowledge of all the shocks hitting the economy and is not implementable. Simple rules that respond to cyclical conditions—in line with Basel III guidance—perform poorly, whereas a small static capital buffer can do much better.

Suggested Citation

  • Matthew B. Canzoneri & Behzad T. Diba & Luca Guerrieri & Arsenii Mishin, 2026. "A Static Capital Buffer is Hard To Beat," Finance and Economics Discussion Series 2026-042, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:103442
    DOI: 10.17016/FEDS.2026.042
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    References listed on IDEAS

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    JEL classification:

    • C54 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Quantitative Policy Modeling
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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