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Bank Liquidity and Capital Regulation in General Equilibrium

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Abstract

We develop a nonlinear dynamic general equilibrium model with a banking sector and use it to study the macroeconomic impact of introducing a minimum liquidity standard for banks on top of existing capital adequacy requirements. The model generates a distribution of bank sizes arising from differences in banks' ability to generate revenue from loans and from occasionally binding capital and liquidity constraints. Under our baseline calibration, imposing a liquidity requirement would lead to a steady-state decrease of about 3 percent in the amount of loans made, an increase in banks' holdings of securities of at least 6 percent, a fall in the interest rate on securities of a few basis points, and a decline in output of about 0.3 percent. Our results are sensitive to the supply of safe assets: the larger the supply of such securities, the smaller the macroeconomic impact of introducing a minimum liquidity standard for banks, all else being equal. Finally, we show that relaxing the liquidity requirement under a situation of financial stress dampens the response of output to aggregate shocks.

Suggested Citation

  • Covas, Francisco & Driscoll, John C., 2014. "Bank Liquidity and Capital Regulation in General Equilibrium," Finance and Economics Discussion Series 2014-85, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2014-85
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    References listed on IDEAS

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    1. Concetta Chiuri, Maria & Ferri, Giovanni & Majnoni, Giovanni, 2002. "The macroeconomic impact of bank capital requirements in emerging economies: Past evidence to assess the future," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 881-904, May.
    2. Driscoll, John C., 2004. "Does bank lending affect output? Evidence from the U.S. states," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 451-471, April.
    3. Adrian, Tobias & Boyarchenko, Nina, 2014. "Liquidity policies and systemic risk," Staff Reports 661, Federal Reserve Bank of New York.
    4. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2009. "A Theory of Liquidity and Regulation of Financial Intermediation," Review of Economic Studies, Oxford University Press, vol. 76(3), pages 973-992.
    5. Gianni De Nicolò & Andrea Gamba & Marcella Lucchetta, 2014. "Microprudential Regulation in a Dynamic Model of Banking," Review of Financial Studies, Society for Financial Studies, vol. 27(7), pages 2097-2138.
    6. Samuel G. Hanson & Anil K. Kashyap & Jeremy C. Stein, 2011. "A Macroprudential Approach to Financial Regulation," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 3-28, Winter.
    7. William Francis & Matthew Osborne, 2009. "Bank regulation, capital and credit supply: Measuring the Impact of Prudential Standards," Occasional Papers 36, Financial Services Authority.
    8. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
    9. Coleman, Wilbur John, II, 1990. "Solving the Stochastic Growth Model by Policy-Function Iteration," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 27-29, January.
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    Cited by:

    1. repec:eee:moneco:v:89:y:2017:i:c:p:25-44 is not listed on IDEAS
    2. O. de Bandt & M. Chahad, 2016. "A DGSE Model to Assess the Post-Crisis Regulation of Universal Banks," Working papers 602, Banque de France.
    3. Tirupam Goel, 2016. "Banking industry dynamics and size-dependent capital regulation," BIS Working Papers 599, Bank for International Settlements.

    More about this item

    Keywords

    Bank regulation; liquidity requirements; capital requirements; incomplete markets; idiosyncratic risk; macroprudential policy;

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • 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

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