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Capital requirements in a quantitative model of banking industry dynamics

Author

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  • Corbae, Dean

    (University of Wisconsin - Madison and NBER)

  • D'Erasmo, Pablo

    (Federal Reserve Bank of Philadelphia)

Abstract

We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on bank risk taking, commercial bank failure, and market structure. We propose a market structure where big, dominant banks interact with small, competitive fringe banks. Banks accumulate securities like Treasury bills and undertake short-term borrowing when there are cash flow shortfalls. A nontrivial size distribution of banks arises out of endogenous entry and exit, as well as banks’ buffer stocks of securities. We test the model using business cycle properties and the bank lending channel across banks of different sizes studied by Kashyap and Stein (2000). We find that a rise in capital requirements from 4% to 6% leads to a substantial reduction in exit rates of small banks and a more concentrated industry. Aggregate loan supply falls and interest rates rise by 50 basis points. The lower exit rate causes the tax/output rate necessary to fund deposit insurance to drop in half. Higher interest rates, however, induce higher loan delinquencies as well as a lower level of intermediated output.

Suggested Citation

  • Corbae, Dean & D'Erasmo, Pablo, 2014. "Capital requirements in a quantitative model of banking industry dynamics," Working Papers 14-13, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:14-13
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    References listed on IDEAS

    as
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    Cited by:

    1. Juliane M. Begenau, 2015. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," Harvard Business School Working Papers 15-072, Harvard Business School, revised Sep 2016.
    2. Tirupam Goel, 2016. "Banking industry dynamics and size-dependent capital regulation," BIS Working Papers 599, Bank for International Settlements.
    3. C. Lanier Benkard & Przemyslaw Jeziorski & Gabriel Y. Weintraub, 2013. "Oblivious Equilibrium for Concentrated Industries," NBER Working Papers 19307, National Bureau of Economic Research, Inc.
    4. Cao, Jin & Chollete, Loran, 2014. "Capital Adequacy and Liquidity in Banking Dynamics: Theory and Regulatory Implications," UiS Working Papers in Economics and Finance 2014/16, University of Stavanger.
    5. Aliaga-Díaz, Roger & Olivero , María Pía & Powell, Andrew, 2016. "Anti-Cyclical Bank Capital Regulation and Monetary Policy," School of Economics Working Paper Series 2016-16, LeBow College of Business, Drexel University.
    6. repec:prg:jnlcfu:v:2017:y:2017:i:4:id:504:p:41-56 is not listed on IDEAS

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    Keywords

    Banking; Capital requirements; Risk; Commercial bank failure; Market structure;

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