IDEAS home Printed from https://ideas.repec.org/p/hbs/wpaper/15-072.html
   My bibliography  Save this paper

Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model

Author

Listed:
  • Juliane M. Begenau

    () (Harvard Business School, Finance Unit)

Abstract

This paper develops a quantitative dynamic general equilibrium model in which households' preferences for safe and liquid assets constitute a violation of Modigliani and Miller. I show that the scarcity of these coveted assets created by increased bank capital requirements can reduce overall bank funding costs and increase bank lending. I quantify this mechanism in a two-sector business cycle model featuring a banking sector that provides liquidity and has excessive risk-taking incentives. Under reasonable parametrizations, the marginal benefit of higher capital requirements related to this channel significantly exceeds the marginal cost, indicating that US capital requirements have been sub-optimally low.

Suggested Citation

  • 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.
  • Handle: RePEc:hbs:wpaper:15-072
    as

    Download full text from publisher

    File URL: http://www.hbs.edu/faculty/pages/download.aspx?name=15-072.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Peek, Joe & Rosengren, Eric, 1995. "Bank regulation and the credit crunch," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 679-692, June.
    2. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2012. "The Aggregate Demand for Treasury Debt," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 233-267.
    3. Markus K. Brunnermeier & Yuliy Sannikov, 2014. "A Macroeconomic Model with a Financial Sector," American Economic Review, American Economic Association, vol. 104(2), pages 379-421, February.
    4. James M. Poterba & Julio J. Rotemberg, 1986. "Money in the Utility Function: An Empirical Implementation," Working papers 408, Massachusetts Institute of Technology (MIT), Department of Economics.
    5. Gary Gorton & Stefan Lewellen & Andrew Metrick, 2012. "The Safe-Asset Share," American Economic Review, American Economic Association, vol. 102(3), pages 101-106, May.
    6. Christopher A. Hennessy & Toni M. Whited, 2007. "How Costly Is External Financing? Evidence from a Structural Estimation," Journal of Finance, American Finance Association, vol. 62(4), pages 1705-1745, August.
    7. Holmström, Bengt, 2013. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262518536, September.
    8. 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.
    9. Allen, Franklin & Carletti, Elena, 2013. "Deposits and Bank Capital Structure," Working Papers 13-13, University of Pennsylvania, Wharton School, Weiss Center.
    10. Bengt Holmstrom & Jean Tirole, 1997. "Financial Intermediation, Loanable Funds, and The Real Sector," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 663-691.
    11. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    12. Matthias Doepke & Martin Schneider, 2017. "Money as a Unit of Account," Econometrica, Econometric Society, vol. 85, pages 1537-1574, September.
    13. Dean Corbae & Pablo D'Erasmo, 2014. "Capital requirements in a quantitative model of banking industry dynamics," Working Papers 14-13, Federal Reserve Bank of Philadelphia.
    14. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    15. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March.
    16. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    17. Gary Gorton & Andrew Winton, "undated". "Bank Capital Regulation in General Equilibrium," Rodney L. White Center for Financial Research Working Papers 17-95, Wharton School Rodney L. White Center for Financial Research.
    18. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December.
    19. Tobias Adrian & Hyun Song Shin, 2011. "Financial Intermediary Balance Sheet Management," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 289-307, December.
    20. Charles A.E. Goodhart & Anil K. Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2012. "Financial Regulation in General Equilibrium," NBER Working Papers 17909, National Bureau of Economic Research, Inc.
    21. repec:fip:fedgsq:y:2005:i:mar10 is not listed on IDEAS
    22. DeAngelo, Harry & Stulz, Rene M., 2013. "Why High Leverage Is Optimal for Banks," Working Papers 13-20, University of Pennsylvania, Wharton School, Weiss Center.
    23. Olivier Jeanne & Anton Korinek, 2020. "Macroprudential Regulation versus mopping up after the crash," Review of Economic Studies, Oxford University Press, vol. 87(3), pages 1470-1497.
    24. Lawrence Christiano & Daisuke Ikeda, 2014. "Leverage Restrictions in a Business Cycle Model," Central Banking, Analysis, and Economic Policies Book Series, in: Sofía Bauducco & Lawrence Christiano & Claudio Raddatz (ed.),Macroeconomic and Financial Stability: challenges for Monetary Policy, edition 1, volume 19, chapter 7, pages 215-216, Central Bank of Chile.
    25. Pierre-Olivier Gourinchas & Olivier Jeanne, 2012. "Global safe assets," BIS Working Papers 399, Bank for International Settlements.
    26. Allen, Franklin & Carletti, Elena & Marquez, Robert, 2015. "Deposits and bank capital structure," Journal of Financial Economics, Elsevier, vol. 118(3), pages 601-619.
    27. Anat Admati & Martin Hellwig, 2013. "The Bankers' New Clothes: What's Wrong with Banking and What to Do about It," Economics Books, Princeton University Press, edition 1, number 9929, October.
    28. Roberto Motto & Massimo Rostagno & Lawrence J. Christiano, 2010. "Financial Factors in Economic Fluctuations," 2010 Meeting Papers 141, Society for Economic Dynamics.
    29. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    30. Priyank Gandhi & Hanno Lustig, 2010. "Size Anomalies in U.S. Bank Stock Returns: A Fiscal Explanation," NBER Working Papers 16553, National Bureau of Economic Research, Inc.
    31. Ben S. Bernanke, 2005. "The global saving glut and the U.S. current account deficit," Speech 77, Board of Governors of the Federal Reserve System (U.S.).
    32. Mathias Dewatripont & Jean Tirole, 1994. "A Theory of Debt and Equity: Diversity of Securities and Manager-Shareholder Congruence," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 1027-1054.
    33. Gorton, Gary & Pennacchi, George, 1990. "Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
    34. Anil K. Kashyap & Raghuram G. Rajan & Jeremy C. Stein, 2008. "Rethinking capital regulation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 431-471.
    35. Nguyen, Thien Tung, 2014. "Bank Capital Requirements: A Quantitative Analysis," Working Paper Series 2015-14, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dean Corbae & Pablo D'Erasmo, 2014. "Capital requirements in a quantitative model of banking industry dynamics," Working Papers 14-13, Federal Reserve Bank of Philadelphia.
    2. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    3. Mendicino, Caterina & Nikolov, Kalin & Suarez, Javier & Supera, Dominik, 2020. "Bank capital in the short and in the long run," Journal of Monetary Economics, Elsevier, vol. 115(C), pages 64-79.
    4. Yoo, Jinhyuk, 2017. "Capital injection to banks versus debt relief to households," IMFS Working Paper Series 111, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
    5. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2020. "Default, Bailouts and the Vertical Structure of Financial Intermediaries," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 38, pages 154-180, October.
    6. Poeschl, Johannes & Zhang, Xue, 2018. "Bank Capital Regulation and Endogenous Shadow Banking Crises," MPRA Paper 92529, University Library of Munich, Germany.
    7. Pozo, Jorge, 2019. "Bank Risk-Taking in a Small Open Economy," Working Papers 2019-016, Banco Central de Reserva del Perú.
    8. Gertler, M. & Kiyotaki, N. & Prestipino, A., 2016. "Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1345-1425, Elsevier.
    9. Robin Dottling, 2018. "Bank Capital Regulation in a Zero Interest Environment," Tinbergen Institute Discussion Papers 18-016/IV, Tinbergen Institute, revised 11 Oct 2019.
    10. Ely, Regis A. & Tabak, Benjamin M. & Teixeira, Anderson M., 2021. "The transmission mechanisms of macroprudential policies on bank risk," Economic Modelling, Elsevier, vol. 94(C), pages 598-630.
    11. Poeschl, Johannes & Zhang, Xue, 2019. "Bank Capital Regulation and Endogenous Shadow Banking Crises," VfS Annual Conference 2019 (Leipzig): 30 Years after the Fall of the Berlin Wall - Democracy and Market Economy 203520, Verein für Socialpolitik / German Economic Association.
    12. Darracq Pariès, Matthieu & Jacquinot, Pascal & Papadopoulou, Niki, 2016. "Parsing financial fragmentation in the euro area: a multi-country DSGE perspective," Working Paper Series 1891, European Central Bank.
    13. Fabrizio Perri & Georgios Stefanidis, 2017. "Capital Requirements and Bailouts," Staff Report 554, Federal Reserve Bank of Minneapolis.
    14. Tetiana Davydiuk, 2017. "Dynamic Bank Capital Requirements," 2017 Meeting Papers 1328, Society for Economic Dynamics.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Juliane Begenau, 2015. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," 2015 Meeting Papers 687, Society for Economic Dynamics.
    2. Begenau, Juliane, 2020. "Capital requirements, risk choice, and liquidity provision in a business-cycle model," Journal of Financial Economics, Elsevier, vol. 136(2), pages 355-378.
    3. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    4. Krishnamurthy, Arvind & Vissing-Jorgensen, Annette, 2015. "The impact of Treasury supply on financial sector lending and stability," Journal of Financial Economics, Elsevier, vol. 118(3), pages 571-600.
    5. DeAngelo, Harry & Stulz, René M., 2015. "Liquid-claim production, risk management, and bank capital structure: Why high leverage is optimal for banks," Journal of Financial Economics, Elsevier, vol. 116(2), pages 219-236.
    6. Jochen Mankart & Alexander Michaelides & Spyros Pagratis, 2020. "Bank capital buffers in a dynamic model," Financial Management, Financial Management Association International, vol. 49(2), pages 473-502, June.
    7. Mark Gertler & Nobuhiro Kiyotaki, 2015. "Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy," American Economic Review, American Economic Association, vol. 105(7), pages 2011-2043, July.
    8. Hanson, Samuel G. & Shleifer, Andrei & Stein, Jeremy C. & Vishny, Robert W., 2015. "Banks as patient fixed-income investors," Journal of Financial Economics, Elsevier, vol. 117(3), pages 449-469.
    9. Behn, Markus & Daminato, Claudio & Salleo, Carmelo, 2019. "A dynamic model of bank behaviour under multiple regulatory constraints," Working Paper Series 2233, European Central Bank.
    10. Matthieu Darracq Paries, 2018. "Financial frictions and monetary policy conduct," Erudite Ph.D Dissertations, Erudite, number ph18-01 edited by Ferhat Mihoubi, November.
    11. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    12. Douglas Gale & Tanju Yorulmazer, 0. "Bank capital, fire sales, and the social value of deposits," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 0, pages 1-45.
    13. Suh, Hyunduk & Walker, Todd B., 2016. "Taking financial frictions to the data," Journal of Economic Dynamics and Control, Elsevier, vol. 64(C), pages 39-65.
    14. Gertler, M. & Kiyotaki, N. & Prestipino, A., 2016. "Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1345-1425, Elsevier.
    15. Alan Moreira & Alexi Savov, 2014. "The Macroeconomics of Shadow Banking," NBER Working Papers 20335, National Bureau of Economic Research, Inc.
    16. Tirupam Goel, 2016. "Banking industry dynamics and size-dependent capital regulation," BIS Working Papers 599, Bank for International Settlements.
    17. Toni Ahnert & Enrico Perotti, 2018. "Seeking Safety," Staff Working Papers 18-41, Bank of Canada.
    18. Goldstein, Itay & Razin, Assaf, 2015. "Three Branches of Theories of Financial Crises," Foundations and Trends(R) in Finance, now publishers, vol. 10(2), pages 113-180, 30.
    19. Douglas Gale & Tanju Yorulmazer, 2020. "Bank capital, fire sales, and the social value of deposits," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 69(4), pages 919-963, June.
    20. Hong Chen & Murray Frank, 2016. "Are Direct Investments by the Federal Reserve a Good Idea? A Corporate Finance Perspective," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(03), pages 1-48, September.

    More about this item

    Keywords

    Capital Requirements; Bank Lending; Safe Assets; Macro-Finance;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • 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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hbs:wpaper:15-072. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (HBS). General contact details of provider: https://edirc.repec.org/data/harbsus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.