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Risk Weighted Capital Regulation and Government Debt

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  • Eva Schliephake

    () (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)

Abstract

Microprudential capital requirements are designed to reduce the excessive risk taking of banks. If banks are required to use more equity funding for risky assets they invest more funds into safe assets. This paper analyzes a government that simultaneously regulates the banking sector and borrows from it. I argue that a government may have the incentive to use capital requirements to alleviate its budget burden. The risk weights for risky assets may be placed relatively too high compared to the risk weight on government bonds. This could have a negative impact on welfare. The supply of loans for the risky sector shrinks, which may have a negative impact on long term growth. Moreover, the government may be tempted to increase its debt level due to better funding conditions, which increases the risk of a future sovereign debt crisis. A short term focused government may be tempted to neglect the risk and, thereby, may introduce systemic risk in the banking sector.

Suggested Citation

  • Eva Schliephake, 2013. "Risk Weighted Capital Regulation and Government Debt," FEMM Working Papers 130011, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
  • Handle: RePEc:mag:wpaper:130011
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    File URL: http://www.fww.ovgu.de/fww_media/femm/femm_2013/2013_11.pdf
    File Function: First version, 2011
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    References listed on IDEAS

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    1. Eduardo Borensztein & Ugo Panizza, 2009. "The Costs of Sovereign Default," IMF Staff Papers, Palgrave Macmillan, vol. 56(4), pages 683-741, November.
    2. Tirole, Jean, 1994. "On banking and intermediation," European Economic Review, Elsevier, vol. 38(3-4), pages 469-487, April.
    3. 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.
    4. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    5. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    6. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, vol. 58(2), pages 429-452, March.
    7. Haucap, Justus & Kirstein, Roland, 2003. "Government Incentives When Pollution Permits Are Durable Goods," Public Choice, Springer, vol. 115(1-2), pages 163-183, April.
    8. Xavier Freixas & Jean-Charles Rochet, 2008. "Microeconomics of Banking, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062704, January.
    9. Roubini, Nouriel & Sala-i-Martin, Xavier, 1992. "Financial repression and economic growth," Journal of Development Economics, Elsevier, vol. 39(1), pages 5-30, July.
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    More about this item

    Keywords

    Capital Requirement Regulation; Government Debt;

    JEL classification:

    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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