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Capital Requirements in a Quantitative Model of Banking Industry Dynamics

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  • Dean Corbae
  • Pablo D'Erasmo

Abstract

We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on equilibrium bank risk taking, commercial bank failure, interest rates on loans, and market structure. We propose a market structure where big banks with market power interact with small, competitive fringe banks. Banks face idiosyncratic funding shocks in addition to aggregate shocks to the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks' buffer stock of net worth. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on financial stability. We then conduct a series of counterfactuals (including countercyclical and size contingent (e.g. SIFI) capital requirements). We find that regulatory policies can have an important impact on market structure in the banking industry which, along with selection effects, can generate changes in allocative efficiency.

Suggested Citation

  • Dean Corbae & Pablo D'Erasmo, 2019. "Capital Requirements in a Quantitative Model of Banking Industry Dynamics," NBER Working Papers 25424, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:25424
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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