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Bank Capital, Liquidity and Systemic Risk

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Abstract

We analyze the impact of capital adequacy regulation on bank insolvency and aggregate investment. We develop a model of the banking system that is characterized by the interaction of many heterogeneous banks with the real sector, interbank credit relations as a consequence of bank liquidity management and an insolvency mechanism. This allows us to study the impact of capital adequacy regulation on systemic risk. In particular we can analyze the impact of regulation on contagious defaults arising from mutual credit relations. We show that the impact of capital adequacy on systemic stability is ambiguous and that systemic risk might actually increase as a consequence of imposing capital constraints on banks. Furthermore we analyze the indirect consequences of capital adequacy regulation that are transmitted to the real economy by their impact on equilibrium interbank rates and thus the opportunity costs of liquidity within the banking system.

Suggested Citation

  • Juergen Eichberger & Martin Summer, 2004. "Bank Capital, Liquidity and Systemic Risk," Working Papers 87, Oesterreichische Nationalbank (Austrian Central Bank).
  • Handle: RePEc:onb:oenbwp:87
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    References listed on IDEAS

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    1. Jürgen Eichberger & Martin Summer, 2005. "Bank Capital, Liquidity, and Systemic Risk," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 547-555, 04/05.
    2. Hans Gersbach & Jan Wenzelburger, 2003. "The Workout of Banking Crises: A Macroeconomic Perspective," CESifo Economic Studies, CESifo, vol. 49(2), pages 233-258.
    3. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A model to analyse financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 107-142.
    4. Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers 79, Oesterreichische Nationalbank (Austrian Central Bank).
    5. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1991. "Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups," The Quarterly Journal of Economics, Oxford University Press, pages 33-60.
    6. 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.
    7. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, January.
    8. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Risk Assessment for Banking Systems," Management Science, INFORMS, pages 1301-1314.
    9. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, pages 236-249.
    10. Anil K. Kashyap & Jeremy C. Stein, 2004. "Cyclical implications of the Basel II capital standards," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 18-31.
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    Citations

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    Cited by:

    1. Jürgen Eichberger & Martin Summer, 2005. "Bank Capital, Liquidity, and Systemic Risk," Journal of the European Economic Association, MIT Press, pages 547-555.
    2. Elahi, M.A., 2011. "Essays on financial fragility," Other publications TiSEM 882f55bb-10dc-4e49-95ef-e, Tilburg University, School of Economics and Management.
    3. Itai Agur, 2011. "Bank Risk within and across Equilibria," DNB Working Papers 305, Netherlands Central Bank, Research Department.
    4. Krause, Andreas & Giansante, Simone, 2012. "Interbank lending and the spread of bank failures: A network model of systemic risk," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 583-608.
    5. Agur, Itai, 2014. "Bank risk within and across equilibria," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 322-333.
    6. Gerhard Illing, 2007. "Financial Stability and Monetary Policy – A Framework," CESifo Working Paper Series 1971, CESifo Group Munich.
    7. Heinz Zimmermann, 2007. "Credit risk transfer, hedge funds, and the supply of liquidity," Working papers 2007/20, Faculty of Business and Economics - University of Basel.
    8. VanHoose, David, 2011. "Systemic Risk and Macroprudential Bank Regulation: A Critical Appraisal," Journal of Financial Transformation, Capco Institute, vol. 33, pages 45-60.

    More about this item

    Keywords

    Capital Adequacy; Systemic Risk; Banking Regulation; Financial Stability;

    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
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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