IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/28179.html
   My bibliography  Save this paper

Incentives through the cycle: microfounded macroprudential regulation

Author

Listed:
  • di Iasio, Giovanni
  • Quagliariello, Mario

Abstract

We use an incentive model in which improvements to fundamentals boost the ability of leveraged financial firms (banks) to expand the balance sheet (as in Adrian and Shin 2010). The rise in asset prices due to the amplified response of procyclical systems distorts bankers' incentives in providing (costly and non observable) monitoring effort. On the one hand, the fundamental value of assets positively affects the optimal effort of the banker, thus allowing supervisory authorities to relax incentive-compatible capital requirements and boosting asset demand and prices. On the other hand, in a macro perspective, high prices positively affect the banker's payoff in the bad state of asset liquidation (via asset prices), jeopardizing incentives. This type of externality follows from a purely “macro” phenomenon à la Borio (2003) and should be taken into account by the regulatory authority in designing capital requirements. In procyclical and advanced (low agency costs and highly liquid) financial systems, incentive compatibility requires a higher capital requirement in the face of an improvement to fundamentals. Our results provide a theoretical foundation to the countercyclical buffer provided for by the Basel Committee.

Suggested Citation

  • di Iasio, Giovanni & Quagliariello, Mario, 2011. "Incentives through the cycle: microfounded macroprudential regulation," MPRA Paper 28179, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:28179
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/28179/1/MPRA_paper_28179.pdf
    File Function: original version
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Karl E. Case & Robert J. Shiller & Anne K. Thompson, 2012. "What Have They Been Thinking? Homebuyer Behavior in Hot and Cold Markets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 43(2 (Fall)), pages 265-315.
    2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    3. repec:hrv:faseco:33077921 is not listed on IDEAS
    4. Christopher L. Foote & Kristopher S. Gerardi & Paul S. Willen, 2012. "Why did so many people make so many ex post bad decisions? the causes of the foreclosure crisis," FRB Atlanta Working Paper 2012-07, Federal Reserve Bank of Atlanta.
    5. Thakor, Anjan V, 1996. " Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 51(1), pages 279-324, March.
    6. Douglas W. Diamond & Raghuram G. Rajan, 2011. "Fear of Fire Sales, Illiquidity Seeking, and Credit Freezes," The Quarterly Journal of Economics, Oxford University Press, vol. 126(2), pages 557-591.
    7. Fabio Panetta & Paolo Angelini & Ugo Albertazzi & Francesco Columba & Wanda Cornacchia & Antonio Di Cesare & Andrea Pilati & Carmelo Salleo & Giovanni Santini, 2009. "Financial sector pro-cyclicality: lessons from the crisis," Questioni di Economia e Finanza (Occasional Papers) 44, Bank of Italy, Economic Research and International Relations Area.
    8. 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.
    9. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    10. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
    11. Emmanuel Farhi & Jean Tirole, 2012. "Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts," American Economic Review, American Economic Association, vol. 102(1), pages 60-93, February.
    12. Ricardo J. Caballero & Alp Simsek, 2013. "Fire Sales in a Model of Complexity," Journal of Finance, American Finance Association, vol. 68(6), pages 2549-2587, December.
    13. 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.
    14. Oosterloo, Sander & de Haan, Jakob, 2004. "Central banks and financial stability: a survey," Journal of Financial Stability, Elsevier, vol. 1(2), pages 257-273, December.
    15. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.
    16. Gennaioli, Nicola & Shleifer, Andrei & Vishny, Robert, 2012. "Neglected risks, financial innovation, and financial fragility," Journal of Financial Economics, Elsevier, vol. 104(3), pages 452-468.
    17. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-762, November.
    18. Giovanni Dell'Ariccia & Robert Marquez, 2006. "Lending Booms and Lending Standards," Journal of Finance, American Finance Association, vol. 61(5), pages 2511-2546, October.
    19. Gabriele Galati & Richhild Moessner, 2013. "Macroprudential Policy – A Literature Review," Journal of Economic Surveys, Wiley Blackwell, vol. 27(5), pages 846-878, December.
    20. Adrian, Tobias & Song Shin, Hyun, 2010. "Financial Intermediaries and Monetary Economics," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 12, pages 601-650 Elsevier.
    21. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    22. Shleifer, Andrei & Vishny, Robert W., 2010. "Unstable banking," Journal of Financial Economics, Elsevier, vol. 97(3), pages 306-318, September.
    23. Martin Ruckes, 2004. "Bank Competition and Credit Standards," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 1073-1102.
    24. repec:fip:fedgsq:y:2009:x:41 is not listed on IDEAS
    25. Hyman P. Minsky, 1992. "The Financial Instability Hypothesis," Economics Working Paper Archive wp_74, Levy Economics Institute.
    26. John Geanakoplos, 2010. "The Leverage Cycle," NBER Chapters,in: NBER Macroeconomics Annual 2009, Volume 24, pages 1-65 National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Macroprudential regulation; financial stability; capital requirement.;

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

    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:pra:mprapa:28179. 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: (Joachim Winter) or (Rebekah McClure). General contact details of provider: http://edirc.repec.org/data/vfmunde.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.