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

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  • Juliane Begenau

    (Harvard Business School)

Abstract

This paper presents a quantitative dynamic general equilibrium model in which households' liquidity preference change the standard intuition of how higher bank capital requirements affect the economy. The mechanism is that a reduction in the supply of safe and liquid assets in the form of bank debt increases bank lending through a general equilibrium effect. I embed this mechanism in a two-sector business cycle model in which banks provide liquidity and have excessive risk-taking incentives. I quantify this model using data from the National Income and Product Accounts and banks' regulatory filings. Welfare is maximized at 14% equity as a share of risk-weighted assets. This level of capital requirement trades-off a reduction in the provision of safe and liquid assets against an increase in lending and a reduction in risk-taking by banks.

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  • Juliane Begenau, 2015. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," 2015 Meeting Papers 687, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:687
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    Cited by:

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    3. Mendicino, Caterina & Nikolov, Kalin & Suarez, Javier, 2017. "Equity versus bail-in debt in banking: an agency perspective," ESRB Working Paper Series 50, European Systemic Risk Board.
    4. Lubello, Federico & Petrella, Ivan & Santoro, Emiliano, 2019. "Bank assets, liquidity and credit cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 265-282.
    5. Claessens, Stijn & Coleman, Nicholas & Donnelly, Michael, 2018. "“Low-For-Long” interest rates and banks’ interest margins and profitability: Cross-country evidence," Journal of Financial Intermediation, Elsevier, vol. 35(PA), pages 1-16.
    6. Tim Landvoigt & Juliane Begenau, 2016. "Financial Regulation in a Quantitative Model of the Modern Banking System," 2016 Meeting Papers 1462, Society for Economic Dynamics.
    7. Mendicino, Caterina & Nikolov, Kalin & Suarez, Javier, 2017. "Equity versus Bail-in Debt in Banking: An Agency Perspective," CEPR Discussion Papers 12104, C.E.P.R. Discussion Papers.
    8. Ingo Fender & Ulf Lewrick, 2016. "Adding it all up: the macroeconomic impact of Basel II and outstanding reform issues," BIS Working Papers 591, Bank for International Settlements.
    9. Claessens, Stijn & Coleman, Nicholas & Donnelly, Michael, 2017. ""Low-For-Long� Interest Rates and Banks' Interest Margins and Profitability: Cross-Country Evidence," CEPR Discussion Papers 11842, C.E.P.R. Discussion Papers.
    10. Skander Van den Heuvel, 2019. "The Welfare Effects of Bank Liquidity and Capital Requirements," 2019 Meeting Papers 325, Society for Economic Dynamics.
    11. 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.
    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. Federico Lubello & Ivan Petrella & Emiliano Santoro, 2018. "Chained financial frictions and credit cycles," BCL working papers 116, Central Bank of Luxembourg.

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