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Financial Regulation in a Quantitative Model of the Modern Banking System

Author

Listed:
  • Tim Landvoigt

    (University of Texas Austin)

  • Juliane Begenau

    (Harvard Business School)

Abstract

This paper builds a quantitative general equilibrium model with commercial banks and shadow banks to study the unintended consequences of capital requirements. In particular, we investigate how the shadow banking system responds to capital regulation changes for traditional banks. A key feature of our model are defaultable bank liabilities that provide liquidity services to households. In case of default, commercial bank debt is fully insured and thus provides full liquidity services. In contrast, shadow banks are only randomly bailed out. Thus, shadow banks' liquidity services also depend on their default rate. Commercial banks are subject to a capital requirement. Tightening the requirement from the status quo, leads households to substitute shadow bank liquidity for commercial bank liquidity and therefore to more shadow banking activity in the economy. But this relationship is non-monotonic due to an endogenous leverage constraint on shadow banks that limits their ability to deliver liquidity services. The basic trade-off of a higher requirement is between bank liquidity provision and stability. Calibrating the model to data from the Financial Accounts of the U.S., the optimal capital requirement is around 20\%.

Suggested Citation

  • Tim Landvoigt & Juliane Begenau, 2016. "Financial Regulation in a Quantitative Model of the Modern Banking System," 2016 Meeting Papers 1462, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1462
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    File URL: https://economicdynamics.org/meetpapers/2016/paper_1462.pdf
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    References listed on IDEAS

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    1. Roland Meeks & Benjamin Nelson & Piergiorgio Alessandri, 2017. "Shadow Banks and Macroeconomic Instability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(7), pages 1483-1516, October.
    2. Flannery, Mark J & Sorescu, Sorin M, 1996. "Evidence of Bank Market Discipline in Subordinated Debenture Yields: 1983-1991," Journal of Finance, American Finance Association, vol. 51(4), pages 1347-1377, September.
    3. Elenev, Vadim & Landvoigt, Tim & Van Nieuwerburgh, Stijn, 2016. "Phasing out the GSEs," Journal of Monetary Economics, Elsevier, vol. 81(C), pages 111-132.
    4. Priyank Gandhi & Hanno Lustig, 2015. "Size Anomalies in U.S. Bank Stock Returns," Journal of Finance, American Finance Association, vol. 70(2), pages 733-768, April.
    5. Juliane Begenau, 2015. "Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model," 2015 Meeting Papers 687, Society for Economic Dynamics.
    6. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Financial Regulation in a Quantitative Model of the Modern Banking System
      by Christian Zimmermann in NEP-DGE blog on 2016-11-30 03:33:00
    2. Setting Bank Capital Requirements
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2020-10-12 11:41:47

    Citations

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    Cited by:

    1. Stefan Gebauer & Falk Mazelis, 2019. "Macroprudential Regulation and Leakage to the Shadow Banking Sector," Discussion Papers of DIW Berlin 1814, DIW Berlin, German Institute for Economic Research.
    2. Sebastian Di Tella & Pablo Kurlat, 2017. "Why are Banks Exposed to Monetary Policy?," NBER Working Papers 24076, National Bureau of Economic Research, Inc.
    3. Gebauer, Stefan & Mazelis, Falk, 2018. "The Role of Shadow Banking for Financial Regulation," VfS Annual Conference 2018 (Freiburg, Breisgau): Digital Economy 181581, Verein für Socialpolitik / German Economic Association.
    4. E. Jondeau & J-G. Sahuc, 2018. "A General Equilibrium Appraisal of Capital Shortfall," Working papers 668, Banque de France.
    5. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2020. "Default, Bailouts and the Vertical Structure of Financial Intermediaries," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 38, pages 154-180, October.
    6. Kai Ding & Enoch Hill & David Perez-Reyna, 2018. "Optimal Capital Requirement with Noisy Signals on Banking Risk," Documentos CEDE 016429, Universidad de los Andes - CEDE.
    7. Zhang, Xue & Poeschl, Johannes, 2017. "Bank Capital Regulation in a Model of Modern Banking Crises," VfS Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168275, Verein für Socialpolitik / German Economic Association.
    8. Federico Lubello & Abdelaziz Rouabah, 2017. "Capturing macroprudential regulation effectiveness: A DSGE approach with shadow intermediaries," BCL working papers 114, Central Bank of Luxembourg.
    9. Magill, Michael & Quinzii, Martine & Rochet, Jean-Charles, 2020. "The safe asset, banking equilibrium, and optimal central bank monetary, prudential and balance-sheet policies," Journal of Monetary Economics, Elsevier, vol. 112(C), pages 113-128.

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