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Capital Requirements in a Quantitative Model of Banking Industry Dynamics

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  • Pablo D'Erasmo

    (FRB Philadelphia)

  • Dean Corbae

    (University of Wisconsin)

Abstract

We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on bank risk taking, commercial bank failure, 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 as well as aggregate shocks to the fraction of performing loans in their portfolio. A nontrivial size distribution of banks arises out of endogenous entry and exit, as well as banks' buffer stock of net worth. We test the model using business cycle properties and the bank lending channel across banks of different sizes. We then conduct a series of counterfactuals (including countercyclical requirements and size contingent (e.g. SIFI) requirements). We find that regulatory policies can have an important impact on market structure itself.

Suggested Citation

  • Pablo D'Erasmo & Dean Corbae, 2018. "Capital Requirements in a Quantitative Model of Banking Industry Dynamics," 2018 Meeting Papers 1221, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:1221
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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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