Regulation and the Broader Financial Sector

The global financial crisis triggered a new comprehensive approach to regulating the financial sector. On the one hand, regulators revisited old instruments such as minimum bank capital requirements that have been at the core of the Basel regulatory framework since its inception. On the other hand, they introduced new regulations that targeted the amount of safe assets that banks hold. Moreover, considerations were also given to regulating the amount of safe assets held by asset managers. The crisis made it clear that regulators had to focus on the so called macro-prudential rather than micro-prudential approach to bank regulation, which considers the systematic and general equilibrium linkages between various financial institutions. The existing literature often studies commercial banks in isolation from the rest of the financial sector. This paper attempts to fill this gap. It studies the linkages between commercial banks and asset managers, and how they affect the effectiveness of a number of the newly proposed regulatory instruments. Some of the key questions the paper addresses are the following: Is the effectiveness of the minimum bank capital and safe asset requirements, as measured by the increase of social welfare, probability and severity of banking crises, amplified or dampened by the presence of asset managers? How does financial sector regulation affect bank and non-bank equity prices and, through that channel, real output and welfare? What is the optimal joint regulation of asset managers and commercial banks?