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Welfare analysis of bank capital requirements with endogenous default

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  • Fernando Garcia-Barragan
  • Guangling Liu

Abstract

This paper presents a tractable framework with endogenous default and evaluates the welfare implication of bank capital requirements. We analyze the response of social welfare to a negative technology shock under different capital requirement regimes with and without default. We show that including default as an additional indicator of capital requirements is welfare improving. When implementing capital requirements, a more aggressive reaction to the default rate is more effective for weakening the negative effect of the shock on welfare. Compared with output gap, the credit-to-output gap is a better indicator for implementing the countercyclical capital buffer.

Suggested Citation

  • Fernando Garcia-Barragan & Guangling Liu, 2017. "Welfare analysis of bank capital requirements with endogenous default," Working Papers 688, Economic Research Southern Africa.
    • Handle: RePEc:rza:wpaper:688
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    References listed on IDEAS

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    1. Paolo Angelini & Laurent Clerc & Vasco Cúrdia & Leonardo Gambacorta & Andrea Gerali & Alberto Locarno & Roberto Motto & Werner Roeger & Skander Van den Heuvel & Jan Vlček, 2015. "Basel III: Long-term Impact on Economic Performance and Fluctuations," Manchester School, University of Manchester, vol. 83(2), pages 217-251, March.
    2. Rafael Repullo & Javier Suarez, 2013. "The Procyclical Effects of Bank Capital Regulation," Review of Financial Studies, Society for Financial Studies, vol. 26(2), pages 452-490.
    3. Rubio, Margarita & Carrasco-Gallego, José A., 2014. "Macroprudential and monetary policies: Implications for financial stability and welfare," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 326-336.
    4. Rubio, Margarita & Carrasco-Gallego, José A., 2016. "The new financial regulation in Basel III and monetary policy: A macroprudential approach," Journal of Financial Stability, Elsevier, vol. 26(C), pages 294-305.
    5. Repullo, Rafael, 2013. "Cyclical adjustment of capital requirements: A simple framework," Journal of Financial Intermediation, Elsevier, vol. 22(4), pages 608-626.
    6. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
    7. Kanngiesser, Derrick & Martin, Reiner & Maurin, Laurent & Moccero, Diego, 2017. "Estimating the impact of shocks to bank capital in the euro area," Working Paper Series 2077, European Central Bank.
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    10. Charles Goodhart,Dimitrios Tsomocos & Martin Shubik, 2013. "Macro-Modelling, Default and Money," FMG Special Papers sp224, Financial Markets Group.
    11. Liu, Guangling (Dave) & Seeiso, Nkhahle E., 2012. "Basel II procyclicality: The case of South Africa," Economic Modelling, Elsevier, vol. 29(3), pages 848-857.
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    More about this item

    Keywords

    Bank capital requirement; Default; Welfare; DSGE;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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