Cyclical effects of bank capital requirements with imperfect credit markets
This paper analyzes the cyclical effects of bank capital requirements in a simple model with credit market imperfections. Lending rates are set as a premium over the cost of borrowing from the central bank, with the premium itself depending on firms’ effective collateral. Basel I- and Basel II-type regulatory regimes are defined and a capital channel is introduced through a signaling effect of capital buffers on the cost of bank deposits. The macroeconomic effects of various shocks (a drop in output, an increase in the refinance rate, and a rise in the capital adequacy ratio) are analyzed, under both binding and nonbinding capital requirements. Factors affecting the procyclicality of each regime (defined in terms of the behavior of the risk premium) are also identified and policy implications are discussed.
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