[We compare various bank capital regulation regimes using a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period and the business cycle determines loans' probabilities of default. Banks hold endogenous capital buffers as a precaution against shocks that impair their future lending capacity. We find that Basel II is more procyclical than Basel I but makes banks safer, and it is generally superior in welfare terms. For high social costs of bank failure, the optimal capital requirements are higher but less cyclically varying, like those currently targeted by Basel III.]

We assess the procyclical effects of bank capital regulation in a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that under cyclically-varying risk-based capital requirements (e.g. Basel II) banks hold larger buffers in expansions than in recessions. Yet, these buffers are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level underlying Basel II can reduce its procyclical effects on the supply of credit without compromising banks’ long-run solvency targets.

By identifying the possibility of imposing a creditable threat of liquidation as the key role of informed (bank) finance in a moral hazard context, we characterize the circumstances under which a mixture of informed and uninformed (market) finance is optimal, and explain why bank debt is typically secured, senior, and tightly held. We also show that the effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders, and that in the optimal renegotiation-proof contract informed debt capacity will be exhausted before appealing to supplementary uninformed finance.

[By identifying the possibility of imposing a credible threat of liquidation as the key role of informed (bank) finance in a moral hazard context, we characterize the circumstances under which a mixture of informed and uninformed (market) finance is optimal, and explain why bank debt is typically secured, senior, and tightly held. We also show that the effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders, and that in the optimal renegotiation-proof contract informed debt capacity will be exhausted before appealing to supplementary uninformed finance.]

The authors extend E. Maskin's results on Nash implementation. First, they establish a condition that is both necessary and sufficient for Nash implementability if there are three or more agents (the case covered by Maskin's sufficiency result). Second--and more important--they examine the two-agent case (for which there existed no general sufficiency results). The two-agent model is the leading case for applications to contracting and bargaining. For this case, too, they establish a condition that is both necessary and sufficient. The authors use their theorems to derive simpler sufficiency conditions that are applicable in a wide variety of economic environments. Copyright 1990 by The Econometric Society.

This paper examines the use of stage mechanisms in implementation problems and provides a partial characterization of the set of subgam e perfect implementable choice rules. It is shown that, in many economic environments, virtually an y choice rule can be implemented. To illustrate the power of this approach, the paper discusses a number of models in which it is possible to implement the first-best (although it wouldn't have been possible to do so without using stage mechanisms). The diversity of these models suggests that subgame perfect implementation may find wide application. Copyright 1988 by The Econometric Society.

A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from performing loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains.

[A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from performing loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains.]

We present a model of the relationship between real interest rates, credit spreads, and the structure and risk of the banking system. Banks intermediate between entrepreneurs and investors, and can monitor entrepreneurs projects. We characterize the equilibrium for a xed aggregate supply of savings, showing that safer entrepreneurs will be funded by nonmonitoring banks and riskier entrepreneurs by monitoring banks. We show that an increase in savings reduces interest rates and spreads, increases the relative size of the nonmonitoring banking system and the probability of failure of monitoring banks. We also show that the dynamic version of the model exhibits endogenous boom and bust cycles, and rationalizes the existence of countercyclical risk premia and the connection between low interest rates, credit spreads, and the buildup of risks during booms.