Journal of Financial Economics Vol. 136 No. 2 2020
Capital requirements, risk choice, and liquidity provision in a business-cycle model
Abstract
This paper develops a dynamic general equilibrium model to quantify the effects of bank capital requirements. Households’ preferences for liquid assets imply a liquidity premium on deposits. The banking sector supplies deposits and has excessive risk-taking incentives. I show that the scarcity of deposits created by an increased capital requirement can reduce the cost of capital for banks and increase bank lending. A higher capital requirement also increases banks’ monitoring incentives, which improves the efficiency of banks’ activities. Under reasonable parameterizations, the marginal benefit of a higher capital requirement related to this channel significantly exceeds the marginal cost, indicating that US capital requirements have been suboptimally low.
- DOI
- 10.1016/j.jfineco.2019.10.004
- Volume
- 136
- Issue
- 2
- Pages
- 355-378
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref