Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model

Abstract

This paper develops a quantitative dynamic general equilibrium model in which households' preferences for safe and liquid assets constitute a violation of Modigliani and Miller. I show that the scarcity of these coveted assets created by increased bank capital requirements can reduce overall bank funding costs and increase bank lending. I quantify this mechanism in a two-sector business cycle model featuring a banking sector that provides liquidity and has excessive risk-taking incentives. Under reasonable parametrizations, the marginal benet of higher capital requirements related to this channel signicantly exceeds the marginal cost, indicating that US capital requirements have been sub-optimally low.

Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation

“…Consideration of the optimal level of the leverage tax would involve assessing the role of frictions (e.g., the tax advantage of debt) and services (e.g., the liquidity services associated with deposits) that attend intermediary leverage (as in, for example, Begenau (2015)). As stabilization properties are of independent interest, we leave examination of the optimal level of a macroprudential instrument to other research, although we are cognizant of the possibility that incorporation of additional features relevant in a study of the optimal level of a macroprudential instrument may also affect the desirability of alternative stabilization approaches.…”

Low-For-Long Interest Rates and Banks' Interest Margins and Profitability: Cross-Country Evidence

“…And a limited pass-through of policy rates, combined with the adverse effects on banks of low rates, could hamper monetary policy transmission and disrupt the transmission channel of interest rates to lending (the bank lending channel, e.g., Kashyap andStein, 1995, 2000). More generally, low interest rates may adversely affect banks in a number of ways (see further Shin, 2016 for a discussion, and the model of Brunnermeier and Koby, 2016, with specific reference to negative interest rates; and the model of Begenau, 2015, with reference to the demand for safe assets). While this paper does not review these channels, the adverse effects we find of low interest rates for banks point to these possibilities.…”

How Cyclical Is Bank Capital?

“…The effect of bank capital on lending received more scrutiny with the advent of Basel I (Haubrich and Wachtel (1993), Berger and Udell (1994)), and more recent worries about regulatory-induced cyclicality are addressed in Gordy and Howells (2006), and Goodhart et al (2004), with post-crisis modelling efforts by Repullo and Suarez (2013), among others. Representative papers calibrating the optimal cyclical properties of capital regulations are Estrella (2004), Begenau (2013), Jokivuolle et al (2014), andDavydiuk (2017). Flannery and Rangan (2008) and Rajan (2009), conversely, emphasize the market forces driving observed levels of bank capital.…”