Microprudential Regulation in a Dynamic Model of Banking

Abstract

This paper studies the quantitative impact of microprudential bank regulations on bank lending and value metrics of e ciency and welfare in a dynamic model of banks that are financed by debt and equity, undertake maturity transformation, are exposed to credit and liquidity risks, and face financing frictions. We show that: (a) there exists an inverted U-shaped relationship between bank lending, welfare, and capital requirements; (b) liquidity requirements unambiguously reduce lending, e ciency and welfare; and (c) resolution policies contingent on observed capital, such as prompt corrective action, dominate in e ciency and welfare terms (non-contingent) capital and liquidity requirements.

Revisiting the Impact of Bank Capital Requirements on Lending and Real Activity

“…The approach of this study is commendably eclectic, as the median across different estimates is considered to take into account model uncertainty. In Table 4 De Nicolò et al (2012Nicolò et al ( , 2014 assess the impact of capital regulations-as well as that of liquidity requirements-on bank lending and metrics of efficiency and welfare in a fully dynamic set-up. They study an industry composed of homogenous and infinitely lived banks (barring default) that make fully dynamic choices of risky investment subject to decreasing returns.…”

Capital Buffers in a Quantitative Model of Banking Industry Dynamics

“…Roadmap 5 For example, De Nicolo et al [26] show an inverted U-shaped relationship between capital requirements and bank lending. 6 Among others, see Aliaga-Diaz and Olivero [4], Begenau [9], Bianchi and Bigio [10], Clerc et al [19], Elenev, Landvoigt, and Van Nieuwerburgh [31].…”

“…where θ,t denotes the (possibly) size and state dependent liquidity requirement and cash π i θ,t+1 (z t+1 = z) is evaluated in a stress scenario. 26 There is limited liability on the part of banks. This imposes a lower bound equal to zero in the event the bank exits.…”

“…. 26 Notice that an increase in A i θ,t+1 and decrease in d i θ,t+1 help to satisfy both the risk weighted capital requirement in (6) and the liquidity coverage ratio in (7). 27 There are many papers on managerial myopia providing a foundation for such behavior.…”

Dynamic Banking and the Value of Deposits

“…With a diversified depositor base, a bank essentially views deposits as debts that retire at a stochastic rate. Bianchi andBigio (2014), De Nicolò, Gamba, andLucchetta (2014), and Vandeweyer (2019) also recognize such payment shocks. However, in their models, deposits are one-period contracts (with intra-period shocks), so banks can freely adjust the deposit base every period.…”