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Capital Regulation and Credit Fluctuations


Rochet, Jean-Charles; Gersbach, Hans (2017). Capital Regulation and Credit Fluctuations. Journal of Monetary Economics, 90:113-124.

Abstract

We provide a rationale for imposing counter-cyclical capital ratios on banks. In our simple model, bankers cannot pledge the entire future revenues to investors, which limits borrowing in good and bad times. Complete markets do not sufficiently stabilize credit fluctuations, as banks allocate too much borrowing capacity to good states and too little to bad states. As a consequence, bank credit, output, capital prices or wages are excessively volatile. Imposing a (stricter) capital ratio in good states corrects the misallocation of the borrowing capacity, increases expected output and can be beneficial to all agents in the economy. Although in our economy, all agents are risk-neutral, counter-cyclical capital ratios are an effective stabilization tool. To ensure this effectiveness, capital ratios have to be based on ex ante equity capital, as classical capital ratios can be bypassed.

Abstract

We provide a rationale for imposing counter-cyclical capital ratios on banks. In our simple model, bankers cannot pledge the entire future revenues to investors, which limits borrowing in good and bad times. Complete markets do not sufficiently stabilize credit fluctuations, as banks allocate too much borrowing capacity to good states and too little to bad states. As a consequence, bank credit, output, capital prices or wages are excessively volatile. Imposing a (stricter) capital ratio in good states corrects the misallocation of the borrowing capacity, increases expected output and can be beneficial to all agents in the economy. Although in our economy, all agents are risk-neutral, counter-cyclical capital ratios are an effective stabilization tool. To ensure this effectiveness, capital ratios have to be based on ex ante equity capital, as classical capital ratios can be bypassed.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:October 2017
Deposited On:22 Nov 2017 13:45
Last Modified:19 Feb 2018 09:21
Publisher:Elsevier
ISSN:0304-3932
OA Status:Closed
Publisher DOI:https://doi.org/10.1016/j.jmoneco.2017.05.008
Related URLs:http://www.sciencedirect.com/science/article/pii/S0304393217300594 (Publisher)
Other Identification Number:merlin-id:14749

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