Abstract

http://ssrn.com/abstract=1573298
 
 

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Citations (36)



 


 



A New Capital Requirement for Large Financial Institutions


Oliver Hart


Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Luigi Zingales


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); University of Chicago - Polsky Center for Entrepreneurship; European Corporate Governance Institute (ECGI)

September 2009


Abstract:     
We design a new, implementable capital requirement for large financial institutions (LFIs) that are too big to fail. Our mechanism mimics the operation of margin accounts. To ensure that LFIs do not default on either their deposits or their derivative contracts, we require that they maintain an equity cushion sufficiently great that their own credit default swap price stays below a threshold level, and a cushion of long term bonds sufficiently large that, even if the equity is wiped out, the systemically relevant obligations are safe. If the CDS price goes above the threshold, the LFI regulator forces the LFI to issue equity until the CDS price moves back down. If this does not happen within a predetermined period of time, the regulator intervenes. We show that this mechanism ensures that LFIs are always solvent, while preserving some of the disciplinary effects of debt.

Number of Pages in PDF File: 40

Keywords: Capital requirements, banking, CDS

JEL Classification: G21, G28

working papers series





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Date posted: March 17, 2010  

Suggested Citation

Hart , Oliver and Zingales, Luigi, A New Capital Requirement for Large Financial Institutions (September 2009). Available at SSRN: http://ssrn.com/abstract=1573298 or http://dx.doi.org/10.2139/ssrn.1573298

Contact Information

Oliver D. Hart
Harvard University - Department of Economics ( email )
Littauer Center
Cambridge, MA 02138
United States
617-496-3461 (Phone)
617-495-7730 (Fax)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Luigi Zingales (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-3196 (Phone)
773-834-2081 (Fax)

Chicago Booth School of Business Logo

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
University of Chicago - Polsky Center for Entrepreneurship
Chicago, IL 60637
United States
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
HOME PAGE: http://www.ecgi.org
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