Abstract

http://ssrn.com/abstract=2467761
 


 



The System-Wide Effects of Bank Capital Regulation on Credit Supply and Risk-Taking


Milton Harris


University of Chicago - Finance

Christian C. Opp


University of Pennsylvania - The Wharton School

Marcus M. Opp


University of California, Berkeley - Finance Group

October 14, 2015


Abstract:     
We propose a tractable framework to examine the system-wide effects of bank capital requirements. In our model, banks can serve a socially beneficial role by financing firms that are credit rationed by public markets, but banks' access to deposit insurance (and implicit debt guarantees) creates socially undesirable risk-shifting incentives. Equity ratio requirements reduce banks' risk-taking incentives, but may also constrain banks' balance sheets. When existing bank capital is sufficiently high, increases in equity-ratio requirements unambiguously improve welfare and the stability of the banking system. However, when bank capital is scarce, increased equity-ratio requirements induce credit rationing of both bank-dependent firms with positive NPV projects and risky firms with negative NPV. In this case, the net effects on welfare and the risk-taking of banks are ambiguous, as they depend on which type of credit rationing dominates. Our model provides conceptual guidance on the cyclicality of optimum capital requirements as well as their dependence on the development of public markets and the cross-sectional distribution of firms.

Number of Pages in PDF File: 24

Keywords: capital requirements, credit supply, bank-dependent firms, macroprudential regulation, banks, competition, public capital markets

JEL Classification: G21, G28


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Date posted: July 19, 2014 ; Last revised: October 28, 2015

Suggested Citation

Harris, Milton and Opp, Christian C. and Opp, Marcus M., The System-Wide Effects of Bank Capital Regulation on Credit Supply and Risk-Taking (October 14, 2015). Available at SSRN: http://ssrn.com/abstract=2467761 or http://dx.doi.org/10.2139/ssrn.2467761

Contact Information

Milton Harris
University of Chicago - Finance ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
(773) 702-2549 (Phone)
(773) 753-8310 (Fax)
HOME PAGE: http://faculty.chicagobooth.edu/milton.harris/

Chicago Booth School of Business Logo

Christian C. Opp
University of Pennsylvania - The Wharton School ( email )
3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-573-3186 (Phone)

Marcus M. Opp (Contact Author)
University of California, Berkeley - Finance Group ( email )
Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
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